Explainer: What are Crypto Sandwich Bots?

DeFi is evolving and so are the trading strategies to attract lucrative returns. Off-late, sandwich trading bots have garnered widespread popularity for their ability to mint profits from price fluctuations. 

What are Crypto Sandwich Trading Bots? 

To put it simply, a crypto sandwich bot is an automated trading tool that monitors large buy/sell orders and places their own order (sandwich) between them. They use a technique called ‘sandwich trading’ that utilizes the price movements of an asset. 

The bots take total advantage of the blockchain’s transparency by analyzing the pending orders in the queue in a mempool. 

In an industry pacing at a CAGR of 9%, while valuing total revenue at USD 37K MN, traders are likely to utilize such tools. 

Inner Workings of a Crypto Sandwich Bot 

Core Components of Crypto Sandwich Bots:

• Mempool Monitoring
• Order Execution
• Trading Strategy

     1. Mempool Monitoring: Continuously scanning the mempool for large pending transactions that could move the market price significantly.

     2. Order Execution: Rapidly executing the front-running and opposing trades to capture the price movement.

     3. Trading Strategy: Implementing algorithms to identify profitable opportunities and manage trade entries/exits.

Sandwich trading bots continuously monitor the pool of pending transactions, waiting for confirmation and inclusion in the subsequent block. Once the bot detects a large pending transaction in the mempool, it executes two trades, as explained below: 

• First, the bot executes a trade at the current market price before a large order is processed. 
• Next, the crypto sandwich bot executes an opposite trade that closes the position and captures the price movement as triggered by the original large order. 

The bot literally ‘sandwiches’ the transaction between two trades; it pays a lower price to get in and exits at a higher price. Thus, it earns significant profits from the price difference. 

Since the blockchain ledger is transparent, Sandwich trading crypto bots are able to foresee pending transactions before they are included in the block. 

The trading strategy enables algorithms to identify profitable opportunities based on factors like order size, slippage tolerance, and market conditions, while managing trade entries, exits, and risk management.

Sandwich Trading Crypto Bot: An example for better understanding

Consider a large pending transaction on a DEX to buy 100 units of crypto, say ‘X’ 100 ETH worth $20,000 at the current market price of $200 per X. 

• The sandwich bot’s mempool monitoring system detects this large buy order waiting to be confirmed on the blockchain.
  
• Before the large 100 X buy order is processed, the crypto sandwich bot quickly executes its own buy order for 50 X at the current market rate of $200 per X, spending $10,000.
  
• Immediately after, the large 100 X buy order gets processed, consuming liquidity and driving up the price of X to say $202.
  
• With X now trading at $202, the sandwich trading bot sells its 50 X for $10,100 (50 * $202).
  
• So while “sandwiching” the larger trade, the bot was able to:
             * Buy 50 X at $200 each for $10,000
             * Then sell those 50 X at $202 each for $10,100
             * Netting a profit of $100 in a matter of seconds/minutes

Sandwich Crypto Bots – Benefits for traders and platforms

Here’s a quick run-through of the benefits for everyone:

• Liquidity provision: Maintaining liquidity in DEX order books, which can benefit other traders by reducing slippage and enabling smoother execution of large orders.
  
• Incentive for innovation: Incentivizes developers to create more advanced DEX protocols and scaling solutions that are resistant to front-running attacks, fostering continued innovation in the space.
  
• Automated trading opportunities: For the teams developing and operating crypto sandwich bots, they represent a potentially lucrative automated trading strategy that can generate profits without the need for human intervention.
  
• Price discovery: By rapidly reacting to large pending transactions, sandwich bots can help facilitate more accurate price discovery by immediately reflecting the impact of these orders on the market price.
  
• Stress testing DEX infrastructure: The high-frequency trading activity of sandwich trading bots can stress test the performance and throughput capabilities of DEX platforms, helping identify bottlenecks and areas for improvement.
  
• Regulatory compliance: Legitimate sandwich bot operations can be conducted in a fully transparent and regulated manner, adhering to applicable laws and guidelines governing financial trading activities.

While we are at it, it is worth mentioning another school of thought that argues against the use of such trading strategies. In DeFi, however, it is still not illegal to use sandwich trading for the above-mentioned pros. Not to miss, the regulatory landscape surrounding sandwich trading crypto bots is still evolving. 

Crypto Sandwich Bot Development: The 7-point Checklist

At first, it may sound like building just another trading platform, but crypto sandwich bot development requires deep-rooted expertise in blockchain, AI, and, of course, trading! 

The following components should form the core of your product:

• Mempool Monitoring: Implement efficient algorithms to continuously scan the mempool for large pending transactions that could significantly impact market prices.
  
• Order Execution Engine: Build a low-latency order execution system with robust connectivity to DEX nodes or relayers for rapid trade placement.
  
• Crypto Sandwich Bot Trading Strategy Logic: Develop algorithms to identify profitable sandwiching opportunities based on factors like order size, slippage tolerance, and market conditions.
  
• Transaction Signing and Broadcasting: Implement secure and efficient methods for signing and broadcasting transactions to the blockchain network.
  
• Scalability and Load Balancing: Ensure the sandwich trading crypto bot can handle high trading volumes and scale horizontally across multiple nodes or clusters.
  
• Security and Risk Management: Implement robust security measures to protect private keys and mitigate risks like flash crashes or network disruptions.
  
• Backtesting and Optimization: Rigorously backtest and optimize the sandwich trading bot‘s performance using historical data and simulations to refine the trading strategies.

Not to miss, choosing the right blockchain will be a key challenge if you don’t have tech expertise in this domain. Different blockchains and DEXs may have varying mempool structures and transaction fees, impacting the crypto sandwich bot‘s effectiveness. At Antier, we handhold our partners in researching all Layer-1, and Layer-2 blockchains and choosing the most appropriate platform.  

What is the future of Sandwich Trading Bots in DeFi? 

As the DeFi ecosystem continues to mature, a DEX protocol and a sandwich trading bot, in general, are likely to evolve in response to each other:

• DEX Protocol Improvements: Developers are exploring ways to mitigate front-running attacks, such as implementing commit-reveal schemes or encrypting mempool data.
  
• Privacy Solutions: Techniques like concealed transactions and privacy-preserving computation could make it harder for bots to identify and exploit pending transactions.
• Sandwich Trading Crypto Bot Evolution: Crypto sandwich trading bot creators may develop new strategies to circumvent countermeasures, potentially leading to a cat-and-mouse game between protocols and bots.

DeFi Strides Forward

As DeFi matures, crypto sandwich bots emerge as key players, reshaping the landscape with their nimble strategies. Their ability to swiftly capitalize on market inefficiencies underscores their significance in the DeFi narrative.