Trading in asset markets has changed a lot in the last century. Shares of stocks used to be traded through pieces of paper, and “charting” of asset prices was done by hand. Human brokers were needed in order to physically place orders and keep records. However, technology has vastly changed the landscape of asset markets, and now any retail investor with a smartphone can buy or sell stocks, bonds, and derivatives.
The progress of computing capabilities has indisputably created more accessible trading environments. However, it has also changed the act of trading itself. In 2008, trading through computer algorithms became widely available with the launch of Betterment, spawning a new wave of “robo-advisors” that managed investment portfolios without human intervention. Robo-advisors were the first automated trading systems, and they inspired the development of more advanced, programmable trading tools (like bots) in traditional markets.
It was inevitable for these automated systems—and their offspring—to expand into the extremely tech-focused cryptocurrency asset markets. Crypto trading bots offer algorithmic (rule-based) trading of crypto assets in order to facilitate automated strategies. They are computer programs in which users define rules for buying and selling crypto. Trades are then automatically executed by connecting with either centralized or decentralized exchanges.
Those with programming skills can code these software tools themselves, but third-party crypto trading bots are available for purchase, as well. These include Coinrule, Cryptohopper, Bitsgap, and 3Commas.
How do crypto trading bots work?
Trading bots are simply software, and all programs can be conceived as having inputs and outputs.
Inputs – Bots use rules and information to execute trades. Just as a trader might want to buy an asset when it falls to a certain valuation, they can code a bot to do the same. These rules can become quite complex through technical analysis (TA), which comprises multiple strategies based on asset price, trading volume, chart candle patterns, and other indicators.
However, in order to apply the rules, bots must access cryptocurrency prices, digital charting software, and other important information. This is accomplished through Application Programming Interfaces (APIs), which are pieces of software that connect other pieces of software. For instance, an API allows a bot to collect potentially large volumes of pricing data from various sources like exchanges or oracles quickly and often.
Outputs – APIs also allow bots to generate their outputs: trades. After processing the relevant data and applying rules to that data, bots place trades on behalf of the users. These buy and sell orders are executed on either centralized or decentralized exchanges without any manual human intervention.
Uses for crypto trading bots
One reason that traders may want to use a bot is to remove the “human element” from their trading as much as possible. That is to say: even though traders program the rules, their emotions can still prevent them from following the rules. Meanwhile, bots are unemotional and follow rules to the letter. Many subscribe to the theory that this makes for more efficient—and potentially profitable—trading.
Bots are also able to move more quickly than people. That is why high frequency trading relies on computers to place quick trades to take advantage of fast-moving market forces. More and more, artificial intelligence (AI) is also being incorporated into bot-assisted trading.
What are the risks of using trading bots?
Many of the risks that come with crypto trading bots are the same as the risks of trading by other means. Mostly, crypto assets have historically experienced a lot of price volatility—especially when compared with traditional assets—and this can translate into significant losses.
However, other risks are unique to bots. In fact, even though one of the benefits of bots is that they are automated, that means they can’t react to market changes in a way that a human trader can. They must be re-programmed in order to adapt to new conditions. If left alone, that means they could act in a way that the user did not intend, potentially resulting in unprofitable trading activity. Furthermore, if they are programmed incorrectly, they can be unpredictable.
Additionally, third-party trading bots have access to user funds, which requires a high degree of trust. If a bot platform acts maliciously (or is hacked), users’ crypto wallets are at risk of being drained.
- Cryptocurrency trading bots are pieces of software that automate trading using pre-programmed rules.
- Bots operate using algorithmic rules set by users, usually based on technical analysis, and APIs that allow them to connect with exchanges.
- Specific risks of using crypto trading bots include programming errors, over-automation, and (in some cases) the need to trust third-party platforms.