Cryptocurrency Dark Pool

Learn about dark pool liquidity and the risks and benefits associated with them. Discover why these private forums for trading securities, derivatives and other financial instruments exist and the purpose they serve.
Author: Rosemary Barnes
Time to reading: 8 minutes

What are Cryptocurrency Dark Pools?

Dark pools enable large investors to trade with each other independently of the standard exchanges. This article summarises how cryptocurrency dark pools work and the role they play in the cryptocurrency space.

With traditional investing, dark pools refer to private exchanges that operate outside the standard exchanges such as NASDAQ and NYSE. Dark pools enable large organisations and investors to trade large volumes of financial products discreetly and anonymously. They differ in that there is no visible order book and trades are not publicly visible, or only become visible after they have been executed. This is one of the benefits of dark pools, as an intention to buy or sell a large volume of a specific financial instrument could have an adverse effect on their trade before it is even executed. It also ensures that slippage is avoided.

Advantages of Using a Dark Pool

  • Decreased impact on market sentiment as traders can conceal their intentions

  • Price improvement as matching of trades is usually done based on the average of the best available bid and ask price

  • No slippage as traders can be sure that they will be able to execute their entire trade at the intended price

For these reasons, it was only a matter of time before dark pools started to have a presence in the cryptocurrency markets and the number of dark pools in cryptocurrency trading has risen in recent years accordingly. Indeed, several exchanges are now offering a dark pool trading facility to customers for a fee. Hence, within the cryptocurrency ecosystem, dark pools work in a similar way to the traditional financial markets, serving as places for trades between large institutional investors, while helping to bolster liquidity at exchanges. There are also a few differences.

Differences Between Crypto Dark Pools and Standard Dark Pools

There are two ways in which cryptocurrency dark pools differ from standard dark pools. Firstly, the former requires cross chain transactions or transactions between multiple blockchains of cryptocurrencies. Many exchanges offer pairings for dark pool buy and sell orders in order to facilitate trading between cryptos. Secondly, the execution of dark pool orders usually differs. Rather than directly matching buy and sell orders, a Matching Engine using multiparty computation (MPC) protocol is used. This breaks down a large order into a number of smaller orders which are then connected to buyers and are then reconstructed using identifying information. Breaking down of orders in this way ensures security and anonymity.

Compared with regular dark pools, cryptocurrency dark pools offer the advantage of better digital verification techniques and the associated protocols help facilitate a fair market price for all participants by eliminating the possibility of price manipulation. In addition, future developments in cryptographic verification methods will make the process of using dark pools even safer with the use of open-source protocol that can verifiably maintain the same rules for each participant.

Dark pools are also useful in illiquid cryptocurrency markets since as we have already seen, they allow traders to execute larger trades with no slippage. While a sizable order could have a considerable impact on an illiquid market, the same trade can be executed in a dark pool with no slippage.

While the use of dark pools in cryptocurrency is seen by some as controversial and are sometimes blamed for generating increased volatility and putting slower traders at a disadvantage, their benefits mean that we will undoubtedly continue to see them play an increasingly important role in the crypto market.

    cryptocurrency marketscryptocurrency dark pooldark pooldark pool trading
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