Decentralized Exchanges (DEX) nip several issues related to their centralized counterparts in the budsuch as the concentration of liquidity in the hands of a few actors, the commitment of funds in the event of a security breach, the closed control structure and more. However, one of the problems that he refuses to address is that of speculation. Unscrupulous actors keep finding ways to scam unsuspecting traders.
If you have received less than you expected when making a trade on a DEX, there is a good chance that you are a victim of “front runners”. These bad actors take advantage of the automated market maker (AMM) model to make profits at the expense of unsuspecting traders.
This article will explain the attack vector and help you understand the basic concept of front-running in cryptocurrency trading.the possible consequences and how to prevent cryptocurrency front-running.
What is front-running in cryptocurrencies?
The term “front-running” refers to the process where someone uses technology or market advantage to gain prior knowledge of upcoming transactions. This allows bad actors to take advantage of the next price movement and make financial gains at the expense of those who have entered these transactions. Front-running occurs through the manipulation of gas prices or timestamps, also known as slow matching.
In both centralized and decentralized exchanges, front-running is a frequent activity. The objective of a “front runner” is to buy a portion of tokens at a low price and then sell them at a higher price, while exiting the position.. When executed accurately, it brings profit without risk to the traders who do so.
Trading stocks and assets based on insider knowledge to take advantage of price movement has been a well-known tactic. Although it is illegal and unethical, brokers have dedicated themselves to it. The tactic closely resembles insider trading, with the minor difference that the executor works for the client’s broker and not the client’s business.
What is a front-running bot?
Front-running is carried out by cryptocurrency front-running bots that work on a millisecond time frame. Before a person blinks, they can read a chain of transactions, calculate the optimal transaction size and gas price, set up the transactions, and execute them.
The principle of a front-running bot works by listening for pending transactions on the blockchain. By interacting with the blockchain through an interactive script, the bot buys before the buyer and sells right after. The bot analyzes cryptocurrency trends and executes trades for profit.
Front-running tactics on decentralized exchanges
When an operation occurs, the system transmits it to the blockchain, which requires miners to verify the transaction. However, in any major blockchain, the flow of incoming transactions exceeds the capacity of the next block. Unmined transactions are left in a pool of pending transactions called a mempool.
Blockchain mempools are transparent, a feature that front runners exploit. By knowing the mood of traders, they are able to predict upcoming price movements and place their own orders accordingly.. They set a higher gas price on your trades to encourage you to pick up your trades before your pending ones, thereby preempting unsuspecting traders.
Ways to avoid front-running by traders
There is no single solution to solve front running problems on all platforms. Rather, various approaches against front-running need to be followed in different projects, depending on the scenarios.
Use large pools of liquidity
Front runners like low liquidity poolsas there is less chance of competition, as well as less chance of your transaction being interrupted by a large order unexpectedly altering the pool weight. Executing your trades in large pools of liquidity makes it less likely that you will be affected by frontrunning.
Keep max slip low
Is the question “how can I avoid slipping” recurring to 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) for it. If you set the slippage to 1% of your order, then you will not receive less than 495 USDT. Nevertheless, if the slip tolerance is larger, there will be more deviation.
Therefore, the formula is simple: Keep the max slip low, around 0.5%-2%, to fend off front runners. If you’re going to do a large order, keep the slip on the bottom keel. Front runners want you to keep the slide high, so it’s best to do the opposite.
Pay more for gas
Front runners are delighted to see slow trades because it gives them more time to come up with an order to set up their trade and make a profit. Underpaying for gas makes your transactions queue longer, giving front runners more time to formulate their strategy and harm your interests.
Overpaying for gas encourages 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 the average or simply use the fast gas option in your wallet. If you are placing a large value order, it is even more important to try to complete transactions promptly..
Place a low value order
To make a profit, front runners have to meet some minimum thresholds. They have to pay the gas fees twice, when entering and leaving the market, and also recover the amount paid as a negotiation fee. Your benefits only start when you recover your expenses.
Currently, prominent 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 execute the frontrunning, they are likely to spend $50 to complete the operation. This also means that If your trade makes less than $50 in profit, the chances of it being targeted by frontrunners are negligible.
When you go into a low-value deal, you pretty much make it unprofitable for frontrunners. Most of the time, trading with amounts less than $1,000 is safe.
find a taker
A public order book is the first thing that attracts front runners. If you manage to find a taker, you will be able to cover a certain order and you will be able to stay away from the public markets and, subsequently, from front-running. When you find a taker and successfully trade a price, a trustless on-chain trade is executed.
Ways to avoid front-running on DEXs
DEXs can take care of several design points to make front-running difficult to execute:
Front runners look for slow matching speed to place their orders before execution. A DEX can ensure fast matchmaking to leave little room for front runners to get their process up and running. A super fast block time will make front runners unable to react. For most front runners, who are not as technically inclined, this should be enough.
Decentralized matchmaking engine
In the case of a centralized matching engine, it is difficult to establish that the exchange itself is not involved in the front running. Decentralized matchmaking engines, on the other hand, allow anyone with a full node to view the matchmaking in real time.. They can manually check the last block transaction against the current order book.
Periodic auction comparison
Periodic auction matching adds an additional layer of front running security. It adds a non-deterministic layer that makes it unlikely that anyone will know the next execution price unless they are aware of the matching logic, the incoming orders for the next block, and the current order book and transaction price from the block. last pairing.
How to avoid front-running in Ethereum 2.0
Some traders wonder about the impact of the full release of Ethereum 2.0 later in 2023, which will merge the mainnet with the Beacon Chain and introduce a proof-of-stake (PoS) consensus mechanism. Validators that must process transactions at one time will be informed of their positions in advance.
An epoch is a defined period of time in a blockchain network.. This time span is used to describe when certain events will take place on a blockchain network, such as when incentives will be distributed or when a new set of validators will be assigned to validate transactions.
In this scenario, it will be more difficult for front runners to find profitable trades on a blockchain full of transactions, but not impossible.. Many front runners are technically proficient, so the possibility cannot be ruled out. DEXs can cover design points like quick match, decentralized match engine, and regular auction match to minimize chances of front-running.
Clarification: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information set forth herein should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.