What is Smart Order Routing and How Does Work In Crypto

Smart Order Routing (SOR) is a technology used in financial trading that automatically directs orders to the most suitable market or exchange in order to get the best price and execution for a particular trade.

SOR systems analyze real-time market data and route orders based on factors such as price, volume, liquidity, and fees. This helps traders to optimize their trading strategies and reduce trading costs by accessing multiple markets simultaneously.

SOR is commonly used in electronic trading systems for equities, options, futures, and foreign exchange (FX) trading. SOR is utilized in crypto in the form of DEX aggregators.

Key Takeaways

• On TradFi markets, Smart order routing was helping stock traders find the most profitable path for order execution. On a crypto market, this approach can also be quite useful.
• The key problems that cryptocurrency traders face include fragmented liquidity, the lack of trading liquidity for large orders, and inconsistent prices.
• SOR addresses all these problems by finding the best route for executing orders in real time in a fully automated manner.

What is a Route in the Stock Market?

In stock trading, the term “route” describes the path that an order takes to get executed. The most simple example of a route implies the following.

Say, a trader places an order on a stock exchange. A broker picks up this order and then transmits it further to a market maker to agree upon the price.

To help the customer get the best deal, the broker may send out the request to many different market makers at once. This will help him find the one who offers the best price.

Market makers, in turn, aggregate liquidity through different markets. At this, they usually work with such exchanges as NASDAQ, NYSE, and AMEX.

There is a problem, though. 

The markets and market makers are aplenty while a single broker simply cannot cover them all so as to find truly the best deal. Thus, users have to deal only with what brokers offer to them.

This is where smart order routing comes to help. With the predefined algorithms and rules, it automatically scans all the offers to find smart routes that would result in the most efficient deal.

How Does Smart Order Routing Work in Crypto?

The crypto market has a lot in common with TradFi systems. It surely has some perks and bonuses that make it superior. Yet, the basic principles remain the same.

Therefore, smart order routing can help to optimize the execution of trading orders here in a similar fashion. Here is what a typical step-by-step scenario looks like for those who use this method:

1. A trader places an order specifying the desired asset and the price that he is ready to pay.
2. Having received the order, the SOR algorithm starts analyzing the market data in real time. At this, it captures the information from various exchanges and liquidity pools.
3. SOR identifies the best execution route that would help the trader get the best deal. The order may be divided into several parts across different trading venues depending on the liquidity that different sources provide.
4. The system executes the order and updates its status. Thus, traders can rely on a fully automated process to find the best deal.

In fact, these are exactly the principles that DEX aggregators such as CowSwap and Matcha.xyz rely on. 

They scan a large number of decentralized exchanges and help traders find the best price for their orders at a given moment in time.

The Key Problems of Cryptocurrency Traders

Blockchain features many advantages when compared with traditional stock markets. 

Cryptocurrency traders have gained an opportunity to execute their orders 24/7 in a fast and efficient manner. At the same time, transaction costs have significantly decreased while blockchain provides its users with an unprecedented level of transparency.

Yet, the new technology comes with its own downsides as well. At this, crypto traders face the following key problems:

Fragmented liquidity. 

The number of crypto assets available for trading grows every year. So does the number of trading platforms, both centralized and decentralized. 

With such a great variety of choices, crypto liquidity becomes fragmented which complicates the process for its participants.

The lack of liquidity for large orders.

Traders who want to convert large sums of crypto may come across liquidity issues, too. In fact, it is practically impossible to find a platform that would provide the best deal for that. 

Thus, traders have to perform a lot of manual work to covert crypto in small portions buying out the whole order book. 

Meanwhile, the rate gets worse with every closed deal, and traders eventually lose money.

Inconsistent prices. 

Not only do the prices of cryptocurrencies constantly change. Due to market inconsistency, they may also vary on different platforms at a given moment in time.

Even if a trader gets verified accounts of a few dozen of platforms, there would still be no guarantee of the best price. Worse than that, the price may easily change while the order itself gets executed.

How Does Smart Order Routing Address These Pains?

Smart order routing can be very beneficial to cryptocurrency traders as it is capable of easing all of these pains. 

Here are some of the key advantages of this technology:

• Best price execution. Smart order routing helps traders to achieve the best price by allocating the path across various exchanges. 
• Full automation. SOR automatically checks prices across multiple platforms in real time. It eliminates routine work and helps traders place buy and sell orders in a much more efficient way.
• Faster trades. Thanks to full automatization, SOR can help traders to save time that they would otherwise spend on routine tasks.
• Solution to liquidity fragmentation. With smart order routing, it’s possible to allocate liquidity for large deals across different platforms. In TradFi, large investors often rely on the so-called “dark pools” to maintain their anonymity and avoid a sharp jump in stock prices. SOR represents an alternative way to solve this problem.
• Arbitrage opportunities. On top of everything, this technology can help to utilize market inefficiencies and make profits on arbitrage trading.

Thus, smart order routing in crypto represents the best solution for those who want to find the best deal for exchanging cryptocurrencies. 

Smart Order Routing as the Means of Dexs Upgrade

In the early years of crypto, traders had to deal with centralized exchanges - just because there was no other option available.

The first decentralized exchanges such as 0x or Loopring provided them with the so-needed level of security. They enabled their users to make trades on a peer-to-peer basis by using their custodial wallets.

Yet, since they relied on traditional order books, order based DEXs were never able to provide a sufficient level of liquidity.

Liquidity pools that emerged a few years later have solved this problem. Some of the first DEXs that relied on this solution include Uniswap, Balancer, and PancakeSwap.

Yet, as their number and popularity grew in time, users had to face the same problem of fragmentation again.

Smart order routing can solve this problem and move the whole enterprise to a totally new level.

Smart Order Routing vs Algorithmic Trading

Smart order routing and algorithmic trading are two different strategies used in the world of trading. While both strategies aim to maximize trading efficiency, they work in different ways. 

Smart order routing is focused on finding the best execution venue for a particular order, while algorithmic trading involves the use of algorithms to automate trading decisions based on predefined criteria. 

Smart order routing is more focused on order routing and execution, while algorithmic trading is more focused on analyzing market data and making trading decisions based on that analysis. 

Both strategies have their benefits and can be used together to create a more comprehensive trading strategy.