What exactly does low latency mean in the context of cryptocurrencies? This article will dive into that, explaining what it is and why it is important to crypto markets and exchanges.
The cryptocurrency market is extremely volatile by nature. Those who are active participants know this and adapt to its unpredictability by being more vigilant than ever before. Due to this infamous volatility, the prices (in other words, the data) can change quickly and at any moment. Their alteration can even occur within a fraction of a millisecond.
For a computer network to adapt to the rapid changes of this data, it needs to be optimized to analyze large volumes of data. Moreover, they need to be able to do so within very short time intervals. Put simply, to manage volatile data, the network should operate with the least possible delay. In other words, ‘low latency’. The lower the latency or delay in a computer network, the more efficient the network will be.
What is it? Low latency meaning
The term ‘low latency’ describes a computer network that is capable of processing a high volume of data messages. What’s more, it allows them to do so with a minimal amount of delay (i.e. latency). The design of these networks helps to support operations that typically demand near-real-time access to constantly changing data. Low latency in capital markets is the utilization of algorithmic trading as a means to react to market events. To elaborate, it makes them react faster than the competition, which in turn increases the profitability of trades.
What is seen as “low” is, for that reason, relative. However, it is also somewhat of a self-fulfilling prophecy. There are a lot of organizations and companies that are using the term ‘ultra-low latency’ to describe latencies under 1 millisecond. Regardless, it is a definition that is continuously evolving, with the amount of time that is “low” gradually shrinking.
Low latency is appealing in a wide variety of use cases. Generally speaking, lower latency is almost always a considerable improvement over slower packet transport. Among the several fields that low latency is in includes online gaming. The reason it is so desirable here is that it aids in creating a gaming environment that is more realistic. The term, however, is a common way to describe specific types of business use cases. One such case, in particular, is high-frequency trading that occurs within capital markets.
High-frequency trading is something that is completely automated. The execution of trades draws from the processing of algorithms that optimize trades. Specifically, trades that stem from the frequently changing market prices. Capital markets firms often compete on the speed of the processing of these algorithms and trade executions.
When it comes to the latency measurement, there are a few common phrases in relation to the process:
- Average latency: This term is indicative of the mean average time for a message to transfer from one point to another. The lower it is, the better. Times that clock in at under 1 millisecond are quite commonplace in a market data system.
- Co-Location: This is the act of tracking down high-frequency trading firms’ and proprietary traders’ computers. Particularly, within the same premises where the location of the exchange’s computer servers are. This effectively grants traders the access they need to see stock prices slightly before any other investor. The continuous increase in demand for co-location would result in many stock exchanges expanding their data centers.
- Latency Jitter: There are many use cases in which latency predictability in the delivery of a message is just as important as achieving a low average latency. In fact, it could be more important. This latency predictability often goes by the name of ‘Low Latency Jitter’. It describes a noticeable deviation of latencies pertaining to the mean latency measurement.
- Throughput: A common definition of this term is it’s the amount of data that is processed per unit of time. It refers to the number of messages that the system is receiving, sending, and processing. Moreover, its measurement is usually in the number of updates per second. Throughput has a notable parallel to latency measurements. Most of the time as the message rate increases, the latency figures will also.
Back in the early days of crypto markets, the dominating forces were both retail market participants and point-and-click traders. Since then the market would evolve and players with considerably more experience would enter the field. There is a high focus put on systematic and algorithmic trading within the traditional financial community. This essentially means that the same strategies are now working across the fast-growing cryptocurrency market. In the case of these firms, their DNA is not trading, nor is it just speculation. It also extends to technology.
In algorithmic trading, role latency plays is a vital one. This mostly derives from the fact that speed is a crucial entity in regards to the execution of a trade. In essence, the common outcome of low latency is competitive prices for trade execution. For a majority of firms, it was this lack of infrastructure that was not permitted entry into the market.
Because of this, the introduction of solutions focusing on low latency will provide plenty of benefits. It will simplify the entry of strong market participants from traditional markets. In addition, it will supply improvements to the underlying quality of the crypto market. This will be possible thanks to boosting liquidity and improving market fragmentation.
What the industry needs
For the cryptocurrency market, there are a handful of barriers that they need to overcome. In particular, for the following cases:
- Matching the standards that institutional investors are expecting
- Access to prosperous liquidity pools
- Considerably better infrastructure for high-speed trades with the lowest latency possible
Among the biggest issues is regulatory ambiguity. There are very few jurisdictions that have mature regulatory systems within the cryptocurrency industry. Nevertheless, it is crucial for the bulk of them to preserve a high level of corporate governance. By maintaining this, they are able to gain institutional trust. This can typically include strong Know Your Customer (KYC) procedures. Furthermore, it can include proper trade surveillance and market abuse observations.
Education and awareness are both areas in which the market needs to also make room for improvement. The subtle distinctions of analyzing crypto markets are very specific when it comes to the asset class. For that matter, fundamentals are usually incoherent and different from the prices that one sees on the screen. Another factor that is gradually becoming of great importance is the security of assets. This is due to growing cases of exchange hacks being a major cause of concern for many investors.
However, in a surprising twist, very few exchanges offer industry-standard Financial Information Exchange (FIX) connectivity. This is despite it currently being a substantial drawback on the part of the crypto industry for many institutional clients.
Latency & Cryptocurrency
The responsibility lies on cryptocurrency exchanges to effectively transmit the real-time prices of crypto assets they are offering to traders. As mentioned before, the markets are volatile, so these crypto prices change within milliseconds. Therefore, exchanges need to be capable of processing data fast enough to update the real-time prices. Moreover, they need to process the traders’ actions.
For cryptocurrency exchange platforms, especially those handling crypto derivatives, latency determines the level of success a trader can achieve.
For the average trader, placing and closing trades at the exact right moment at the anticipated price is always exciting. That being said, with cryptocurrency prices being volatile by nature, accomplishing this could be quite difficult with certain exchange platforms. For instance, a trader is expecting to place a long CFD trade on Bitcoin at $6,636.6. However, let’s assume that by the time the order placement occurs, the price is jumping to $6,636.9. According to the trader, if the contract was to close at $6,637.0, the profit margin will already be lowered.
Why it is a need for investors
The majority of cryptocurrency exchange platforms have a total lack of industry-standard connectivity. This is something that is becoming more and more apparent as time goes on, especially as low-latency options gain popularity. Traders who are looking to exploit price divergences across an array of trading venues are experiencing higher levels of competition. They are willing to go through it in order to boost network latency and tick to trade responses.
In an ever-growing manner, the solution to this appears to be collocation and hosting. Particularly, at data centers in association with major financial hubs such as New York and Tokyo. Collocation is gradually becoming more widespread within the crypto industry. Consequently, the market will eventually demand quotes for Best Execution and Best Bid Offer. Ones that require a sturdy network infrastructure, as well as low-latency connectivity across multiple major liquidity pools.
Digital asset exchanges wanting to tap into the increase of institutional investors need to remember something important during their endeavors. They need to ensure that the development of the product is with the best elements of traditional high-speed electronic trading. Collaborating with time-proven custody solution providers, as well as massive liquidity pools, within the market is a wise idea. Taking on this partnership has the potential to offer the best of both worlds for its participants.
So, why is it important?
Cryptocurrency exchanges that work in low latency mode provide various advantages to those engaging in the trade. This low level of delay makes it possible for traders to gain access to real market prices in real-time. The orders of traders are also processed in microseconds, guaranteeing that their placement is at the expected price levels.
Closing orders in low latency crypto exchanges take place efficiently at the exact same time. The closure of the trade is typically at the exact price where the trader pulls out. For example, a trader could purchase a BTCUSD CFD pair at $6597.0 and aiming to close the order at $6597.7. Afterward, the price eventually reaches $6507.7 and the trader places a request for the closure of the trade. It takes only a single second for the request to undergo an execution. So, by the time of closing the order, the price slides back to below $6576.9. The order will end up closing at a loss. This was not at all the case at the time in which the trader was initially placing the request.
This leads to the foregone conclusion of a low latency effect on crypto markets. The lower an exchange’s latency is, the more lucrative it will become to trade on a cryptocurrency exchange. By having low latency, traders are able to place orders at the exact that they intend to. In addition, they have free rein to close the orders at the price they want to.