Trading bots and the advantages of HFT

Cryptocurrency is an alternative medium of exchange consisting of numerous decentralized crypto coin types. The essence of each crypto coin is in its cryptographic foundation. Secure peer to peer transactions are enabled through cryptography in this secure and decentralized exchange network. Since its inception in 2009, the Bitcoin has become a digital commodity of interest as some believe the crypto coins’ worth is comparable to that of traditional fiat currency.

Cryptocurrency is regarded as a decentralized exchange medium that leverages cryptographic functions to process financial transactions. As of January, 2021, there are over 5,000 cryptocurrencies and more than 20,000 cryptocurrency markets with a total market cap of over 600 billion dollars. Figure 1 shows historical data on global market capitalization. The total market cap is computed by aggregating the market cap of all individual cryptocurrencies. The figure depicts the exponential growth in 2017 and 2021.

A cryptocurrency exchange is a venture that permits clients to trade cryptocurrencies. Cryptocurrency exchanges are usually market makers, which leverage the bid-ask spread as a commission for their services, or they can act as a matching platform, by simply charging fees. Exchanges like Chicago Board Options Exchange (CBOE) , Chicago Mercantile Exchange (CME), and BAKKT (backed by New York Stock Exchange) are regulated crypto exchanges.

These exchanges are used for cryptocurrency trading which is the act of selling and buying cryptocurrencies with the goal of making a profit. Cryptocurrency trading has evolved significantly in the past decade. There are several strategies that can broadly be divided into two categories: technical and fundamental. They are similar in the sense that both rely on quantifiable information, which can be backtested against historical data to validate performance. However, recently, another strategy has garnered attention that is called High Frequency Trading, which makes use of trading bots. Such strategies, analogous to the technical strategy, use information from various activities to make buying or selling decisions. Quantitative traders develop strategies using quantitative data derived from volume, price, ratios or technical indicators to benefit from the inefficiencies in the market. Such strategies can be executed automatically, by developing trading bots that make use of algorithms and software. Unlike traditional markets, cryptocurrency markets present an increased number of arbitrage opportunities, with greater transparency and higher fluctuation. Thus, traders and analysts prefer the use of HFT strategies in crypto markets.

Cryptocurrency Trading Bot

A Bot is a software-based trading system that permits transactions, processes trades and information, and executes and accepts orders. A HFT trading system is defined as a set of procedures and principles pre-programmed to allow trade between crypto trading pairs or crypto-fiat pairs. Software used to implement trading algorithms are designed to overcome cybercriminal activities, price manipulation, and delay in transactions. While developing such systems and algorithms, its crucial to consider the base asset, capital market, strategies and investment plan.

Strategies are a critical component while building an effective Bot for cryptocurrencies. There are several commercial trading systems like 3Commas, Capfolio, Freqtrade, CCXT, and Ctubio. These systems can provide support for professional trading strategy, in addition to transparency and fairness from the third-party companies and fast customer services.

HFT is used to define trading goals, rules, and risk controls. HFT using pairs is a strategy that considers two assets, which are similar to each other, but with slightly different spreads. If the spread widens, one must short the higher costing assets and buy the lower costing one. Using this strategy, a profit can be generated if the spread becomes narrow again, reaching a certain equilibrium value. HFT uses historical patterns of transactional data to enable a trader in assessing projected future market scenarios for profitable trades.

advantages of HFT

  • One of the key advantage of creating an HFT black box is speed. Irrespective of how sophisticated one is as a trader, no human can act on market conditions as fast as a piece of very powerful algorithms locked inside a software. The speed further increases if the physical location of the servers is near the exchange that the algorithm is executing the trade on. There is even a specific term for these on-sight services – co-location.
  • In the hands of a dark pool provider, the HFT software can turn into a sophisticated tool and give you a significant advantage over other market players. With an order execution time of several milli or microseconds, you can profit even from the smallest fluctuations in the market.
  • Moreover, since algorithms can scan multiple markets and exchanges simultaneously, they can help find more arbitrage and market making opportunities.
  • Lastly, advocates of HFT believe that HFT makes markets more efficient by increasing competition and levelling the prices.
  • Backtesting applies the rules of trading to historical market data to determine the viability of an idea. When designing a system for HFT, all rules need to be absolute, with no room for interpretation as the computer is unable to makes guesses and needs to be informed about what is required. Traders can test these set of rules on historical data before risking money in live trading. Careful backtesting allows traders to evaluate and fine-tune a trading algorithm to determine the system’s expectancy – i.e., the average amount a trader can expect to win (or lose) per unit of risk.

Disadvantages of using HFT

  • HFT has been revolutionary in replacing human traders in the traditional financial markets. This is a major disadvantage for individual traders as they are unable to compete with institutions that are investing in automating their trading processes.
  • Automation of trading processes also presents the risk of transmitting shocks throughout global financial markets. In May 2010, an event called the “Flash Crash” took place on the electronic securities markets with Nasdaq Composite and S&P 500 experiencing a severe collapse below regular levels. The Dow Jones Industrial Average hit its second-biggest intraday point drop, and the HFT algorithms kicked off an aggressive sell-off procedure to withdraw from the markets owing to the risk of uncertainty.
  • The theory behind automated trading makes it seem simple as one just has to set up the software, code the rules and execute the trade. However, HFT is a sophisticated trading methodology, and not infallible. Contingent on the platform, a trade order could reside on a computer, as opposed to a server. Thus, if an internet connection is lost, an order might not be sent to the market. Discrepancies could also arise between the “theoretical trades” generated based on the strategy, and the platform where orders are entered.

HFT trading Strategies

In the past half-decade, the inclination of major financial institutions to include digital currencies in their portfolios has accelerated. This has resulted in the emergence of a new market for active trading of cryptocurrencies and launch of new coins (ICO/STO). Cryptocurrencies are regarded as the first pure digital asset that have been added to portfolios by asset managers and traded. Between January 2016-August 2019 ICOs have managed to raise over $31 billion. Thus, cryptocurrency trading has witnessed a notable upturn and significant progress in terms of activity and interest.

Thus, cryptocurrencies have garnered a broad market acceptance and rapid development despite their recent inception. Several asset management firms and hedge funds have started including cryptocurrencies into their trading strategies. The research community has spent resources and time in assessing various cryptocurrency trading strategies. Academics further suggest a steep rise in research on various crypto trading strategies with over 80% of research papers appearing in the past 2 years that demonstrates crypto trading as a key research area within the financial trading domain.

Cryptocurrency HFT has 4 key aspects:

• Software systems to support cryptocurrency trading like turtle trading systems, real-time trading systems, and arbitrage trading systems. Such software is used for Systematic trading that includes trading pairs, technical analysis, and other systematic methodologies;

• Use of emerging technologies in trading that includes machine learning, econometric methods, etc;

• Research on co-movements among cryptocurrency;

• Research on market conditions that includes bubbles.

Why building your own bot can be better than trading manually?

  • Longer runtimes – Bots are capable of operating 24/7, however, humans need to taker rest and sleep
  • Speed. The operating speed of Bots is significantly higher than that of humans, considering the time to think and react
  • Lack of Emotions. Bots are immune to basic human emotions like greed or fear. They are programmed to act based on statistically likelihood
  • Larger Capacity. Bots can process several gigabytes of data per second, as opposed to humans

Thus, there are several benefits to building your own bot, as opposed to trading manually. Bots are monotonous and consistent, which is essential for successful trading and is highly counterintuitive to human nature.

However it’s worth noting that a bot is only as good as the human creating it

Types of Trading Bots

There are three key types of cryptocurrency trading bots:

Arbitrage bots – These bots are hardcoded to use the arbitrage strategy. Blackbird is one of the leading examples of arbitrage bots in the market.

Market making bots – These bots place multiple sell and buy orders to get a quick profit. HaasBot is a good example of such a bot that was created in 2015 and is based out of Rotterdam.

Algorithmic trading bots – An algo trading bot is a code-driven software used to generate and execute sell and buy signals in the market. The main components of these bots include rules that signal when to buy or sell, and rules indicating when to close the position alongside rules determining order size and portfolio allocation. Trality is known as one of the best tools for creating these algo trading bots.


Although HFT sounds appealing for several reasons cited above, bots should not be considered a replacement for caution while executing trades. Technology failures can happen, and as such, these systems do require monitoring. Server-based platforms may provide a solution for traders wishing to minimize the risks of mechanical failures.

At VRM Research, we provide regular investment analysis of the cryptocurrency markets in cooperation with our trading department. Check it out and don’t miss the newest trends and developments in the crypto space.