The increasing number of crypto trading platforms is a testament to the fact that crypto trading is well beyond the nascent stage and is continuing to gain stronger acceptance among individual and institutional traders; which brings us to an important question currently making the rounds in crypto circles – how can crypto traders use algorithmic trading to execute trades more efficiently? Enter smart order routing (SOR), an advanced crypto trading algorithm used by crypto traders to navigate volatile crypto markets.
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As an automated process used in online trading, smart order routing follows a set of rules in order to look for market fluctuations. The goal of a smart order routing system is to assess trading liquidity and find the best way possible to execute a trade, it takes advantage of opportunities across a range of trading venues by making use of advanced algorithms.
The price of a certain cryptocurrency is assessed across several major exchanges to find the best price available to optimize the outcome of trading any pairs. Given that optimization is key to crypto trading, advanced algorithms such as smart order routing compare prices across all major crypto exchanges in real-time and simplify trading order execution.
Why is smart order routing particularly important in the crypto ecosystem?
The lack of a central body to regulate crypto markets and the fact that they’re heavily decentralized mandates the need for a system or a set of rules that govern crypto trade orders. In comparison to the US equity market, crypto markets are relatively more volatile which necessitates traders to be equipped with prices of several cryptocurrencies across multiple major exchanges.
How does smart order routing work?
The crypto market is one that is fraught with volatility. The role of a smart order router is therefore to successfully execute a chosen strategy, achieving more than just ‘best price’. In a highly fragmented and fast/dynamic crypto marketplace, smart order routing actually plays a crucial role in minimizing loss.
When a trader order comes through, a smart order router will ideally scan for all possible execution opportunities and will then execute at the best price after deciding on a particular strategy. By taking into consideration several parameters such as price, cost, volatility, position, venue preference, level of market depth, etc., a trader can build their execution strategy to manage or mitigate potential risks.
What are the basic components of a smart order routing system?
Typically, a smart order routing system is cloud-based and makes use of machine learning algorithms, its basic components include:
- A client gateway that’s useful to receive incoming orders
- A market gateway that sends orders to trading sites
- Smart order routing implementation – to retain SOR logic as well as custom algorithms in order to process orders
- Feed handlers (to provide market data for decision making)
- A client front-end as the user interface
Like any trading strategy, smart order routing comes with its own set of advantages and disadvantages.
- Since smart order routing assesses prices across multiple exchanges, it has the ability to simultaneously access several trading venues to identify the most suitable and efficient price execution strategy.
- It’s a useful framework for the use of custom algorithms.
- It provides traders with adequate information about each exchange and equips them with additional validation and control.
Along with involving a fair degree of complexity, smart order routing does come with its own issues such as additional latency and a risk of loss.
What’s the future of smart order routing like?
There’s been a significant increase in crypto players making use of smart order routing to gain a competitive advantage, while still maintaining essential standards in compliance and best execution against a likely background of much more intense scrutiny and regulation. As crypto markets continue to evolve, the role of automation and computerized algorithms in making decisions about how and where an order is executed is quite likely to increase, creating more space for advanced trading algorithms like smart order routing.