How the Experts Game the Cryptocurrency Industry With DeFi

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With the sheer number of innovations launching left, right, and center, many would agree that the cryptocurrency industry is in the midst of a cambrian explosion of sorts, with promise and potential to be had in practically every corner.

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Decentralized Finance, or DeFi, is quickly emerging as a hotbed for this potential, thanks to a range of products and tools that help users maximize the efficiency of their capital and turn a generous profit.

Cryptocurrency Industry DeFi

But there is one particular class of users who have taken the capabilities of DeFi and run with it, producing potentially incredible profits as a result. We’re talking about the so-called ‘early movers’ and experts, who take the leap and leverage new tools and DeFi platforms to their maximum potential.

The Pros Leverage Decentralized Options

The past few weeks have seen the cryptocurrency sphere shaken with extreme volatility, and the vast majority of cryptocurrencies saw their volatility reach their highest values this year.

As you might expect, this has massively increased the number of potentially profitable opportunities for swing traders and day traders, who were able to trade within a much larger range than normal. However, as with most things, those in the know are the ones that are able to truly maximize their returns in this market.

One of the ways traders are beginning to do this is by leveraging decentralized options trading platforms. As you might be aware, options are digital contracts that give the holder the right to buy or sell an underlying asset at a specific price on a specific date in the future. They’re generally used by traders looking to speculate on the direction of a price movement (e.g. up/long or down/short).

Until recently, traders have been restricted to trading only the limited range of options contracts that were made available on centralized exchanges. But now, traders are beginning to leverage platforms like Premia to create their own unique decentralized options contracts - which can represent any token the platform supports.

Through exchanges like Permia, users can set their own strike price, expiry date, and number of options contracts to trade, and then make these available on the marketplace. As a result, they are able to speculate on both the direction and magnitude of change for whichever token they choose, while sourcing liquidity for their options at the same time.

Expert traders have already begun leveraging these types of tools to capitalize on the erratic price movements of popular DeFi coins, like Uniswap (UNI), Wrapped Ether (WETH), Yearn Finance (YFI), and more — many of which are not available on centralized options exchanges.

The Flash Bots Epidemic

If you have placed a high value order on Uniswap with high slippage and/or a relatively low fee in recent months, then you may have noticed that your trade is executed at or close to the lowest acceptable price as per your order settings.

Now, most of the time you may be tempted to think that the market just happened to take a dip the moment before you told, leading to your order being filled at a lower price than expected. But while this is sometimes the case, it is more likely than not that you were the victim of a frontrunner — sometimes known as a flash bot.

These bots work to extract value from those trading on decentralized exchanges through a process known as a “priority gas auction (PGA)”. In short, when a bot recognized a high value trade with high slippage, it will automatically form another high value transaction, with a slightly higher fee per byte. As is standard, miners will then order the transaction based on their fee, leading to the bot transaction being ordered before the trader’s transaction.

This allows the bot to change the pool weighting of a decentralized liquidity pool before the trader’s order is executed, temporarily driving up the price before they buy, then driving it down again after.

Cryptocurrency Market DeFi

As we can see from the above example, we can see that there were three transactions included in the same block (mined at 06:12). The first transaction (bottom) is the bot, the transaction was actually broadcast after the trader’s transaction (middle) but was still mined first due to its higher fee.

The bot purchased the asset at a slightly lower price (bottom), the trader then purchased at a slightly higher price (middle), following which the bot sold their tokens at the now inflated price driven up by the first two buy orders (top). Overall, the bot managed to extract a guaranteed 0.09 ETH from the trader by manipulating the liquidity pool through a PGA.

Unfortunately, the skills and capital involved in creating a successful frontrunner strategy make the practice largely unattainable to most regular investors. As a result, the practice is currently being exploited by a handful of experts that have the correct capabilities.