Frontrunning: How Traders Benefit from Market Information

Frontrunning is a trading practice that affects both traditional financial markets and crypto exchanges. In this technique, informed market participants use their knowledge of large upcoming transactions to strategically place their own orders and profit from the resulting price movements. This article explains the mechanisms behind frontrunning, why it is problematic, and how traders can protect themselves from it.

Basics: What is behind Frontrunning?

Frontrunning refers to the practice of exploiting insider knowledge about a large upcoming transaction to gain a trading advantage. A broker, trader, or service provider who learns about a large order strategically places their own positions ahead of this transaction, anticipating that the market will move in their favor.

The behavior has several characteristic features:

Access to confidential information: The frontrunner knows details about large upcoming transactions before they are publicly known.

Advantageous order placement: Based on this knowledge, the frontrunner buys or sells the same asset before the customer order is executed.

Profit realization: When the large transaction affects the price as expected, the frontrunner closes their position with profit.

Frontrunning in Traditional Financial Markets

In stock markets, commodity markets, and foreign exchange markets, frontrunning is a well-known issue. A scenario could unfold as follows:

An institutional investor instructs his broker to buy one million shares of a company. The broker realizes that this large order will likely drive the stock price up. Before executing the customer order, the broker buys 10,000 shares at the current price himself. After the customer's large order has driven the price up, the broker sells his shares at higher prices and realizes his profit.

This practice violates the trust relationship between broker and client and undermines market integrity. For this reason, frontrunning is legally prohibited in many countries. Regulatory authorities enforce strict rules to protect confidential client information and ensure fair market conditions.

Frontrunning in the Crypto Space: A Growing Problem

Blockchain technology has created new dimensions for frontrunning. On decentralized exchanges (DEXes) and in DeFi protocols, frontrunning works differently than on regulated markets.

How Frontrunning Works on Blockchains

In public blockchains like Ethereum, Solana, and the BNB Chain, transactions are visible before they are confirmed. Malicious actors or bots can specifically monitor these visible transactions.

The typical process:

1. A large trade is buffered in the Mempool and is visible to the public.
2. A bot detects this large order and places a higher gas fee.
3. The increased fee will prioritize the bot transaction and process it first.
4. The bot buys the token at the current price
5. The original large order will then be executed and drives the price
6. The bot sells its position at a profit

On Solana, the mechanism works similarly: Validators can use priority fees to favor transactions. The system allows bots and privileged actors to place their orders ahead of others.

Slippage tolerance as an attack surface

Markets with low liquidity are particularly susceptible to frontrunning. The slippage tolerance – the maximum price deviation that a trader accepts – plays a central role.

An example: Bob wants to buy a low-traded token on a decentralized exchange and sets a high slippage tolerance (, e.g. 50% ), to ensure that his trade is executed. A frontrunning bot detects this order, pays higher gas fees, and buys large amounts of the token first. The price increases. Then Bob's order is executed, but at a higher price than the original – within his tolerance, but with unnecessary costs. The bot sells its purchased tokens to Bob at this elevated price and profits from the difference.

MEV (Maximal Extractable Value) on Solana

Solana is struggling with the concept of MEV. MEV describes the profit that validators or bots can achieve by reordering transactions within a block. On Solana, actors can pay priority fees to have their transactions placed preferentially – a direct mechanism for frontrunning.

When an MEV bot identifies a large buy or sell order, it quickly places its own order with higher fees. Its transaction is processed first, benefiting from the impending price movement of the large order, and the bot realizes profits at the expense of the original trader.

Why is frontrunning problematic?

Frontrunning violates fundamental market principles:

Exploitation of trust: Financial intermediaries are obligated to act in the interest of their clients. Frontrunning constitutes a breach of trust.

Unequal Opportunities: Only those with access to privileged information can benefit. Ordinary traders are at a disadvantage.

Financial Losses: Frontrunning causes unnecessary costs and losses to other market participants.

Market distortion: The practice leads to inefficient prices and reduces trust in decentralized systems.

Protective Measures Against Frontrunning

Traders can employ multiple strategies to protect themselves from frontrunning:

Reduce Slippage Tolerance: A lower slippage tolerance ( e.g. 0.5% instead of 50% ) drastically reduces profitability for frontrunners, as the order would fail faster.

Private transactions use: Some services allow private transactions that hide their values before they are confirmed.

Order fragmentation: Splitting large transactions into several smaller positions makes them less attractive to frontrunner bots.

Utilize MEV protection mechanisms: Protocols are working on solutions such as:

• MEV-blocker that protect transactions
• Private Mempools that hide transactions from the public mempool
• Fair-ordering systems that determine the order arbitrarily
• MEV auctions that distribute profits fairly

Conclusion

Frontrunning is an unethical trading practice that is regulated in traditional markets and poses a constantly growing challenge in the crypto space. While decentralized systems lack central regulators, traders can minimize their vulnerability through conscious strategy and modern protective tools. Protocol developers are continuously working on technical solutions to create fair trading environments. Those who understand frontrunning and actively counter it can avoid costly losses and contribute to a more integral market structure.