Exploring the Brighter Side of Dark Pools in Cryptocurrency Markets
Dark pools, notorious for their anonymity in the traditional financial markets, are becoming a staple of cryptocurrency trading. However, in an October 2, 2018 report, CoinMarketCap argues that the once frowned up practice of anonymous selling might not be that bad for cryptocurrencies.
What Are Dark Pools?
Once reserved for traditional trading institutions such as asset-management companies, dark pools are now becoming a staple of cryptocurrency trading. But what are dark pools and why does so much controversy surround them?
Dark pools, simply put, are electronic trading platforms used in advanced markets. And while electronic trading platforms have been around for almost three decades, they’re very different from traditional exchanges. Dark pools allow traders to buy or sell large blocks of shares without having to disclose their identities, their trading volumes, or prices.
Most of the bad reputation these platforms have is due to its rather unfortunate name. Dark pools have nothing to do with the dark web nor the black market, which is why they’re so often misunderstood.
The word pool is interchangeable with the world market, while the term dark refers to the practice of markets omitting bids or offers. When dark pools are discussed within the context of cryptocurrencies, the assumption is that these dark markets would operate as continuous non-displayed limit order books.
However, CoinMarketCap disputes this claim in its report, saying that only a small minority of dark pools operate in such a manner. The report, written by Josh Greenwald, CEO & Founder of LXDX, a digital asset exchange platform, explained that dark pools usually derive their pricing from lit exchanges – markets that display their bids and asks.
Dark Pools Are Necessary
Greenwald pointed out that dark pools were initially built to minimize the market impact of displaying institutional-sized orders on lit platforms. As high-end trading algorithms are becoming the norm on lit exchanges, both small retail investors and large institutions are looking for ways to bypass these bots and run a profitable trade.
CoinMarketCap said that dark trading could be the best alternative. Dealing with a single set of willing buyers, outside of the public market’s view, facilitates a single fair execution price with delayed and dampened price impact, Greenwald explained in the post.
As simply turning off the lights on the pricing feed is not enough to meaningfully change the market’s dynamics, the argument people have against dark trading – namely that it’s either illegal or immoral – just doesn’t stand.
Greenwald argues that dark pools might be good for the market as they’re good for institutions, who themselves are often mutual funds, ETFs, or other aggregations of smaller investors. And if the market is good for institutions, then it by definition must be good for retail.
Dark pools have probably been one of the main factors that have attributed to market fragmentation when it comes to the world of cryptocurrencies. Trading the same product in many places and on many types of venues speaks to the core values of blockchain: decentralization, antifragility, and less dependence on a few trusted gatekeepers, Greenwald said.