The term front-running refers to the unethical and sometimes illegal practice whereby a person or bot, having prior knowledge of a future major trade that will influence the price of an asset, executes its own trade before that major trade is processed in order to profit from the anticipated price movement.
Front-running: How it works
While in traditional finance front-running involves brokers obtaining inside information, in the crypto space, especially on decentralized exchanges (DEXs), front-running is largely automated:
- Transaction visibility in mempool: When a transaction is initiated on a blockchain (such as Ethereum), it is not processed immediately. Instead, it is placed in a public holding area called the mempool (memory pool). Here, all pending transactions are visible to anyone.
- Large transaction detection: bots constantly scan the mempool to find large transactions with significant impact on the price of a cryptocurrency. For example, a bot might detect a large order to buy a particular token.
- Preemptive trade execution: After detecting such a trade, the front-running bot places its own trade (buy or sell the same token) with a higher gas fee. This higher fee ensures that the bot’s transaction will be processed faster, ahead of the original transaction.
- Taking advantage of price movement:
- If the original transaction was a big buy, the front-running bot transaction buys the token at the current price. Once the original trade executes, increased demand causes the price to increase. The bot then sells the token at the inflated price, making a profit.
- If the original trade was a big sale, the front-running bot’s trade sells the token at the current price. Once the original trade runs, the increased bid causes the price to drop. The bot then buys the token back at the low price, making a profit.
Why front-running is a problem
- It disadvantages ordinary traders: Retail traders end up buying assets at higher prices than they should or selling at lower prices, reducing their profitability.
- Undermines confidence in the market: When users see bots exploiting blockchain’s transparency, trust in the fairness and integrity of the decentralized market diminishes.
- Increased costs: Can lead to higher transaction costs and delays in processing transactions for other users.
- Artificial volatility: Distorts supply and demand dynamics, introducing artificial volatility.
Example:
Imagine an investor wants to buy 100,000 tokens on a DEX, and this order is large enough to influence the price. A front-running bot detects this order in mempool. The bot quickly buys the tokens with a higher gas commission, ensuring that its transaction is processed first. When that investor’s trade executes, the token price goes up. The front-running bot immediately sells the tokens it bought, profiting from the price difference.
(Limited) safeguards:
While it is difficult to completely eliminate front-running in transparent environments like blockchain, there are some measures users can take:
- Set a low slippage tolerance: This limits how much the execution price can vary from the expected price. If the variation is too large, the trade is canceled, reducing losses caused by front-running.
- Private Transactions: Some protocols and tools allow transactions to be sent directly to miners/validators, bypassing the public mempool and reducing front-running opportunities.
- Using MEV (Maximal Extractable Value) protection solutions: Front-running is a form of MEV. There are projects that develop solutions to minimize MEV, such as Flashbots or SUAVE, which try to create a fairer trading environment.
- Executing large orders in smaller portions: Breaking a large order into several smaller orders can reduce the impact of each individual transaction and make it more difficult for front-running bots to detect.
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