Brief explanation of Dark Pool

List of contents

• What is a dark pool?

• What are the benefits of using a dark pool?

• What makes dark pools controversial?

• Decentralized dark pools

• Closing

What is a dark pool?

Dark pools are private containers that help exchange financial instruments. This differs from public exchanges in that here there is no visible order book, and trades are not visible to the public (or only visible if the order has been executed).

Liquidity in the dark pool market is known as dark pool liquidity. Most dark pool trading is done in block trades. Block trade is a large asset transaction at a predetermined price.

Dark pools first appeared in the 1980s and have been used mostly by institutional investors trading large amounts of securities.

Using dark pools allows institutions to place orders and execute trades without indicating their intentions first. This is very useful, as their intention to buy and sell large amounts of assets has a detrimental impact on their trading even before the order is executed.

Dark pools have grown to become a sizable part of the global equity market, and this article will discuss their potential impact on the cryptocurrency environment.

What are the benefits of using a dark pool?

• No impact on market sentiment: Traders who want to trade large amounts can hide their intentions from fellow investors.

• Better prices: Matching trades are usually done based on the average of available bid and ask prices. Thus, both buyers and sellers get a more profitable trade than if they had done it in the open market (Buyers have to buy lower, and sellers have to sell higher).

• No slippage: Since most dark pool trades are executed in block trades at predetermined prices, traders can ensure that they can execute all their trades at the intended price.

What makes dark pools controversial?

• Conflict of interest: Since the order book is invisible, there is no guarantee that trades are executed at the best price. If the company facilitating these trades has a conflict of interest, it is possible to cloud the real price of the market.

• Adverse effects on market prices: If most trading occurs in dark pools, prices on public exchanges will not reflect true market prices. Most investing and trading relies on the free flow of information, and dark pools hinder the availability of this information.

• Susceptibility tohigh-frequency traders (HFTs): Dark pools can be an ideal playground for high-frequency traders who engage in predatory practices. If they have the privilege to access order book data, they can place large orders and take advantage of other unsuspecting traders.
  Dark pools also allow another method called pinging, which is the placement of very large amounts of small orders to plan hidden large orders. It is used to measure areas of liquidity in the order book and gives high frequency traders an advantage that could be considered unhealthy for the market.

• Shrinking average trade size: Since their emergence in the 1980s, the average size of dark pool trades has continued to decline significantly. This indicates that it is no longer only financial institutions trading at large sizes that use dark pools. This makes its existence no longer attractive and may even be detrimental to the wider market. Things can lead to a healthier market if small orders are executed in exchange with a publicly visible order book.

Decentralized dark pools

Similar to dark pools in traditional equity markets, dark pools for trading cryptocurrencies are available on some trading platforms.

When compared to dark pools in general, decentralized dark pools have the advantage of having a more secure digital verification method. Decentralized dark pool protocols can maintain fair market prices for all participants without the possibility of price manipulation.

In trades involving multiple blockchains, inter-chain atomic swaps can be used to facilitate trades without the need for an intermediary party.

Decentralized dark pools can also use other new cryptographic technologies such as zero-knowledge proofs to verify the integrity of dark pool transactions.

Dark pools can also be useful in illiquid cryptocurrency markets, as they allow traders to execute trades in larger amounts without any slippage. Large orders are likely to have a significant impact in an illiquid market, but these can be executed in a dark pool without slippage.

Due to the lack of institutional traders, dark pools have had only a minor effect on the cryptocurrency market, but this is likely to change in the future.

Closing

Due to the lack of transparency, dark pools have always brought controversy since their existence. In any market, hiding a large portion of trading volume is not desirable.

With the latest developments in cryptographic verification methods, the process of using dark pools can become more secure. Open-source protocols can be built in a way where every participant is treated with the same rules, this reduces the risks in using dark pools.