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frontrunning (n): the practice by market makers of dealing on advance information provided by their brokers and investment analysts, before their clients have b
by alexpetralia 8y ago
frontrunning (n): the practice by market makers of dealing on advance information provided by their brokers and investment analysts, before their clients have been given the information
The prototypical example is a large investment bank hearing about a large client buy order, then putting in a buy order first on their own book, knowing it will go up due to the client order. It is a violation of your fiduciary duty to the client.
- Misdicorl 8y agoMarket makers aren't agents/brokers. They do not have clients.
- tptacek 8y agoRight, and races between mutually disinterested market participants aren't frontrunning, which is what I assume the subtext of that comment was.
- BubRoss 8y agoExcept one party doesn't realize it is a race.
- tptacek 8y agoThat doesn't matter. The actual offense of frontrunning involves an agent-principle relationship between the parties.
- phildaian 8y agoAuthor of the paper here. I justified our use of the word "frontrunning" on a Twitter thread: https://twitter.com/phildaian/status/1116698738343460864 https://twitter.com/phildaian/status/1116698738343460864 There are a few different points here. Firstly, there are plenty of unambiguous definitions of frontrunning that are accepted by the scientific community that this blatantly does fall under; see the Clark SoK we cite in our paper for this in the blockchain space, or the definition Wikipedia uses, which was from an economics article by Khan & Lu (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1140694 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1140694): "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade." The second point here is even if you want to restrict the definition to require privileged information, privilege in p2p networks is not binary: there are some nodes that are better peered on the topology, have better mining equipment, etc. who can use these privileges to extract market rent, harming the security of a blockchain. This is a complex and dense paper that took 8 people 18 months to produce, and I recommend you read it with an open mind, rather than having a gut reaction to whether we use your preferred definition of "frontrunning". I also recommend reading the primary source material directly, or at least my summary on Twitter - https://twitter.com/phildaian/status/1116155236433956865 https://twitter.com/phildaian/status/1116155236433956865 Happy to answer any questions!
- scottlocklin 8y agoIt's not a "preferred definition." Your definition of frontrunning is simply incorrect. FWIIW Michael Lewis is considered to be a serial fabulist by most people on Wall Street; his "flash boys" was a particularly egregious example of this, being a marketing effort for IEX, which was funded by friends of Michael Lewis.
- phildaian 8y agoI linked you to several sources for my definitions and you haven't commented on any of them, so no idea how you could reach that conclusion. I've explained to you that even with your restrictive definition, our paper covers analogous behavior in DEXes. Yes, it's very surprising, no, shocking, that people on Wall St. are reluctant to have behaviors like this called out publicly.... I am not Michael Lewis and cannot speak to the accuracy of his facts; our work is a scientific paper backed by a lot of data currently undergoing peer review. The views on HFT and market design in the paper are similarly informed by cited work that is quite extensive in its data analysis, and peer reviewed. I recommend you read it!
- tptacek 8y agoHelp me understand what you're trying to say with that middle paragraph, about how "shocking" it is that people on Wall St. are reluctant to have behavior called out? To what behavior are you referring? I'll add: on Twitter you noted that virtually every HFT trader, lawyer, and quant pushed back (either to your definition or to your allusion to Lewis's unfortunate book). You seem to think that's added credibility for your argument. Isn't a near-universal rejection of that argument from subject matter experts sort of damning for the position you're trying to take?
- scottlocklin 8y agoYou pointed out no such thing, and regardless; no such bona fide definition of "front running" exists. You got it wrong: admitting your error would be the honest thing to do. It's OK to be wrong; that's part of science and rational enquiry. It's not OK to not admit that you're wrong. FWIIW I'm not on Wall Street; I work in tech. Wrong again. Your results are both trivial and basically linkbait. Everyone who knows what a time priority order book is knows there are stale orders on DEX exchanges. The fact that people are arbing them is markets doing what they're supposed to do; creating one price across disconnected markets. Anyone who knows what they're doing and uses a DEX knows this; DEXes are for people who for whatever reason can't use central exchanges, or for smart contracts that are less concerned with getting the best price marked to the millisecond. In fact I pointed out the stale order issue to people who created the one of the more popular DEX protocols over lunch. They pointed out what DEXes are for. I guess nobody sent you the memo. It's OK to not know this; I didn't know. Personally I think they're bloody stupid, but you making their use out to be something sinister or poorly understood is ... well, a lot like Michael Lewis paranoid lunacy. I realize you're not Michael Lewis, but you're taking on the title of his execrable book to sell ... something much less science fictiony and exploitative than his tall tales, but still fairly off the mark.
- chatmasta 8y agoIn the case that they also run the exchange where they are making the market, they most certainly do have clients.
- bunderbunder 8y agoI think that the definition in the parent's comment is erroneous. You don't have to be a market maker in order to front run; any broker-dealer can do it. That said, I think you're off a bit on the nomenclature, too. Market makers can indeed have clients. For example, [1] is a list of the Chicago Mercantile Exchange's market makers for equity options. Citigroup, which has clients out the wazoo, is on the list. It's (presumably) just that the market making operations themselves are not done on behalf of a client. You're maybe conflating the concept of a market maker with that of a proprietary trading firm. It's very common for market makers to be prop shops. Prop shops, by virtue of not having clients of their own, are perhaps some of the least-well-positioned firms to engage in frontrunning. But a player like Citigroup or Goldman Sachs (which does a fair bit of currency and interest options market making) could have a relatively easy time of it. [1]: https://www.cmegroup.com/trading/equity-index/e-mini-equity-index-options-rfq-contact-directory.html https://www.cmegroup.com/trading/equity-index/e-mini-equity-...
- JumpCrisscross 8y ago> Market makers can indeed have clients Market makers generally don't have clients. Once upon a time, I was a big-bank algorithmic equity derivatives market maker. We only had counterparties. Sometimes, those counterparties were our own bank's sales-trading desks. We were isolated from them, in terms of supervision and information access. (The sales-traders had clients.)
- BonesJustice 8y agoI work on a market making team at a major investment bank, and I can back this up. There is a very clear and serious separation between those who trade bank funds and those who trade client funds. We are not allowed to know anything about their positions, accounts, strategies, etc. (and vice versa). Not only are there very stringent access controls in place to prevent cross-contamination, but there are physical boundaries as well. When the guy who runs the business side of our team started collaborating on a project with a team that did client trading, he had to move off our trading floor and into an office, and we had to revoke this access to, well, pretty much everything. He wasn’t allowed to go near our traders’ desks. It stayed that way until the project ended.
- branchless 8y agobanks are often also market makers
- ABCLAW 8y agoA lot of people, including the author of Flash Boys, would dispute how narrow that definition is. You don't need a client for there to be a systemic problem with trading on everyone else's advance information when the advance information is the buy order itself. Wikipedia states, for instance: >Front running, also known as tailgating, is the prohibited practice of entering into an equity (stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large pending transaction that will influence the price of the underlying security. No client needed.
- SilasX 8y agoWeird, I remember an earlier version of the Wikipedia article distinguishing frontrunning (client orders, you buy for yourself, you fill order) from tailgating (client orders, you fill order, you buy for yourself). Edit: And that version claimed tailgating is legal. Looks like it was in this version: https://en.wikipedia.org/w/index.php?title=Front_running&oldid=469233082#Tailgating https://en.wikipedia.org/w/index.php?title=Front_running&old...
- ABCLAW 8y agoYeah, not sure why they accepted that edit. Tailgating is something entirely different.
- tptacek 8y agoFollow the cite from the Wikipedia definition you just quoted and you'll find, in the linked paper, that it goes right back to Flash Boys.
- ABCLAW 8y agoThe definition is probably cited in a lot of places because it's literally just the definition of insider trading. Which frontrunning is a form of. A nice neutral primer on the HFT frontrunning debate can be found here, which contains a note regarding the HFT industry's attempt to advance the 'fiduciary' requirement. https://fas.org/sgp/crs/misc/R43608.pdf https://fas.org/sgp/crs/misc/R43608.pdf Matt Levine, for instance, is very firmly on the 'keep frontrunning to only mean brokers interceeding before client orders' side of the semantic battle. Charlie Munger, by contrast, had no issues calling out the entire HFT industry as 'evil' and 'legalized front-running'. All this to say, there's clearly a lot of fight over the semantics here. If you want to look at the official industry position, look at the communication between SIFMA and FINRA during the relevant time period wrt frontrunning regulations. You'll see SIFMA makes repeated reference to recognizing they have a duty in respect of customer orders, while the FINRA rules (5270, for instance) do not track this language. SIFMA attempted to conflate Rule 5270 (Front Running of Block Transactions) with Rule 5320 (Prohibition Against Trading Ahead of Customer Orders). I know a few people who have admitted in private that this strategy was not a mistake. Rule 5270 notably has no exclusionary requirement that the non-public knowledge is in respect of a client trade. Rule 5270 also contains a definition of Publicly Available Information, which requires that the trade be COMPLETED prior to it being public. To note how much of a gong show this situation was, note that in requests from SIFMA to delay the implementation of Rule 5270, FINRA said they'd grant the extension because firms needed time to train staff and retool systems - but FINRA explicitly noted that the activities prohibited under 5270 were almost all already illegal and covered by other FINRA rules. So insider trading on non-public information is illegal and that's not news. Unless everyone does it with computers for a while. The regulator would look like an idiot for charging practically the entire industry, so instead they tell people they have a few years to knock off all that silly business while giving them a stern finger wagging. But they only 'fixed' it for large orders, and then only in an official sense. The SEC hasn't done much in the way of enforcement on this point.
- jijji 8y agoA large investment bank Knight Trading would queue orders after the market closes, and then in the morning they had software that would insert their own buy/sell orders based on what was sitting in the queue from the previous night. Doing this they were guaranteed to make a certain amount of profit every day, and from what I was told it was perfectly legal.
- fnord123 8y agoKnight was a market maker, not an investment bank.
- trickstra 8y agodoes that make it ok?
- fnord123 8y agoA market maker's job is to have orders sitting on the book to provide liquidity to the market.
- trickstra 8y agosure.. but does that mean it's ok if they stuff them with their own orders in a way nobody else can and that gives them guaranteed profit at the expense of others?
- fnord123 8y agoIt does. And exchanges and other venues are continually updating to prevent market micro-structure from being able to be easily exploited.
- WalterBright 8y agoI never put in trades to be executed at the next opening. One always gets an adverse price that way.
- Tomminn 8y agoThe origin of the term is kind of comical to modern ears: The terms originate from the era when stock market trades were executed via paper carried by hand between trading desks. The routine business of hand-carrying client orders between desks would normally proceed at a walking pace, but a broker could literally run in front of the walking traffic to reach the desk and execute his own personal account order immediately before a large client order. [1] [1] https://en.wikipedia.org/wiki/Front_running https://en.wikipedia.org/wiki/Front_running
- mieseratte 8y agoReminds me of the term "sneakernet." I wonder if "front running" was a thing back in the days of manually moving changes onto a source control server located in-office. I can imagine a mad dash to get code in first on a Friday afternoon.
- arthur_pryor 8y agosneakernet is still a useful thing for large transfers (even in literal walking distance, sometimes). like if i'm sending a large file to a person in the same office or house, i might prefer to just put it on a thumb drive and hand it to them, instead of copying it to some network share or something. i imagine this will be true for a while (i.e. the practical throughput of sneakernet in many cases will keep outpacing the practical throughput of wired and wireless networks, probably for a long time).
- Terr_ 8y ago> The origin of the term is kind of comical to modern ears It's interesting, but I don't think it stands out as "comical" from the finance realm, given that programmers unironically talk about "race" conditions during the "handshakes" from "tunneling" with a "certificate" in order to to "serve" up "pages". On a far-more-obscure note, the etymology of "computer" itself can be traced back towards "something which counts using small pebbles of limestone."
- smnrchrds 8y ago
- JumpCrisscross 8y ago> It is a violation of your fiduciary duty to the client It is a violation of being put in a position of confidence with respect to privileged information. Front-running clients is always bad. But one need not have a fiduciary relationship with a counterparty to front run them. Practically speaking, however, when non-client relationships involve front-running, we usually go after them as insider trading. (For example, suppose I trade for a hedge fund. I hear my PM is going to buy X. So I buy X. One, I front ran my own shop's order. But two, I also violated their confidence.)
- tptacek 8y agoThis expanded definition --- of the possibility of "frontrunning" when in possession of confidential information --- is the context of the Khan & Lu paper the paper coauthor cites below to justify his use of the term in this Ethereum paper, and, of course, does not really apply here. It's of course worth mentioning that in the US, "insider trading" is itself defined largely in terms of fiduciary duty. There's nothing wrong with developing and exploiting proprietary sources of tradable information; in fact, as Matt Levine points out, that's kind of the point of a market (to aggregate information and discover prices). What's really problematic is when you're given access to private information in confidence and then use that information to trade against the owners of that information. (I imagine this is not new to you; just for the thread).
- tanderson92 8y agoIn even succint-er Levine-y terms: its not about fairness, it's about theft.
- evrydayhustling 8y agoThe "duty" part is why this definition doesn't apply well to this case. Arbitrageurs here are working with the same public information of all other participants, and have accepted no obligations towards the folks whose orders are informing them. Although this is clearly a structural issue with the exchanges that participants should be aware of, the term "malfeasance" is being thrown around a bit loosely in the paper.
- deleted 8y ago[deleted]
- bitreality 8y agoI have been trying to simply visualize how a front runner makes money. Now I think I understand it. Basically, a front runner looks for orders which will move the price on an exchange. So if an exchange has the following sell orders: 0.1 BTC @ $5100 0.1 BTC @ $5110 0.1 BTC @ $5120 And someone places either a market buy for 0.3 BTC, or a limit buy for 5120+, then they would expect to get 0.3 BTC @ 5110 average price. However, the front runner, if they can see this order is about to be placed, could theoretically buy 0.2 BTC @ $5105 average, and instantly relist them for 5120, knowing they will be immediately sold to the $5120 limit / 0.3 BTC market buy order about to be placed, in this case pocketing $15/BTC
- Ntrails 8y ago> in this case pocketing $15/BTC minus fees and commissions (trading being negative sum is always worth highlighting)
- menzoic 8y agoSounds similar to what Robinhood does.