A mainstay of conventional finance markets, dark pools of liquidity are popping up in the cryptosphere. Is this a good thing for investors? Does it matter? What even is a dark pool? Hint: they have nothing to do with the dark web but everything to do with institutional money. Understanding the reason behind their existence sheds light on whether or not dark pools will benefit the crypto community.
To those that don’t have backgrounds in conventional finance, dark pools are either two words that have never come up next to each other in the same sentence or a commonly misunderstood part of healthy markets. The term is short for dark pools of liquidity, which essentially translates to private venues for institutions to exchange assets in large block-sized orders while minimizing the impact to public markets. That’s a bit of a mouthful, however, so let’s stick with dark pools.
Dark and Lit Markets
Users in the trading interface on a typical cryptocurrency exchange will see a lot of the same components across different platforms: candlesticks, market pairs, balances, trade history, and the order book and depth chart. Those last two items illustrate the current public market: the bids, the asks, and the volume of each. When a trader submits an order to buy tokens, other traders can see that bid appear in the order book. That visibility into the order (and all other orders on the exchange) defines a lit market.
Conversely, in a dark market, those bids and asks are hidden from all parties. This idea was born out of a need to minimize market impact. Posting institutional-sized orders in lit markets can cause slippage of the bid or ask because other traders can see that there’s a whale in the pool, and react by driving the price in an unfavorable direction. In a dark pool, however, a trader can post an offer that’s not seen by other parties, but if it matches with another offer it gets filled. Dark pools typically use market order types using mid-price derived from public lit exchanges. Traders need not specify a bid or ask price, but simply state their intention to buy or sell and the quantity of the order. For example, a trader may put in an order to purchase 1000 BTC at market price, while another a trader independently submits an order to sell 1500 BTC at a market price, and those two orders match and fill.
Are dark pools good for crypto?
While there’s very little precedent in which to make an accurate prediction of whether or not dark pools will benefit the crypto community, the case can be made that yes, dark pools are probably a good thing for digital currency markets. They provide a venue for institutions to trade and may, therefore, facilitate the entrance of institutional liquidity into the market. Diversity in markets--and marketplaces-- also adheres to a primary cornerstone of blockchain: decentralization. Dark pools provide one more type of platform for the exchange of assets; it’s up to traders to self-select for where they want to trade.
Cody Solomon, Director of Marketing at LXDX