The Future of High-Frequency Trading: DeFi

HFT is one of capital markets’ most enigmatic and frequently misunderstood aspects. HFT is associated with speed, technological innovation, and secrecy, thanks to Michael Lewis’ book “Flash Boys.”

HFT quant funds are some of the least transparent players in the trading ecosystem. HFT enterprises are shrouded in secrecy in part due to the intense rivalry in the industry, the short duration of alpha chances, and the fact that HFT seeks to profit from momentary market inefficiencies that can be quickly addressed once they become public knowledge.

What if, however, decentralized finance (DeFi) were to alter the HFT game’s rules? While it may sound lofty, such an approach to DeFi is practical.

HFT methods use comparable infrastructure regardless of whether we are talking about stocks, commodities, currencies, or derivatives. This infrastructure includes dark pool connectivity, order flow feeds, and other widely used building blocks like algorithmic stablecoins. DeFi is a fintech that alters HFT strategy dynamics and is based on blockchain technologies. The new guidelines give a new playing field for HFT tactics, challenging long-standing HFT tenets and giving the well-established sector a fresh perspective.

Not a flaw, but rather a handy characteristic

HFT is sometimes regarded as a result of shortcomings in the structure of the capital markets and the makeup of particular financial instruments.

What happens when we create a new financial infra that prioritizes HFT and other variations like arbitrage trading?

This is the situation with DeFi automated market makers (AMMs) who use arbitrage to bring prices in liquidity pools back to the proper level. Considering that it can take many translations to return to market-fair prices, the transaction method used by AMMs is far from capital-efficient, but it gives HFT a new perspective. An original idea in DeFi is to use HFT mechanics as the foundation of a new financial instrument like AMMs.

HFT appears to be the primary use case for flash loans. To enable various HFT arbitrage methods without requiring big pools of capital upfront, requesting significant amounts of capital in a single transaction is essential. Products like flash swaps, which have proven popular among HFT bots, are made possible by integrating AMMs and flash loans.

Other DeFi protocols, including algorithmic stablecoins, private-pool integrators, or DeFi indexes, seem to be the best for HFT scenarios. HFT is accepted and occasionally even welcomed in the DeFi community. But this HFT is a different kind. DeFi has altered the dynamics of HFT to create a situation where speed is not the only important factor.

It now entails more than just speed

HFT strategies have always been known for their lightning-fast trading, as the name suggests. That has been both a blessing and a disaster because the HFT sector has developed by attempting to achieve negligible speed advantages instead of fundamental technological advancements. Trading speed is still quite crucial in the context of DeFi, but it is not the only HFT tactic that has been particularly effective. Additional factors influence the success or failure of HFT methods of DeFi’s programmable, on-chain nature.

The following five elements offer new dimensions to the planning and execution of HFT strategies in DeFi, even though there are significant distinctions between HFT in DeFi and conventional capital market structures: block time speed factor, trading transparency factor, cost factor, MEV factor and principal protocol element.

We will go deeper into all the five factors in the next blog post and try to explain their impact.