Market manipulation has been a thorn in the financial trading system, it has plagued the traditional financial system in many ways. Frontrunning in crypto is one such market manipulation in blockchain transactions.
Frontrunning in crypto can be likened to getting extra food in the school refectory. However, you overheard while passing the chefs that the extra would be enough for only twelve persons.
Then you get your friends to quickly go and queue not necessarily because they want to eat but so that you can give out the food at a price.
That’s exactly what happens with frontrunning in crypto, the manipulation occurs when a trader has knowledge of upcoming bulk transactions and places a transaction to occur before those transactions occur.
Bulk transactions often change the tide of the market, usually driving up the market price. The first noticeable case was in 2017, the perpetrators used bots and submitted trades with high transaction fees to execute trades before others.
In cryptocurrency, transactions with high transaction fees are processed before others. This means that the fee attached to a transaction determines the speed at which that transaction is processed on the network.
Those who engage in frontrunning often employ this method to get their transaction processed ahead of the other transactions that would possibly increase the market price.
Then they would immediately put up trade on decentralized exchanges when the price has increased, this way they earn profits from exploiting the time differences between transactions.
It is illegal, and while it allows those who practice it to earn profits. It undermines the market efficiency and trust and this if not checked can lead to a loss of investor confidence and a reduced adoption rate.
There are various negative impacts of frontrun in crypto some of which include price manipulation, and reduced liquidity. When traders notice the market price is manipulated, they are most likely to pull out and this reduces the liquidity rate.
It is therefore pertinent that measures to eliminate and in the worst case scenario mitigate frontrun in crypto.
The aim should be to have a market where all participants have equal access as well as ensure transparency and trust in the system.
There are several ways that it can be done, outlined below are approaches that can help.
Transaction Fee Reform: If there is no priority attached to the transaction fee rate, frontrun would find it hard to thrive. Eliminating the use of transaction fees as a benchmark for processing transaction frontrun would be greatly reduced if not eliminated.
Privacy-preserving technique: Some of the techniques that can be employed here are homomorphic encryption, and zero-knowledge proofs among others.
The role of these techniques are to ensure that transaction details are hidden from the blockchain until it is completed.
Transaction order randomization: Having the transaction order book randomized will make it difficult to predict the exact timing of transactions, therefore making it harder to frontrun.
Increased education and awareness: A lot of traders are yet to understand the full scopeof frontrunning, therefore increased education and awareness will inform them of the risks as well as how to protect themselves on trading and exchange platforms.
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