How to avoid front-running on decentralized exchanges

Decentralized exchanges (DEX) can nip in the bud some of the problems associated with centralized exchanges such as concentration of liquidity in the hands of a few participants, leakage of funds in case of security breaches, closed control structures, etc. One issue that has not subsided, however, is front-running. Unscrupulous people are still finding ways to scam unsuspecting traders.

If you receive a lower-than-expected transaction amount when trading on a DEX, then there is a good chance that you are getting front-running. These criminals exploit the Automated Market Maker (AMM) model, sacrificing unsuspecting traders for profit.

This article will explain attack vectors and help you understand the basic concepts of front running in crypto exchanges, the potential consequences, and how to prevent front running.

What does front-running in cryptocurrencies mean?

The term "front-running" refers to the process by which someone uses technological or market advantage to obtain information about upcoming transactions in advance. This allows criminals to take advantage of upcoming price swings to gain financial gain at the expense of those who introduced these transactions. Front-running in cryptocurrencies is achieved by manipulating gas fees or timestamps, also known as slow matching.

Front-running activity is high on both centralized and decentralized exchanges. The goal of a front-running trader is to buy a large amount of tokens at a low price and then sell them at a higher price while exiting the position. When executed precisely, it yields risk-free profits for the front-runner.

Trading stocks and assets based on inside information and profiting from price movements is a well-known strategy. Although illegal and unethical, stockbrokers have been getting involved. This tactic is very similar to insider trading, with one subtle difference: The executor works for the client's commission, not the client's business.

What is a front-running trading bot?

Front-running is done using crypto bots that run on the millisecond scale. Using robots, in the blink of an eye, they can read a string of transactions, calculate the optimal transaction size and gas fee, configure the transaction and execute it.

The core function of the front-running bot is to listen for pending transactions on the blockchain. Using an interactive script to interact with the blockchain, the bot buys before the buyer and sells immediately after the buyer. Robots analyze trends in cryptocurrencies and execute trades for profit.

Front-running strategies on decentralized exchanges

When a transaction occurs, the system broadcasts it to the blockchain, requiring miners to verify the transaction. However, in any significant blockchain, the incoming transaction stream is greater than the capacity of subsequent blocks. Unmined transactions stay in the mempool.

The blockchain mempool is transparent, and front-running traders take advantage of this. By understanding the sentiment of ordinary traders, they are able to predict upcoming price movements and place their orders accordingly. They set a higher gas price on their transactions, thereby encouraging their transactions to be picked ahead of upcoming transactions, thereby pre-empting other unsuspecting traders.

Ways traders can prevent front-running

There is no single solution to the front-running problem on all platforms. However, depending on the scenario, different projects need to follow different anti-frontrunning methods.

Use a liquid pool

Front-running traders favor less liquid pools because there is less chance of competition and their trades cannot be disrupted by a large order that accidentally changes the weight of the pool. Therefore, trading in a large liquidity pool can greatly reduce the possibility of being attacked by front-running transactions.

The maximum slippage should not be too high

Does the question “How do I avoid slippage” keep stinging at you? What you can do is set a maximum slippage tolerance on most decentralized exchanges. In other words, you can fix the largest deviation from the expected return. You can refer to the following example to understand.

Suppose you place an order on a DEX and expect to receive 500 Tether (USDT). If you set the slippage value to 1% of the order, then you will receive no less than 495 USDT. However, if the slippage tolerance is larger, the deviation will be larger.

Therefore, the formula is simple: set the maximum slippage value not too high, about 0.5%-2%, so as to avoid front-running traders. If you are placing a large order, keep your slippage low. Front-running traders want you to keep your slippage high, so you just do the opposite.

Pay Excess Gas Fee

Front-running traders are happy to see slow trades because it gives them more time to frame orders to take advantage of your trades. Gas prices that are too low will make your transaction queue longer, giving front-runners more time to formulate strategies, and harming your interests.

Paying a higher gas fee will encourage miners to validate your transaction faster, reducing your chances of being a target. To achieve this, you can set the gas price higher than average, or simply use the fast gas option on your wallet. If you place a large value order, you need to pay more attention to this, and complete the transaction quickly by paying the excess gas fee.

Place an order with a smaller value

In order to be profitable, front-runners must meet some minimum thresholds. When entering and exiting the market, the gas fee needs to be paid twice, and the gas fee needs to be returned. They only start to make a profit after recovering these fees.

Currently, well-known Ethereum automated market makers such as Uniswap, Balancer, and SushiSwap pay a gas fee of $25 per transaction. Because they need two trades to execute the front-running trade, they may need to spend $50 to complete the trade. This also means that if your trade is worth less than $50, the chances of you being targeted by a front-runner are slim to none.

When you take a low-value trade, you are effectively making the front-runner take an unprofitable risk. Most of the time, trades under $1,000 are safe.

find eater

A public order book is the information that attracts front-runners in the first place. If you can find a taker, you can fill a given order and avoid the open market by front-running the trade yourself. When you find a taker and successfully negotiate a price, a trustless on-chain transaction is executed.

The way DEX prevents front-running

DEX can set up several key mechanisms to make it difficult to execute front-running transactions:

quick match

Front-running traders look for slower matching speeds to place orders before execution. DEXs ensure fast matching, leaving no time for front-runners to push through the process. Ultra-fast block times will effectively catch front-runners off guard. For most front-runners who are not very technical, this should be enough.

Decentralized Matching Engine

In the case of a centralized matching engine, it is difficult to determine whether the exchange itself is participating in front-running. On the other hand, a decentralized matching engine allows anyone running a full node to view matches in real time. They can manually match transactions from the latest block with the current order book.

Regular Auction Matching

Periodic auction matching adds an extra layer of security against front-running. This adds a layer of non-determinism, making it impossible for anyone to know the next execution price unless they know the logic of the match, the incoming order for the next block, the trade price, and the current order book from the last match.

How to avoid front-running transactions in Ethereum 2.0

Some traders wonder about the impact of a full release of Ethereum 2.0 later in 2023, when Ethereum merges the mainnet with the Beacon Chain and introduces a proof-of-stake (PoS) consensus mechanism. Validators who process transactions during a certain epoch will be informed of their positions in advance.

An epoch is a defined span of time in a blockchain network. This time frame is used to describe when certain events in the blockchain network occur, such as when rewards are distributed or when a new set of validators is assigned to validate transactions.

In this case, it would be difficult, but not impossible, for front-running traders to find profitable deals in a blockchain flooded with transactions. Many front-runners are technically savvy, so you can't rule that out. Decentralized exchanges can cover mechanisms such as fast matching, decentralized matching engines, and regular auction matching to minimize the possibility of front-running transactions.

Cointelegraph Chinese is a blockchain news information platform, and the information provided only represents the author's personal opinion, has nothing to do with the position of the Cointelegraph Chinese platform, and does not constitute any investment and financial advice. Readers are requested to establish correct currency concepts and investment concepts, and earnestly raise risk awareness.