Crypto and the Latency Arms Race: Crypto Exchanges and the HFT Crowd

Max Boonen is founder and CEO of crypto trading firm B2C2. This post is the second in a series of three that looks at high-frequency trading in the context of the evolution of crypto markets.

Carrying on from an earlier post about the evolution of high frequency trading, how it can harm markets and how crypto exchanges are responding, here we focus on the potential longer-term impact on the crypto ecosystem.

The rise of "Alternative microstructures" is mostly evidenced in crypto by the surge in electronic OTC trading, where traders can receive better prices than on exchange.

Crypto exchanges must not forget their retail roots.

Crypto exchanges that favour the fastest traders will find that winner-takes-all latency strategies do not improve liquidity.

Trudeau further remarks that official, paid-for co-location is better than what he pejoratively calls "Unsanctioned colocation," the fact that crypto traders can place their servers in the same cloud providers as the exchanges.

As the crypto market matures, the business model of today's major cash exchanges will come under pressure.

Exchanges have to pick a side: either cater to retail or court HFTs. Now that an aggregator like Tagomi runs transaction cost analysis for their clients, it will become plainly obvious to investors with medium-term and long-term horizons that their price impact on exchange is worse than against electronic OTC liquidity providers.

In the alternative, what if crypto exchanges focus on HFT traders? In my opinion, the CME is a much better venue for institutional takers as fees are much lower and conventional trading firms will already be connected to it.

My hypothesis is that most exchanges will not be able to compete with the CME for fast traders, and must cater to their retail user base instead. In a future post, we will explore other microstructures beyond all-to-all exchanges and bilateral OTC trading.