The crypto market mirrors traditional finance in many ways, one of which is using privileged information to gain an unfair advantage over others and use it to achieve financial gains at the expense of other market participants.
When brokers or brokerage firms use prior knowledge of pending trade orders from clients to execute trades for themselves benefiting from the anticipated price movement, it is known as front-running in traditional finance (TradFi).
This practice is not only unethical but also illegal in most financial markets.
However, in crypto where decentralisation is a key feature, front-running has found its way to DeFi, although different from how it is done in traditional finance the concept is still the same.
What Is Front-Running Crypto?
Front-running in crypto is more sophisticated form than in TradFi.
Here miners/validators, people who run blockchain nodes or anybody with knowledge of the transaction queue or the “mempool” that contains future/pending transactions that are yet to be settled take advantage of this knowledge and place their own transaction before the anticipated transaction(s) is/are placed and settled in other to achieve financial gains.
It simply places a transaction in a queue with the knowledge of a future transaction. It happens when a miner or anyone with access to information on pending transactions, places an order that would earn them a profit based on the pending trade.
For front running to be successful monitoring the transaction queue and speed of execution of attack when a major transaction is noticed are essential, that is why bots are commonly used in this type of attack.
How Transactions Are Added To The Blockchain
When a blockchain user creates a transaction it is not added to the blockchain distributed ledger immediately instead it is broadcasted to the nodes on the network and placed in a queue or “mempool”.
A mempool is a sort of waiting room for transactions that are yet to be validated and added to blocks in a blockchain.
When a new block is being built, block creators ( miners or validators) draw transactions to add to the block from the current pool of pending transactions.
The order in which transactions are added to blocks is typically determined based on the transaction fees.
While different blockchains have a minimum transaction fee at any given time, users can set their own fees, which means that users can pay for priority by putting a higher fee on a particular transaction.
Block creators who receive this fee and are trying to make a profit, will most likely prioritize transactions with higher fees and add transactions to new blocks based on fees and not in the order in which they were received.
Taking Advantage Of The Process
Attackers take advantage of this process of adding transactions to blocks based on fees by paying higher fees to ensure that their transactions are processed first before the pending transaction that they are anticipating.
This is called front-running in crypto, for instance:
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Preventing Front-Running Attacks In Crypto
The simplest way to avoid front-running is by paying higher fees that way your transaction will be prioritized by miners and validators but this is expensive and unsustainable.
So let's highlight some other ways to minimize the chances of front-running attack occurrence:
Order Matching Mechanisms: DEXS can do this by executing trades based on the order in which they were received rather than prioritizing higher transaction fees, if this is implemented the advantage gained by front-runners is diminished.
Layer 2 Solutions: layer-2 scaling solutions are usually faster than layer-1 where it takes longer to add new blocks to the network, utilizing scaling solutions such as payment channels or sidechains, can help reduce the impact of front-running by enabling faster and more private transactions off the main blockchain.
Rate Limiting: Implementing limits on the frequency and number of transactions from a single address can deter front-runners who often operate by flooding the network with rapid, successive transactions.
Batch Transactions: This is done by bundling several transactions together and processing them as one unit, hence it becomes more difficult for attackers to single out and exploit individual trades.
Delay Mechanisms: Exchanges and DEXs can Introduce a small delay between the broadcasting of a transaction to the network and its execution, this can help mitigate front-running as this delay gives all transactions a fair chance to be included in a block without being exploited by front-runners.
Place a low-value order Front-runners usually target major/huge trades this is because to make a profit, front-runners have to meet some minimum thresholds.
They have to pay the gas fees twice, on entering and exiting the market, and also recover the amount paid as the trading fee.
Their profits begin only after they get back their expenses. Therefore small trades are not attractive to front-runners.
Monitor for Bots: Exchanges, protocols and DEXs can implement continuous surveillance for automated bots that might be looking to exploit front-running opportunities this can help in early detection and mitigation.
Smart Contract Audit: Regular audits by reputable firms such as Hashlock can identify vulnerabilities in smart contracts that might be prone to front-running or other malicious activities.
It is noteworthy to know that while these measures/remediations can help reduce the occurrence/impact of front-running, no solution is entirely fool proof.
[Author’s Note: This article does not represent financial advice, everything written here is strictly for educational and informational purposes. Please do your own research before investing.]
Author: Godwin Okhaifo
