“Flash Boys”-like trading manipulation is becoming prevalent in the young cryptocurrency market and is estimated in the billions of dollars, per the new study conducted by researchers at Cornell Tech and other universities. Four of the five major cryptocurrencies plunged this week on news of the report, including Bitcoin, Ethereum, Litecoin and Ripple, when it was detailed in a story in Bloomberg.
The study says that manipulation has become prevalent on certain decentralized cryptocurrency exchanges (DEXes), and is likely rampant on centralized crypto exchanges as well. "We have no idea what the extent of the malfeasance is on centralized exchanges," said Ari Juels, a professor at Cornell Tech during a blockchain conference at Cornell Tech’s New York City campus. “If we extrapolate from what we’ve seen on DEXes, it could well be on the order of billions of dollars."
Crypto Behaviors Mimics Wall Street
The study's title is appropriately called, "Flash Boys 2.0," because these trades are operating much like the ones in the famous Michael Lewis book, 'Flash Boys,’ in which traders use high frequency trading and market exploiting behaviors to win trades ahead of slow rivals. In the crypto case, special arbitrage bots move ahead of ordinary users’ trades on decentralized exchanges, per Bloomberg. These autonomous trading programs allow market manipulators to anticipate other traders’ movements and profit off of them. These traders also are able to get priority ordering by paying higher fees, allowing them to take advantage of practices including front running, the authors said in the report released last week.
How Crypto 'Flash Boys' Trade
- Traders use special arbitrage bots to anticipate and profit from ordinary users’ trades
- Traders pay higher fees to get priority for practices like front running, aggressive latency optimization
- Market-exploiting behaviors mimic common practices from high-speed Wall Street traders
DEX Design Threatens Blockchain Security
DEXes, although still not the primary method of cryptocurrency trading, are growing in popularity as companies like Binance build out their own infrastructure.
“We explain that DEX design flaws threaten underlying blockchain security,” says the Cornell Tech report. "These bots exhibit many similar market-exploiting behaviors -- front running, aggressive latency optimization, etc.-- common on Wall Street…”
The paper’s authors tracked six decentralized exchanges since October, where they spotted over 500 bots generating as much as $20,000 daily, per Bloomberg. The researchers also constructed their own autonomous trading program to get a deeper insight into how these trades were executed, and even received a few buyout offers.“This should incentivize the community to consider new exchange designs,” said Cornell Tech's Juels.
The study highlights the broader risk of investing in the crypto space. An earlier Bloomberg story outlined a study which tracked the top 100 crypto exchanges’ websites and determined that nearly 90% of volume was suspect. Despite that, cryptocurrency continues to win attention from institutional investors, including Harvard’s massive endowment, which is backing a crypto-company.