Execution quality

Bringing transparency to order handling and execution

Retail traders in both traditional equities and existing DeFi markets have low visibility to how "good" their orders were executed. DFlow will release a series of products to address these pain points in the order execution cycle to help retail traders better understand how their orders were handled and executed.

Let's take a look at a number of new key stats that will be available with the launch of DFlow.

Price improvement

Price improvement refers to the cost savings that result when an order is executed at a price that's better than the best market price. In US equities, price improvement is calculated as the signed difference (e.g. -1 for buys and +1 for sells) between order execution price and the National Best Bid and Offer (NBBO), a consolidated tape of prices from various regulated exchanges. According to official disclosure, retail investors enjoy approximately $3-4 billion of price improvement annually.

On DFlow, orders are executed against a set of best-execution standards and price improvements will be calculated based on those benchmarks.

A breakdown of a hypothetical $1 bid/ask spread.

A breakdown of a hypothetical $1 bid/ask spread. The $1 spread is split amongst price improvement to retail traders, profit to market makers for providing liquidity, and earnings to wallets for routing order flow.

What is price improvement

Let's say a token has a bid of $14 and offer of $15 on an exchange. A market maker might quote $14.3 to buy and $14.7. A retail investor would have paid $14 to sell but now she can sell for $14.3 to the market maker – a price improvement of $0.3. On the other hand, she would have paid $15 to buy on the exchange but now she can buy for $14.7 – a price improvement of $0.3.

The market maker makes $0.4 from the spread and can pay the source of order flow (e.g. wallets) $0.1 (this is referred to as order flow monetization while still netting $0.3. Market makers don't have to improve prices on all orders, but they are incentivized to do so because they compete with each other for order flow. Better skilled market makers can provide more price improvements and therefore attract more order flow.

What is size improvement

In addition to price improvement, market makers can provide size improvement, which happens when the number of filled shares is greater than what's available at the best market price. The token has 150 tokens offered at $15 but an incoming buy order of size 525 is filled at $14.7, the price improvement is $0.3 per token. However, when taking into account the volume-adjusted price, the real savings is around $1.3 per token. This is because if the order was routed to the exchange, the trader would’ve paid 150 at $15, 175 at $16, and 200 at $17 for an average of around $16. Market makers on DFlow can fill orders at the best price regardless of size up to a reasonable amount.

Market prices for order flow

When market makers bid into auctions, they are pricing order flow. The price is derived from the winning bid of an auction, which is always for one specific token pair. For example, $1 million in notional size of ETH-USDC flow between $100 and $5,000 may be currently worth 1,000 USDC. The continuous bidding of auctions by market makers means price discovery of order flow is market-driven and in real-time.

Wallets can refer to order flow prices to make calculations regarding potential earnings. Market makers can use historical prices as a reference when bidding for order flow. The market price is updated live as new auction winners are announced.

Post-trade reporting

Transparency and having proper disclosures are essential for maintaining fairness and protecting retail investors in DeFi markets. DFlow focuses on making information both available and accessible.

Regulation in traditional markets

US equities is regulated by the Securities and Exchange Commission (SEC) and the primary regulation is called Regulation NMS (National Market System). Of the thirteen adopted rules in Regulation NMS, there are two primary ones that require market participants to release public reports on order execution. The intention is to improve transparency in retail order execution.

Rule 605: a monthly report published by "market centers" (e.g. broker-dealers) to show basic stats on execution quality like how market orders of various sizes are executed relative to a public quote (including price improvements, execution speed). 605 reports can be found directly from market makers like Citadel or Virtu, and a sample schema can be found on the SEC's website.

Rule 606: a quarterly report published by broker-dealers on their order routing practices. Brokers like Robinhood are required to publish these reports and a recent sample can be found here.

Provable and verifiable reports

DFlow intends on making significant improvements to existing reporting standards. Without clear and provable reporting on execution quality, retail investors have a difficult time making informed decisions on whether they are trading on the best venues and if they received the best possible prices.