High Frequency Trading

What is high-frequency trading?

High-frequency trading, or algorithmic trading, is a practice that has been used in traditional stock trading for some time. However, it is becoming increasingly popular in crypto. Before we can dive into how it’s being used in crypto, we should first understand what HFT is.

HFT is frequently debated mostly because most people do not understand what HFT is or what it means, even in traditional markets. There are different kinds of HFT, but its basic definition is “the automation of trading strategies enabled by computers to transact a large number of orders in fractions of a second.” High-frequency traders use this automization to quickly analyze the market to manage risks and execute orders based on strategies used before, in a very fast way. This is done by leveraging algorithms, hence the term “algorithmic trading.”

By integrating information into prices quickly and efficiently, HFT creates greater efficacy in the market.  Greater efficacy translates to narrower bid/offer spreads, improved price, and fewer instances of price discrepancies. Speed is everything to traders because faster execution speeds result in greater profit. When exchanges started to incentivize companies to add liquidity to the market, this type of trading became popular.

"Speed is everything to traders because faster execution speeds result in greater profit."

HFT has both improved market liquidity and removed bid-ask spreads that previously would have been too small. However, it’s a notoriously controversial practice, and it has been criticized for taking human decisions and interactions out of the equation by replacing many brokers with mathematical models and algorithms. Decisions happen so quickly that the market moves significantly without reason.

For example, on May 6, 2010, the Dow Jones Industrial Average (DJIA) suffered its largest single-day point drop ever.  It declined 1000 points and fell 10% in just 20 minutes.  But then it rose again. Investigators revealed that a massive order caused a sell-off for the crash. Also, HFT has been criticized because it allows large companies to profit at the expense of the “little guys”, or the institutional and retail investors.

High Frequency Trading

Now, back to crypto. Seeing as several elements and practices of traditional markets have seen their blueprints implemented in crypto markets and trading, HFT naturally followed suit. Several high-frequency trading firms have started trading operations in cryptocurrencies. DRW, for example, is a Chicago-based proprietary trading firm that buys and sells bitcoin through a subsidiary called Cumberland Mining.  DRW is the largest firm of this kind.

Jump Trading, DV Trading, and Hehmeyer Trading are other trading firms that have invested in crypto. The main attraction high-frequency traders see in investing in crypto is the recent volatility in prices for digital currencies. The rise of cryptocurrencies has been exponential.  As the world’s most widely-used digital coin, bitcoin has increased 500% since the start of 2019. That rise, however, has been volatile. For example, China’s announcement of a ban on initial coin offerings resulted in a steep market drop. Such conditions are ideal for HFT, which uses algorithms to conduct rapid bulk trades.

Nonetheless, the same critiques that HFT receives when it comes to traditional markets also apply to crypto ones. The entry of HFT to bitcoin may not be good news for volatility in cryptocurrency prices. A 2010 paper from MIT’s Sloan School of Management concluded that high-frequency trading is positively correlated with stock trading, with stocks overreacting to fundamental news. This goes back to what happened on May 6, 2010, with the DJIA.

Furthermore, there is the issue of “colocation”. This is when a client’s server is placed in the same facility or cloud as the exchange’s. This allows them to execute trades up to a hundred times faster than normal, giving them an edge on the rest of the market. Huobi, based in Singapore, ErisX, in Chicago, and Gemini in NY are two examples of crypto exchanges that offer colocation to some of their investors/clients. The main critique of this practice is that it gives HF Traders a massive advantage over regular crypto traders, which some view as unfair.

BXB is a crypto exchange, but we differ from others because we offer something unique: Tap Trading. This combines traditional financial derivative contracts with a gamification experience. Users can enjoy the high-leverage and high returns of complex financial derivatives contracts without the hassle of complicated computations and complex tools.

"Users can enjoy the high-leverage and high returns of complex financial derivatives contracts without the hassle of complicated computations and complex tools."

 HFT maybe something that gives unfair advantage for the “big guys”, but for the everyday trader, Tap Trading is the tactic that simplifies the (sometimes) over-complicated world of trading.

High Frequency TradingHigh Frequency Trading