Why High Frequency Traders are Turning to Crypto

By Gerrit van Wingerden, Caspian CTO and Co-Founder

Many discussions in the cryptocurrency industry right now seem to revolve around how institutional investors are preparing to dive into the space. With daily rumination about the likely acceptance of Bitcoin ETFs, the ongoing interest displayed by financial players and the release of professional trading platforms, it certainly appears that 2019 is poised for an influx of institutional money into the burgeoning field.

This influx could manifest itself in a number of ways, with a potential route being High Frequency Trading or HFT. This strategy of using automated tools and algorithms to track markets, detect trends and execute large trades more quickly than a human trader is well established in traditional markets.

Essentially, it is about using speed as a competitive edge and the strategy involves tactics such as colocating HFT hardware with exchange hardware and implementing high speed connections, so that data can travel as fast as possible. Right now, it’s unclear how much HFT is taking place in crypto but, with sophisticated algorithmic traders already providing a lot of the liquidity for some of the less well-known coins, it’s certainly reasonable to assume it will increase. Plus, the latest offerings from major exchanges suggest that they are aimed at servicing HFT needs.

As mentioned, this type of trading is based around the understanding that algorithms react more quickly than humans by several orders of magnitude. So, in a market composed primarily of human traders, those deploying HFT strategies clearly possess the upper hand. Over time, however, as the market becomes flooded with options for those looking to compete, the same opportunities are much scarcer as margins, and opportunities for arbitrage dwindle.

The volatility of traditional markets pales in comparison to that of the cryptocurrency ones. In the case of major stock market indices and gold, there’s an annualised volatility of 10–15% (currency pairs are even lower). Contrast that with cryptocurrency, which moves at an estimated 100%.

Movements are irrational, and it’s rare that big news or observable events can be linked to price swings. The human condition is such that we constantly seek to ask why, which often leads to frustration when erratic market movements come seemingly out of the blue.

In spite of the nascency of the markets for tokens and cryptocurrencies, the space is already hugely fragmented, often leading to discrepancies in the prices of listed assets from platform to platform. Some choose to game these inconsistencies by manually purchasing the cheaper offering, transferring it to another platform and earning a profit when re-selling it at a higher price. Others are more inventive, employing simple bots coded to identify these disparities and execute trades automatically.

It’s clear that automation is the superior method. Software capable of handling billions of dollars worth of trades has been fine-tuned over the years and, given the boom in the cryptocurrency markets, it was only a matter of time before HFT technologies came into play.

Exactly what effect the increase in this type of trading will have is yet to be seen. It’s worth remembering though that, while there are elements of their approach which are unique, there are many areas of crossover with how existing traders operate.

As mentioned, major exchanges have begun offering co-location of hardware in order to reduce latency and allow HFT algorithms to trade as quickly as possible. This type of infrastructure arrangement is new for the crypto space and driven by HFT’s unique needs. However, it’s worth remembering that other important areas for HFT, such as position monitoring, risk assessments and P&L management, are already served by existing crypto trading platforms.

Overall, the past several years have seen Bitcoin transition from a relatively niche asset traded by programmers and hobbyists into a serious contender on the financial playing field. The proliferation of HFT in the cryptocurrency space is just one example of how digital currencies are becoming more established as financial instruments.

About Caspian

Caspian is a joint venture between TORA, a leading provider of asset management technology and Kenetic a leading blockchain and cryptocurrency hedge fund and investment firm.

Caspian is the first company to provide institutional and experienced investors with a full-stack crypto trading and risk management platform. It equips digital assets investors with a comprehensive Order and Execution Management System (OEMS), Position Management System (PMS), and Risk Management System (RMS), backed by an experienced support team.

The platform, which has the potential to drive further participation in crypto-trading, provides sophisticated connectivity and interoperability across various digital asset exchanges. The solution also offers unified compliance and reporting functionality that enables users to analyze all their trades in one place, regardless of which exchanges they are transacting on. Caspian aim’s to institutionalise the crypto market and has 15 global institutions live on the platform that offers a single interface into 25 exchanges.

About Gerrit van Wingerden

Gerrit is the CTO of Caspian and has been a Managing Director at TORA for the past 12 years. At TORA, he built a software platform which is at the heart of equity trading for hedge funds around the world. In our conversation, we discuss the genesis bringing crypto into the TORA universe, Gerrit’s passion project of building crypto-trading bots in the early days of the industry, and potential trading strategies in the current crypto landscape.

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