Front Running: How This Practice Compromises the Integrity of the Financial Market

Introduction: Understanding the Threat

When we talk about front running in the context of the modern financial market, we are addressing one of the most controversial and harmful practices of contemporary trading. It is a strategy where intermediaries exploit insider information before significant trades are executed, capturing gains at the expense of trusting investors. The phenomenon has intensified especially with the rise of cryptocurrencies and decentralized platforms.

The Fundamentals of Front Running

What Characterizes This Practice?

In the traditional context of the financial market, front running occurs when professionals with access to confidential data make trades for their own benefit before client orders are executed. A broker who knows of an impending large transaction may buy or sell the same asset in their personal account, positioning themselves ahead of the natural price reaction. After the client's order is completed and the market moves as expected, the trader executes their transactions for profit.

This behavior constitutes a serious breach of trust, as it exploits confidential customer information for personal gain, fundamentally compromising fairness.

A Practical Example

Let us imagine a scenario where a large institutional investor wishes to acquire 1 million shares of a company. Upon placing this order through their intermediary, the intermediary recognizes that such a massive purchase will drive up prices. In advance, the intermediary buys 10,000 shares for themselves. When the original order is executed and the price rises as expected, they sell their position at significant profits. Meanwhile, the client pays a higher price than they would have without this manipulation.

Why is Front Running Still Illegal?

Regulations against front running exist for clear reasons:

1. Breach of fiduciary trust: finance professionals have a legal obligation to prioritize the interests of their clients, not their own.
2. Deterioration of market integrity: favors operators with access to information in advance, creating an unequal environment
3. Direct financial losses: investors and market participants suffer losses resulting from this price manipulation.

Regulatory bodies such as the SEC (Securities and Exchange Commission) in the United States impose severe penalties to combat these activities.

Manifestations in Different Markets

Front running is not limited to a single segment. In stock markets, it is historically more documented. In commodities and foreign exchange (forex), traders with insider information also exploit this advantage. However, it is in the cryptocurrency sector that this practice has taken on particularly concerning dimensions.

Front Running in Cryptocurrencies: An Expanded Reality

How It Works in Blockchain Networks

In cryptocurrencies, front running takes on distinct characteristics. In public blockchain networks like Ethereum, Solana, and BNB Chain, transactions remain visible before final confirmation. Traders and malicious bots continuously monitor the network for large pending transactions.

When they identify a significant operation, these dishonest operators pay higher priority fees so that their own transactions are processed first. If a large token purchase is about to be executed, the front runner anticipates by buying the available liquidity beforehand, later reselling to the original trader at an inflated price.

On Ethereum and BNB Chain, this occurs through high gas fees. On Solana, priority fees or advantages of validators with privileged access to transaction data are used.

The Vulnerability of High Slippage

Slippage tolerance represents a critical vulnerability point. When a trader sets a high slippage tolerance on decentralized exchanges, they are exposing themselves to price manipulation.

Consider an operator who wants to buy a low liquidity coin. If their slippage tolerance is very permissive to ensure the completion of the operation, a bot can detect this, acquire the available liquidity in advance through priority fees, and resell the asset at a price much higher than the tolerance allows. The original operator ends up paying significantly more than they planned.

MEV: Maximizing Gains Through Reordering

The concept of Maximum Extractable Value (MEV) further exacerbates the problem. Validators and bots can profit by manipulating the order of transactions within a block. In Solana, this mechanism operates particularly prominently, allowing well-positioned operators to seize value through strategic reordering.

When a large order is detected, a bot equipped with MEV quickly sends its own order to capture the gains from the expected price change. Although the high speed of Solana offers some mitigation, MEV remains a significant challenge.

Available Protection Strategies

Traders operating in a decentralized financial market can implement various defensive measures:

• Aggressively reduce slippage tolerance, limiting vulnerability to price manipulations.
• Use private transactions to hide orders from bots and malicious operators
• Fragment large operations into multiple smaller transactions, reducing visibility and impact
• Employ MEV protection tools, including MEV blockers and private mempools, which offer additional layers of privacy.

By understanding the mechanisms by which front running operates, investors can protect their interests and mitigate unnecessary losses.

Conclusion: The Path to Transparency

Front running represents a fundamental erosion of the ethical principles that should govern the financial market. Whether in traditional or emerging environments like that of cryptocurrencies, this practice destroys fairness and undermines trust. Through a deep understanding of how these strategies work and the adoption of appropriate preventive measures, traders, investors, and regulators can work collaboratively to establish a more equitable, transparent, and secure trading environment for all participants.