How to Avoid Leaders in Decentralized Crypto Exchanges

Decentralized exchanges (DEXs) nip in the bud several problems related to their centralized counterparts, such as: B. Concentration of liquidity in the hands of a few players, compromise of funds in the event of a security breach, closed control structure, and more. One problem that has refused to let up, however, is front running. Unscrupulous gamblers still find ways to scam unsuspecting traders.

If you got less than expected when placing a trade on a DEX, there’s a pretty good chance you’ve been hit by top performers. These bad actors exploit the automated market maker (AMM) model to make profits at the expense of unsuspecting traders.

This article explains the attack vector and helps you understand the basic concept of front running in crypto trading, the possible consequences and how to prevent crypto front running.

What is front running in crypto?

The term “front-running” refers to the process by which someone uses technology or market advantages to gain prior knowledge of upcoming transactions. This allows the bad actors to take advantage of the imminent price movement and generate economic gains at the expense of those who instituted these transactions. Front-running is done via manipulation of gas prices or timestamps, also known as slow matching.

Front running is a common activity on both centralized and decentralized exchanges. The goal of a frontrunner is to buy a piece of token at a low price and later sell it at a higher price, while simultaneously exiting the position. When executed accurately, it brings risk-free profits to the traders who commit it.

Related: DeFi vs. CeFi: Comparing Decentralized vs. Centralized Finance

Trading stocks and assets based on insider knowledge to profit from price movement is a well-known tactic. Although illegal and unethical, brokers have engaged in it. The tactic is very similar to insider trading with only a slight difference that the executioner works for the client’s brokerage and not the client’s business.

What is a front running bot?

Frontrunning is performed using crypto frontrunning bots that operate on a millisecond timeframe. Before a person blinks, he can read a set of transactions, calculate the optimal transaction size and gas price, configure and execute transactions.

The core of a front running bot works by listening for the pending transaction on the blockchain. By interacting with the blockchain via an interactive script, the bot buys before the buyer and sells right after. The bot analyzes the trends of the crypto and executes transactions to make a profit.

Front-running tactics on decentralized exchanges

When a trade occurs, the system sends it to the blockchain and asks the miners to verify the transaction. However, in any major blockchain, the flow of incoming transactions is greater than the capacity of the subsequent block. Transactions that are not mined remain in a pending transaction pool called the mempool.

Blockchain mempools are transparent, a feature that the frontrunners exploit. By gaining insight into trader sentiment, they can predict the upcoming price movements and place their own orders accordingly. They set a higher gas price on their trades to encourage them to pick their trades over the pending ones, giving way to unsuspecting traders.

Ways to prevent front-running on the dealer side

There is no one-size-fits-all solution to solving front running problems across all platforms. Rather, depending on the scenario, different anti-front running approaches must be pursued in different projects.

Leverage large liquidity pools

Leaders prefer pools with low liquidity as there is less chance of competition and their transaction being disrupted by a large order unexpectedly changing the pool’s weighting. If you execute your trades in large pools of liquidity, you are less likely to experience front running.

Keep the maximum slip low

Does the question “How do I avoid slippage?” keep troubling you? What you can do is set a maximum slippage tolerance on most decentralized exchanges. In other words, you can set the maximum deviation from the expected return. An example will help you better understand the scenario.

Suppose you place an order on a DEX and expect a return of 500 Tether (USDT). If you set your slippage to 1% of your order, you will receive no less than 495 USDT. However, if a higher slip tolerance is larger, there will be a larger deviation.

So the formula is simple: keep the maximum slip low, around 0.5% to 2%, to fend off leaders. If you place a large order, keep your slip on the lower keel. Leaders want you to keep slippage high, so you’re better off doing the exact opposite.

overpay for gas

Leaders enjoy slow trades as it gives them more time to develop an order to drive their trade and make a profit. Underpaying for gas will cause your transactions to take longer to complete, giving the frontrunners more time to formulate their strategy and harm your interests.

Overpaying for gas motivates miners to validate your transaction faster, minimizing your chances of becoming the target of a bad actor. To do this, you can set the gas price above average or simply use the quick gas option on your wallet. When you place an order with a large value, it becomes even more important to try to complete the transactions quickly.

Place an order with low value

In order to turn a profit, top performers must meet some minimum thresholds. You have to pay the gas fees twice, when entering and exiting the market, and also get back the amount paid as a trading fee. Their profits only start after they get their expenses back.

Currently, well-known Ethereum-based automated market makers such as Uniswap, Balancer, and SushiSwap pay a gas fee of $25 per transaction. Since they need two transactions to frontrun, they will likely spend $50 to complete the trade. It also means that if your trade yields less than $50 in profit, the chances of you becoming a leader’s target are negligible.

When you enter a low-value trade, you practically make it an unprofitable venture for front-runners. Most of the time, trading amounts below $1,000 is safe.

Find a buyer

A publicly hosted order book is the first thing that attracts front runners. If you manage to find a taker, you can execute a specific order and stay away from public markets and subsequent front running. If you find a taker and successfully negotiate a price, a trusted on-chain exchange will take place.

Ways to prevent front running on the DEX side

DEXs can address several design points to make front running more difficult to execute:

Fast adjustment

Leaders look for slower suitable speed to place their orders ahead of execution. A DEX can ensure quick matching to leave little room for frontrunners to get their process underway. A super-fast block time effectively renders the frontrunners unable to react. For most frontrunners who aren’t that tech savvy, this should be enough.

Decentralized match engine

In the case of a centralized matching engine, it’s hard to determine that the exchange itself isn’t involved in the front running. Decentralized matching engines, on the other hand, allow anyone running a full node to view real-time matching. You can manually reconcile the transaction in the last block with the current order book.

Periodic auction comparison

Regular auction matching adds an extra layer of security right from the start. It adds a non-deterministic layer that makes it unlikely that anyone knows the next execution price unless they know the matching logic, the incoming orders for the next block and the trade price, and the current order book from the last match.

How to avoid front running in Ethereum 2.0

Some traders are wondering about the impact of the full release of Ethereum 2.0 later in 2023, merging mainnet with Beacon Chain, and introducing a Proof-of-Stake (PoS) consensus mechanism. Validators that are to process transactions in an epoch are informed of their position beforehand.

An epoch is a defined period of time in a blockchain network. This timeframe is used to describe when certain events will take place on a blockchain network, e.g. B. when incentives are distributed or when a new group of reviewers is assigned to validate transactions.

Related: Ethereum Upgrades: A Beginner’s Guide to Eth2

In this scenario, it becomes more difficult, but not impossible, for frontrunners to find profitable trades in a blockchain full of transactions. Many frontrunners out there are tech-savvy, so you can’t just rule out the possibility. DEXs can cover design points like fast matching, decentralized match engine, and regular auction matching to minimize the chances of front running.