Employing strategies such as breaking down your transaction into multiple smaller operations, engaging in periodic auction matching, and refining your slippage settings can effectively help deter front-running.
Decentralized exchanges (DEXs) resolve a number of challenges inherent in their centralized counterparts, including the excessive concentration of liquidity among a limited group, risks of fund compromise during a security breach, and opaque control structures. However, there persists a pernicious problem of front-running, where crafty actors continue to exploit others, often catching traders off guard.
If your returns from a trade on a DEX have been notably less than expected, you’ve likely fallen prey to front runners. These malefactors manipulate the automated market maker (AMM) model to reap profits at the cost of the unsuspecting trader.
This piece aims to illuminate the mechanism of such attacks and provide a fundamental understanding of front-running in crypto trading, its potential repercussions, and proven methods to prevent falling victim to crypto front-running.
What does ‘front-running’ mean in the crypto sphere?
The term ‘front-running’ denotes a tactic where individuals leverage technology or market advantage to gain early access to upcoming transactions. This privileged information allows such individuals, often termed as ‘bad actors’, to capitalize on impending price fluctuations, thus accruing financial gain at the expense of those who initially set these transactions in motion. Front-running typically involves the manipulation of gas prices or timestamps, a process also referred to as ‘slow matching’.
Front-running is a common occurrence in both centralized and decentralized exchanges. The fundamental goal of a front runner is to purchase a significant amount of tokens at a lower cost and subsequently sell them at a higher price, strategically exiting the position. When executed with precision, this maneuver results in risk-free profits for the perpetrator.
The practice of trading stocks and other assets based on insider knowledge to exploit price changes is not new. Although it is both illegal and unethical, brokers have been known to partake in this behavior. This method bears a striking resemblance to insider trading, with a subtle difference: the individual executing the trade operates within the client’s brokerage firm, not within the client’s business.
What exactly is a front-running bot?
A front-running bot is a technological tool used to execute front-running operations in the crypto space, functioning within an incredibly rapid millisecond-scale timeframe. In the brief moment it takes for a human eye to blink, these bots can interpret a sequence of transactions, determine the ideal transaction size and gas price, arrange the transactions, and set them in motion.
At the core, a front-running bot operates by scanning for pending transactions on the blockchain. Through an interactive script, the bot interfaces with the blockchain, securing a purchase before the initial buyer and then making a sale immediately afterward. It diligently analyzes the crypto market trends and executes transactions accordingly, all with the primary objective of yielding a profit.
Understanding Front-Running Tactics on Decentralized Exchanges
Whenever a trade takes place, the system announces it on the blockchain, necessitating miners to authenticate the transaction. Nonetheless, on any blockchain of note, the inflow of incoming transactions typically exceeds the capacity of the subsequent block. The transactions awaiting mining are held in a pending transaction pool, known as a ‘mempool’.
The transparency of blockchain mempools is a double-edged sword — it’s this very characteristic that front runners seize upon. By tapping into traders’ sentiments and anticipating upcoming price shifts, front runners can strategize their orders accordingly. They incentivize miners to prioritize their transactions over pending ones by setting higher gas prices, thereby front-running traders who are often none the wiser.
Strategies to Mitigate Front-Running as a Trader
There is no ‘one-size-fits-all’ remedy to address front-running across all platforms. Instead, various bespoke anti-front-running measures should be applied depending on the specific circumstances of different projects.
Opt for Large Liquidity Pools
Front runners often target low liquidity pools as they offer less competition and lower probability of a large, unexpected order disrupting the pool weighting. By conducting your trades within larger liquidity pools, you lessen your chances of being a victim of front-running.
Maintain a Low Maximum Slippage
If you’re continually wondering how to reduce slippage, setting a maximum slippage tolerance on most decentralized exchanges can help. This action determines the maximum permissible deviation from your anticipated return. For instance, if you place an order on a DEX expecting a return of $1000 BUSD (BUSD $1.00), setting your slippage to 1% would ensure that you receive no less than $990 BUSD. However, a larger slippage tolerance will permit more deviation.
The strategy is straightforward: maintain a low maximum slippage, around 0.5%-2%, to deter front runners. If you’re placing a substantial order, keep your slippage on the lower end. Front runners thrive when slippage is high, so it’s best to counter their tactics.
Increase Gas Payments
Slow transactions are a boon for front runners as it provides ample time to strategize an order that leeches off your trade. Paying less for gas prolongs the wait time for your transactions, giving front runners more time to plot against you.
By overpaying for gas, you incentivize miners to expedite your transaction validation, reducing your likelihood of being targeted. You can achieve this by setting a higher-than-average gas price or simply selecting the fast gas option on your wallet. This becomes crucial for high-value orders that need swift execution.
Opt for Low-Value Orders
To generate profit, front runners need to surpass a certain threshold. They bear the gas fees twice (while entering and exiting the market) and must also recover the trading fee. Their actual profit only kicks in once they’ve recouped their expenses.
Presently, renowned Ethereum-based automated market makers like Uniswap, Balancer, and SushiSwap charge a gas fee of $25 per transaction. Since front-runners require two transactions, they’ll likely spend $50 per trade. Thus, if your trade’s profit is less than $50, you’re unlikely to be targeted.
Engaging in low-value trades essentially turns them into unprofitable ventures for front runners. Generally, trades involving amounts under $1,000 are considered safe.
Seek a Taker
Publicly-hosted order books are prime attractions for front runners. If you find a taker, you can fill a given order and avoid the public markets, thereby circumventing front-running. Successful price negotiation with a taker leads to a trustless on-chain exchange execution.
Strategies to Thwart Front-Running on the DEX Side
DEXs can employ several design strategies to render front-running challenging to execute:
Front runners exploit slow matching speeds to insert their orders before the completion of a trade. A DEX can counteract this by ensuring rapid matching, which leaves limited opportunities for front runners to mobilize their schemes. A notably quick block time can effectively stymie front runners, particularly those who lack advanced technical skills.
Decentralized Matching Engine
With a centralized matching engine, it’s challenging to ascertain whether the exchange itself isn’t involved in front-running. In contrast, decentralized matching engines allow anyone running a full node to monitor the matching process in real-time. They can manually match the transaction in the most recent block with the current order book.
Periodic Auction Matching
Implementing periodic auction matching introduces an additional safeguard against front-running. It introduces a layer of uncertainty, making it highly unlikely for anyone to predict the next execution price unless they have knowledge of the matching logic, the orders for the forthcoming block, and the trade price and current order book from the previous match.
Mitigating Front-Running in Ethereum 2.0
Traders are contemplating the ramifications of the full deployment of Ethereum 2.0 slated for later in 2023. This upgrade will merge the mainnet with the Beacon Chain and introduce a proof-of-stake (PoS) consensus mechanism. Validators, tasked with processing transactions within an epoch, will be notified of their assigned roles in advance.
An epoch in the blockchain context denotes a predetermined duration during which specific events in the blockchain network transpire. This could be the disbursement of rewards or the allocation of a new set of validators to authenticate transactions.
In such an environment, front runners may find it increasingly difficult to discover lucrative trades within a blockchain saturated with transactions. However, considering the high level of technical expertise many front runners possess, it would be imprudent to completely discount the possibility of their presence. Hence, DEXs can implement strategies such as swift matching, decentralized matching engines, and periodic auction matching to diminish the chances of front-running.