What Is Dark Pool Trading?

While most of us trade on centralized and decentralized exchanges, a big share of crypto trades takes place in so-called dark pools. This concept has been around for decades in traditional markets but is gaining popularity in crypto too. In today’s article, we discuss what dark pool trading is, the regulation around it, and ways to spot them.

What Is Dark Pool Trading?

The dark pool, therefore, is a place of exchange, where institutional investors (and connected wealthy individuals) can execute trades privately. In some cases, dark pools are accessible to the public via retail brokers. In regular exchanges, the order book is publicly available, so large orders can cause excitement or panic in the markets before the trade is even filled.

Dark pools work without this transparency, allowing players to discretely (and anonymously) find a counterparty for the trade. Dark pools limit the reporting of these trades to the absolute bare minimum that is legally required. As a result, these trades rarely affect the price of the underlying instrument that was traded.

The way this works raises questions about the legality of dark pool trading. Obviously, the secrecy of the dark pool results in participants having more information than the average trader on the open market; the latter doesn’t know about the order until it is reported after all. Many people consider the market to be transparent, but this part of the market definitely is not. Nevertheless, it’s perfectly legal, albeit with limitations.

Why Is Dark Pool Trading Legal?

I struggle to find a conclusive, definite answer to this question. I can think of a few reasons, though. Firstly, the dark pool benefits the institutional investor. Whether we like it or not, this group of people has a huge sway over policy and regulation in the markets. Entire lobbying groups and campaign donations are used to make sure new regulation does not hurt the bottom line of influential players. As long as these influential players benefit from dark pool trading, I doubt it will be made illegal anytime soon.

However, I do not think the benefit goes to the rich alone. When you think of the effect some of these large orders would have if they were to be executed in the open market, the consequences in some cases would be massive. The accounts of many traders could be obliterated by that single order. In that sense, the dark pool is a safeguard that prevents unnecessary volatility. The markets tend to overreact to news, but when the trade has already taken place, some of this effect is mitigated.

Nevertheless, there are strict rules and regulations concerning dark pool trading to prevent misuse. In the past, certain dark pool operators used information made available within the pools to their advantage. They got caught and fined and stricter laws were put in place to prevent this unfair advantage from being used again.

All in all, I think dark pool trading is a good way to provide affluent players with a place to handle large transactions, while minimising the effects on the open market. As long as the transactions are reported transparently after the fact, I don’t see a reason why they should be made illegal.

How to Check Dark Pool Trades?

Dark pools use secrecy for a reason. It is therefore quite difficult for an average trader to spot dark pool trades. However, there are a few things to keep in mind that might help you to identify dark pool trades.

Firstly, do not expect all dark pool trades to look the same. While all dark pools share the common factor of secrecy, they all have different frameworks of rules and conditions. This adds to the difficulty of spotting the trades, as there is no set-in-stone fingerprint for a dark-pool trade.

Now in recent years, dark pools became less of a secret society club. These days, most people are able to participate in the dark pool as smaller size of trades are allowed. This means the discrepancy in available information is changing and more and more players have access to what is called “inside” the dark pool. Moreover, arbitrage is becoming more and more common, where bots and frontrunners figure out what orders are out there to quickly find ways to use that liquidity to their advantage. As I discussed, dark pool operators have been fined for such practices before, but as far as I’m aware other participants can do with the information whatever they want.

With that increased popularity, the edge of having dark pool information is probably going to fade away sooner than later. I can’t help but wonder if you really need to see dark pool trades. After all, it is aimed to prevent market moves, and is quite successful at doing so. If there is no move to capitalize upon, the benefit to the average trader is limited.

The crypto landscape is obviously regulated less strictly, but it will change over time. I, therefore, make the personal conscious decision to “ignore” dark pools, and let others fight for the crumbs of edge that can be found there. I keep preaching the same concept of simplicity, and not putting too many factors in a system. Mine will be fine without dark pool information, will yours?

As usual, please remember this article is based on my limited experience in crypto trading and should not be considered advice. Do your due diligence, have some fun and make some money!