A very different kind of HFT

This blog post discovers more about the crucial factors that differ HFT in DeFi from conventional capital market structures.

Let’s see what offers new dimensions to planning and executions of HFT strategies in DeFi!

Block time speed

In DeFi, the simplest definition of HFT is a trading strategy that takes place every block. Adding trading delays was one of the traditional markets’ most widely used strategies to reduce HFT’s advantage. That is an infrastructural feature that is intrinsic to DeFi.

Trade transparency

When everyone can see the transactions you are trying to execute, and the opposite is true, how can you develop HFT strategies? Unlike conventional capital markets, transparency alters the HFT-DeFi game’s character. Traders must provide native constructs for aggressive rivalry with other strategies that attempt to front-back run it or merely compete with different approaches.

Cost factor

One of the factors contributing to the rise in gas prices in the Ethereum blockchain has been the infamous priority gas auctions (PGAs), in which arbitrageurs participate in transaction bidding. As a result, other blockchain runtimes like Binance Smart Chain, Solana, or Polygon have increased adoption. Aside from the computational reasoning behind certain transactions, strategies must also consider the accompanying costs from the HFT standpoint. Due to the expense involved in the transactions, many perfectly valid HFT deals could end up unprofitable.

Role of MEV

One of the notions in DeFi that has generated the most discussion recently is the miner extractable value (MEV). MEV, first used by Phil Daian et al. in the paper “Flash Boys 2.0,” refers to the revenue that a miner can generate based on its capacity to include transactions in a block in a particular order. MEV is a crucial idea in crypto economics that significantly affects HFT-DeFi techniques. By depending on the miner’s economic interest to determine the final placement of a transaction in a block, MEV imposes a constraint vector on HFT-DeFi techniques. For the sole reason that a miner placed the transaction in an order that benefits another arbitrageur, completely viable HFT trades in a DeFi protocol can lose money.

MEV is also fully opaque and depends on a party whose economic interests could not be compatible with a particular HFT approach for every deal, which makes it impossible to execute. Flashbots, ArcherDAO, and other protocols have been working to develop more transparent and quantifiable dynamics in recent months to lessen the effects of MEV.

Underlying Protocol

HFT traders operate in traditional capital markets, where infrastructure is relatively constant across various long-established asset classes. They must communicate with infrastructure in the DeFi domain, continually evolving thanks to new protocols and runtimes. HFT techniques in DeFi have difficulties when dealing with an unstable, continuously shifting infrastructure, but the inefficiency of newly introduced protocols also opens up a plethora of new opportunities.

Potential Opportunities in HFT

DeFi is one of the most cutting-edge technological developments that can spur new developments in the HFT industry. DeFi is the perfect setting for HFT strategies thanks to its emerging infrastructure, new financial protocols, blockchain runtimes, and programmability as a first-class building block.

HFT in DeFi, however, differs from traditional capital markets. Different dynamics for HFT techniques in the DeFi are determined by block time speed, cost, transparency, MEV, and the nature of the underlying protocols. HFT strategies must now make use of technical advancements specifically suited to the peculiarities of the DeFi sector to take advantage of the opportunities in DeFi rather than relying purely on execution speed. All that makes HFT in DeFi more diverse. In addition to being more peculiar, it is also more technologically advanced and transparent.