Introduction

In this chapter, we delve into the heart of Reform's operations - the trading engine.

We will explore the different algorithms that fuel our high-frequency trading and liquidity provision, designated market making, and arbitrage strategies. We'll also discuss the source of funds for each of these activities and how the resulting profits are utilized.

Prepare for an in-depth exploration of the mechanics behind Reform’s powerful engine!

The engine’s significance in Reform

The trading engine is the core of Reform. To fully understand its significance, it is important to reiterate the engine’s position in the complete revenue stream.

As explained in Chapter 3 regarding Value Flow in Reform, the funds that are raised from the Bonding Treasury flow directly to the trading engine. The engine will then trade to generate realized profits based on three core strategies:

1. High-frequency trading for liquidity provision

2. Special algorithm for projects market making

3. Arbitrage

Let’s explore these techniques below.

Liquidity provision using high-frequency trading algorithms

The trading algorithms are designed to execute a large number of orders at extremely high speeds. The main algorithm being used will be a high-frequency grid and dollar-cost averaging (DCA) algorithm, which fills buy orders. This have proven to be effective in this highly volatile market. This high-frequency trading allows Reform to do liquidity provision on exchanges.

Liquidity provision is a critical aspect of high-frequency trading, where algorithms place maker orders just outside the current market price to capture the spread within the grid.

By doing so, these algorithms provide markets with the necessary liquidity for other traders to execute their orders efficiently. The key to successful liquidity provision lies in the algorithm's ability to process market data in real time, predict short-term price movements, and execute orders with minimal latency in the respective grid.

Reform has developed an Optimized Grid Strategy that enhances the ability to trade with tight spreads, as small as 0.001%, specifically on centralized exchanges. This strategy is tailored to ensure profitability even in highly volatile markets, showcasing the adaptability and resilience of the algorithm.

The core of this approach lies in the creation of a highly optimized grid that operates with little differences between orders. This arrangement allows for the exploitation of even the smallest market movements, ensuring that every opportunity for profit is taken. As a result, this strategy not only supports the liquidity of the market but also generates realized profits directly for the DAO treasury. Moreover, the effectiveness and efficiency of this strategy are transparently demonstrated through data available on the dashboard. This allows users to observe the performance and potential of the Optimized Grid Strategy in real-time, providing a clear and measurable insight into its capability to generate profits.

Algorithm for market making of designated projects

Market making for designated projects involves creating a market for a specific cryptocurrency or token. This practice also incorporate liquidity provision, where these algorithms continuously placing buy and sell orders in the grid to ensure that there is always a market for the asset.

The challenge with market making for designated projects is the higher risk of holding less liquid assets, which might be more volatile. To mitigate these risks, algorithms are designed with risk management strategies that adjust the spread and order sizes based on the current market conditions and the liquidity of the asset.

It's crucial to emphasize the importance of inventory management within these algorithms. This is because if the market maker runs out of assets to buy or sell, it cannot fulfill its role and potentially lead to a loss of liquidity for the asset. Thus, maintaining an adequate inventory is as critical as the strategic placement of buy and sell orders.

To address this, Reform’s inventory is optimized continuously to ensure liquidity is generated without interruption. This optimization is a delicate balance—holding too much of a less liquid asset increases risk while holding too little can result in missed opportunities and ineffective market making. The optimization of inventory, therefore, involves careful analysis of market conditions, trading volumes, and the asset's liquidity to adjust holdings dynamically. By leveraging advanced algorithms, Reform automates the process of inventory optimization, ensuring that decisions about asset holdings are made swiftly and based on the most current market data. This automated decision-making process is crucial for adapting to rapidly changing market conditions.

Algorithm for arbitrage

Arbitrage algorithms seek to exploit price discrepancies of the same asset across different markets or exchanges. The basic principle is to simultaneously buy an asset at a lower price in one market and sell it at a higher price in another, capturing the difference as profit.

Arbitrage algorithms are complex due to the need to factor in transaction fees, transfer times, and the potential impact of trades on market prices. They must quickly identify arbitrage opportunities, execute trades across multiple exchanges, and manage the risks associated with price movements during the arbitrage process. Successful arbitrage requires high-speed data analysis and order execution, as price discrepancies often exist for very short periods.

This capability leverages price disparities to generate short-term profits and strategically balance inventory across exchanges, positioning the firm to benefit from future price fluctuations. For instance, if the firm holds tokens valued at 1000 on one exchange, it can buy the same tokens at a lower price on another exchange and sell them at a higher price on the first exchange. This approach not only yields immediate financial gain but also creates a harmonized balance of assets.

At Reform, the approach to arbitrage is unique. Unlike typical strategies that might rely on a single main exchange for price references, Reform monitor prices on all exchanges in all pairs. This method enhances our ability to exploit arbitrage opportunities effectively.

Rebates

An additional term to understand is called Rebate. A rebate is an incentive offered by exchanges to reward users for the trading volume they generate and for providing liquidity to the exchange. Essentially, the more volume and liquidity users provide, the more they can be compensated through these rebates.

Exchanges may offer 0% fees to further incentivize participation. The rebate level could be significant, potentially adding up to 0.01% of the volume created by the user. For instance, generating a trading volume of $5 million could result in a daily rebate of $5000 if the rebate rate is 0.01%.

This system encourages more participants to offer liquidity, which in turn increases trading volume and, consequently, the rebates earned, creating a beneficial cycle for both the exchange and its users.

The engine that redefines the market

In conclusion, the trading engine is a vital component of Reform's operations, leveraging complex algorithms to generate profits from liquidity provision, project market making, and arbitrage. As we continue to innovate, Reform remains committed to transparency and the integrity of our operations, providing real-time data for users to monitor the performance and potential of our strategies.