Does the Use of Derivatives Increase or Decrease Front-Running Risk on a CEX?
The use of derivatives generally increases the complexity and potential impact of front-running risk on a CEX. Derivatives, especially those with high leverage, magnify the profit potential from small, successful front-running trades on the underlying spot asset.
Furthermore, the need for large-scale hedging or liquidation of derivatives positions can generate predictable, large spot market orders. These large orders are prime targets for front-running, as their price impact is nearly guaranteed to be profitable for the front-runner.
Glossar
Futures Contracts
Mechanism ⎊ Futures contracts, within cryptocurrency and broader financial derivatives, represent standardized agreements obligating parties to transact an asset at a predetermined price on a specified future date; these instruments facilitate price discovery and risk transfer, extending beyond traditional commodities to encompass digital assets and complex financial indices.
Price Impact
Execution Cost ⎊ Price Impact quantifies the immediate change in an asset's market price caused solely by the execution of a single trade, reflecting the inverse of available liquidity at the point of execution.
Profit Potential
Attainment ⎊ Profit Potential in derivatives trading is derived from the ability to employ leverage, hedge existing exposures, or speculate directionally on future price movements with a relatively small initial capital commitment.