7 July 2020
A smart order routing (SOR) system is an automated trading process that aims to execute orders at the best opportunity among different cryptocurrency trading venues and market pairs. When an order comes through, the smart order router will scan for all possible execution opportunities. It will then execute at the best based on a chosen strategy. By controlling various parameters on the algorithm such as price, cost, volatility, position, venue preference, level of market depth, etc. a trader can customize their execution strategy and manage execution risk.
The basic components of a smart order routing system include:
Ideally, the whole system can be cloud-based and empowered by technology such as machine learning.
In general words, smart order routing seeks liquidity, where traders can execute orders without experiencing a drastic change in price. Most institutional investors and brokers will use a smart order routing system in order to find the best prices as quickly as possible to execute trades. With the help of SOR, institutional traders can automate and optimize their trade execution easily. Oftentimes, SOR breaks down a big order into many small orders and executes them at different venues to avoid any price slippage. Thus, SOR is also a great tool to mitigate risks for institutional clients.
Moreover, professional market makers would also use SOR to optimize trade execution and bring liquidity to our clients. As their SOR has access to different order books, crypto liquidity providers can monitor global markets and route a client’s order to a higher liquidity pool if the order is not able to execute due to low liquidity in its current market. Furthermore, smart order routing algorithms can evaluate all existing market pairs available and optimize the order execution route. For example, when there’s an order to buy Ether (ETH) with Bitcoin (BTC), moving position directly from BTC to ETH is not the only option. With a smart order router, we can evaluate all quote currencies and determine the best path to execute. A smart order router is so powerful that it not only executes trades at the best price within milliseconds but also helps capture and optimize arbitrage opportunities.
With the growing popularity of online trading, the number of trading venues has increased drastically, which has fragmented the liquidity – orders are executed across different platforms at a different price. Yet, smart order routers can hedge against the fragmentation by analyzing the market and executing orders towards a unified price. The adoption of SOR will help create a balanced market for many financial instruments, like equities, derivatives, fiat currencies, and cryptocurrencies. As cryptocurrencies’ trading volume has been skyrocketing in recent years, the need for smart order routing adoption is stronger now than ever. Institutional-grade smart order routing systems will allow the fragmented crypto market to become healthy and balanced.