This week I had an interesting conversation about high-frequency (HFT) trading in the crypto markets. A random event led me to speak with a person who had been involved in high-frequency trading (HFT) first hand.

I have always seen HFT as a style of quantitative trading that uses individual quantitaive skills with technical tools in order to exploit price discrepancies. The technique is used by market makers on the derivatives and stock markets, who use their coding skills and technical expertise to seize trading opportunities.

Arbitrage is often involved, when an asset has different prices on two separate exchanges. You can make a profit by buying an asset at $10 and selling it almost instantly for $10.25. Repeating this process can be very profitable. Jump Trading, Citadel Securities and Virtu are some of the most well-known HFT names.

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HFT is a popular topic in pop culture. Michael Lewis’ book ” The Flash Boys” and the film ” The Hummingbird Project both describe fictional efforts to speed up HFT firms’ trading reaction times.

HFT has certainly its critics. Some dismiss it as outright fraud, claiming that they can “front run” their orders because of the faster throughput. Some say it gives institutions an unfair advantage over individuals. Others attribute the rapid drops in price to HFT.

HFT in crypto markets can amplify these criticisms to symphonic proportions. The part of me who enjoys the marriage of markets and technology cannot help but look beyond.

Keone Hon is the CEO of Monad Labs. My curiosity led me to him. His firm’s current mission is to deliver a Proof of Chain (PoS), blockchain that increases transaction throughput and maintains compatibility for the Ethereum Virtual Machine. In his previous role, he was the quantitative trading team leader at a different HFT firm.

While I spent the first part of this article discussing what I thought I already knew, I would like to spend the rest of the column talking about what I have learned. Here are a few takeaways.

What HFT brings to crypto

Crypto itself is still a young technology, so it has a lot to offer. Price dislocations occur more often in crypto markets because there are fewer players than on traditional markets. This means that profits are higher. As more people join, these opportunities will become scarcer.

They also compete against other traders in order to offer the tightest possible quotes.

Hon stated that “professional automated trading provides a service at the end of it all, even though it may not sound like one.”

Different HFT strategies are used

This was, in all honesty, my selfishest question. I love all discussions about strategy and how people synthesize data to create a plan of actions.

HFT has a number of different strategies. Arbitrage is one of the strategies mentioned previously, in which the trader tries to exploit mispricings on different exchanges. Hon explained that other strategies are alpha driven, triggered by “quantitative indicators” which come from analyzing the order book.

During our strategy meeting, I was struck by the importance of being thoughtful not only in execution but also in position management and in exchange evaluation. As part of the requirement to trade across exchanges, it is necessary to maintain inventory, which adds additional counterparty risks, especially with centralized exchanges.

Hon’s response gave me the impression that he believes decentralized exchanges must catch up with their centralized counterparts when it comes to user experience and execution quality. I get the impression that his firm is working to close the gap between decentralized and centralized exchanges.

The Regulations of the United States

How can you talk about crypto and trading without mentioning regulation even once? In that regard, I think his answer will surprise many. Hon’s view of sensible regulation is positive, even if it allows participants to operate within a predetermined framework.

It’s beneficial to ensure that exchanges follow the rules. Hon stated that it’s important to verify that the exchanges have assets and reserves that they claim.

It’s similar to what I was told by other crypto-participants. It is important to have a clear set of rules that are implemented without malice. This will allow crypto participants to work effectively, efficiently, and quickly.

Nick Baker is the editor.