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Trading bots and algorithmic high-frequency trading are ubiquitous on Wall Street, but cryptocurrency networks offer a unique environment for them to help reduce risk, experiment with new methods and even take advantage of market manipulation.
The integration of more advanced software tools for trading with progress in machine learning and decentralised exchanges (DEXs) should further expand on the development of trading bots in the industry.
Despite the rise of algorithmic trading in cryptocurrency markets, it is still a nascent field with a substantial amount of improvement and discovery waiting to unfold.
The future of exchanges and the interoperability of blockchain networks is still unclear at this point, but trading bots should remain a vital tool for traders and institutions to minimize risk and execute large orders efficiently.
Many trading bots during the meteoric rise of the cryptocurrency market last year focused on arbitrage trading between exchanges. Premiums on South Korean exchanges for Bitcoin reached nearly 30 percent in December of last year, compared to US-based exchanges.
With such enormous spreads, it was only natural that trading bots emerged for taking advantage of exchange arbitrage.
The unreal arbitrage spreads coincided with a general market trend of Bitcoin and altcoins exploding in price. As a result, trading bots became popular tools for automated trading in 24/7 markets that seemingly only increased in volumes and prices.
Bots allow traders to successfully trade and monitor their positions using customizable parameters without having to be glued to their screens the entire time. Further, the human emotional error aspect and an inability to compete with bots in the concurrent monitoring of assets on multiple exchanges has led to their further proliferation in the industry.
The disparate regional regulatory frameworks for cryptocurrencies and exchanges expanded on the ability to capitalize on arbitrage spreads due to predictable arbitrage opportunities and market inefficiencies. Market anomalies and manipulation continue to persist in the industry too, leading to discrepancies that bots can potentially capitalize on or assist with investor protection to negative exposure.
Trading bots are also used for improper practices. The Wall Street Journal recently identified instances of spoofing across the markets, while Virgil Capital revealed that they use their own bots to combat “enemy” bots in the market. Interestingly, some traders view the unregulated markets and subsequent manipulation with trading bots as useful, allowing small investors to use sophisticated trading tools that level the playing field.
Further complications in cryptocurrency markets come in the form of direct manipulation by influential participants. The Blockchain Transparency Institute recently reported that over 67 percent of daily trading volume among the top 130 cryptocurrency exchanges is wash trading, accounting for over $6 billion per day. Such discrepancies are difficult to identify by traders and even harder to protect against.
Slippage is also rampant in cryptocurrency markets. Recent slippage research conducted by Sylvain Ribes concluded that inflated exchange volumes and wash trading had led to some astounding metrics, with some discrepancies in slippage revealing fabricated volumes as high as nearly 93 percent on some exchanges. It is worth noting that Ribes defines slippage in his study as the percentage change between mid-spread price and the lowest price he had to consent to sell the asset.
Revelations such as Ribes’ indicate the opaqueness of many influential participants in the cryptocurrency market ecosystem, leading to an entirely unprecedented medium for trading bots to work within, with some likely contributing to wash trading. The future impact of trading bots is also significant considering how the landscape of digital asset markets may look in several years with decentralized exchanges, DAOs, and AI analytics tools.
The prevalence of trading bots in cryptocurrency markets does not come without limitations, however. Many trading tools are purely targeting professional traders with extensive experience and are too sophisticated for mainstream investors. Moreover, there is no standard API for exchanges and using bots for market making is challenging in low volume environments, as is common with many smaller cryptocurrency exchanges and DEXs.
Trading bots in cryptocurrency markets tend to have a substantially high barrier to their use. Open-source trading tools require knowledge of programming languages to tweak them to meet specific needs effectively, and the interfaces tend to be highly advanced. Entrants to the cryptocurrency space are thus unlikely to use these tools, leaving a gap in the playing field to adequately navigate and protect themselves from harmful exposure.
Algorithmic trading tools are also primarily relegated to localized programs that need to be downloaded and hosted on a user’s computer. As a result, users need to keep their computer running 24/7 in step with the cryptocurrency markets, leaving their viability dependent on their Internet connection and requiring manually installed updates.
The increasing realization of the sheer amount of data available and waiting to be uncovered in cryptocurrency markets has brought new tools for investors. Built with innovative machine learning algorithms, social media indicators, and user-friendly interfaces, a new class of trading bots is set to have a sizeable impact on the growth of the market.
Bots are progressively becoming more intelligent, integrating diverse data feeds and real-time indicators as well as enabling enhanced customization to meet trading preferences. Trading bots are beginning to overcome some of their current limitations too, particularly in regards to targeting more mainstream investors with simpler interfaces and more conservative trading protections.
Some better known trading bot in the industry are Gekko, an open source bot and a straightforward tool for investors, Zenbot, which is a little bit more comprehensive than Gekko, and Cryptohopper, which offers advanced bots with intuitive user interface. The latter is also the first solution to incorporate crypto signalers (where experts share investment suggestions based on predictive machine learning.)
Trading bots will continue to evolve in cryptocurrency markets to meet trading needs. Especially once institutional investment starts entering the markets and the volatility and risks of manipulations are reduced, trading bots should begin to flourish with advanced AI and machine learning components.
That said, as crypto is in a tragic low these days in terms of public trust, it’s also safe to stay patient and wait for the market to stabilize before making any investment decisions.