Dark Pools in Cryptocurrency - Crypto Academy / S5W8 - Homework Post for @fredquantum

Introduction

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Hello everyone, I specifically want to thank Prof @fredquantum for this exceptional lecture. I have really had my knowledge horizon receive some higher level of expansion.

1. Discuss Dark Pools in Cryptocurrency in your own words. How does dark pool works?

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Dark pool in crypto are hubs where investors purchase and sell crypto assets privately, without the knowledge of the general public. This simply means that the trading process undergone by investors are in complete anonymity, that way, the adverse effects of slippage, and plummeting of price of the asset in question will be cushioned.

The idea of dark pools helping to keep in check the plummeting of the price of an crypto asset is to satisfy the law of demand and supply which simply says that the higher the supply of an asset, the lower the demand for that asset and that will eventually lead to the drop in price of that crypto asset.

Dark pools are done privately to avoid the general public from seeing that big investors have placed their assets on sale so the people seeing it won't be in fear of the asset price drastically falling and then sell off their holdings which will lead to more plummeting of the price of that asset.

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How Dark Pools Work

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The crypto dark pool is specifically made for larger amounts of investment portfolios which are trading high quantity of cypto on a daily basis. It makes use of the limit orders to execute the selling of assets. This is done by setting the price at which the asset should be sold. When the price of the asset to be sold gets to that limit where the seller intended to sell it, then the order will be filled. This is much different from the market order which the order could be filled immediately but with a little slippage.

In the dark pool, the seller determines the price at which he wants his or her asset to be sold for but certainly not the time it should be sold. This means that the trade might take upto weeks or months before being completed but everything is done in anonymity. Every trader trading in the dark pool only have eyes on their own trade and can't see what's going on with the trades of others. The dark pool could therefore be seen or referred to as privacy pool.

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2. Discuss any crypto exchange that offers a dark pool. How does its dark pool work?

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The idea of dark pool first started in the traditional finance system. It then became important to introduce the idea to the crypto space so that block trades can be kept in anonymity.

Kraken, a UK cryptocurrency exchange in 2016 adopted the idea of dark pool, starting with the Ethereum dark pool. According to Jesse Powell, the CEO of Kraken, he believed that one of the ways of managing the reduction of market impact is to allow large quantity buying and selling of Cryptocurrency to be done secretively without the sentiment of one trader being revealed to another trader.

In 2021, the popular Kraken considered it a great idea to add some other dark pool to their exchange. The Bitcoin dark pool was then added to the exchange.

Kraken have their own specific dark pool where buyers and sellers are committed to trading some specified amount of Bitcoin or Ethereum. They have their minimum amount to be $50k worth of ETH or $100k worth of Bitcoin. This exchange uses the Limit order for the execution of trades. A trader is allowed to set a specific price at which his asset (BTC or ETH) is to be sold and then will have to wait patiently for the order to be filled. The trades of one trader on one end is hidden from that of the other trader on the other end. This is so because there is no order book in the Kraken dark pool, and ofcourse order book is mostly found where there is market orders.

One great advantage of using limit orders in the Kraken exchange is to eliminate slippage.

No one can determine who is the market maker and the market taker in the Kraken dark pool due to the secretive nature of the dark pool.

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3. What are the supported assets on the dark pool mentioned in (2) above? What are the requirements for getting involved in dark pool trading on the platform? Is there any fee attracted? Explain.

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Assets that are supported dark pool.

The Kraken dark is dedicated to focus on just two crypto assets which are ETH which was the first dark pool available in the Kraken exchange, and Bitcoin which was later added in 2021.

These assets have their trading pairs to be;

ETH Pairs

• ETH/BTC

• ETH/CAD

• ETH/EUR

• ETH/GBP

• ETH/JPY

• ETH/USD

BTC Pairs

• ETH/BTC

• BTC/CAD

• BTC/EUR

• BTC/GBP

• BTC/JPY

• BTC/USD

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Requirements for getting involved in Kraken's dark pool

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Since the dark pool of the Kraken exchange is not for every trader, certain criterion have been set aside to be met before trading in the Kraken's dark pool. These criterion are;

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• The trader must have attained the Pro Level verification of the Kraken exchange

• Only limit orders are allowed for the execution of trades.

• The least amount of BTC owned by the trader or investor should be $100k worth.

• The least amount of ETH owned by the trader or Investor should be $50k worth.

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Fee Attracted

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One beautiful thing about the Kraken exchange is that they try to reduce the fee charge for traders who have traded often on the exchange. This means that the number of times a trader has traded on the platform, the lower the fee he or she will be charged in subsequent trades.

But the standard fee attracted by the Kraken exchange is between percentage range of 0.20% to 0.36% of the total asset traded.

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4. For the chosen dark pool, give a brief illustration of how to perform block trading on the platform. (Screenshots required).

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To be able to show how to perform block trade on Kraken, I first have to show how to create an account.

Screenshot taken from Kraken

Here i have provided the details required to open an account on Kraken.

Screenshot taken from Kraken

Next i activated the newly created account.

Screenshot taken from Kraken

As the account has been successfully created, I clicked on Trade then on the New order interface, I switched to Advanced and then clicked on the trading pairs so as to display the list of available pairs in the dark pool.

As at the time of creating this post, the Kraken's dark pool was currently unavailable and because of that, I couldn't access the dark pool.

Screenshot taken from Kraken

But above is a screenshot I took from the from the Kraken site showing how the dark pool looks like.

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5. What's your understanding of the Decentralized dark pool? What do you understand by Zero-Knowledge Proofs?

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Decentralized dark pool is the hub where trading is done in complete anonymity but in a decentralized manner. This is to say that dark pool trades in the decentralized exchange are not facilitated by any third party, but instead, trades are done between peers. The price at which the trade was executed, the identity of the traders, and the trade volume are not divulged.

In the decentralized dark pool exchange, so many processes are curtailed compared to the centralised dark pool exchange. Take for example in the centralised exchange, a user has to go through some verification processes during registration. But a nothing of such is needed in the decentralized dark pool.

The decentralized dark pool helps to curb slippage of price in the mainstream market as a result of large trades execution.

Since there's no order book in the decentralized dark pool, orders are segregated into fragments and put back together using the zero-knowledge proofs.

Finally, in trades that has to do with many cryptos, atomic cross-chain swaps plays a great role in speeding up the transaction process.

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Zero-knowledge Proof

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Zero-knowledge proof is an interactive or non-interactive way of proving the authenticity and trustworthiness of anonymous information without divulging the secret information itself.

Usually, this protocol exists between two persons, one person being the prover and the other person being the verifier. The prover has to be able to make the verifier believe that a secret information or secret data has been correctly computed even when this data still remains unrevealed to the verifier.

The zero-knowledge proof is an ideal protocol in the decentralized dark pool in that it helps the execution of trades between two parties without the details of the trade, like the price, volume and identity of the traders being revealed.

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6. State one decentralized dark pool in cryptocurrency and discuss it. How does it work?

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The decentralized dark pool exchange I want to talk about is Republic protocol (RenEx).

RenEx is the first decentralized dark pool exchange coded with core concealed order book where trades executed are completely kept hidden from every other person, including the Republic protocol itself, except the person that executed the trade.

With it's verifiably fair exchange, traders are at liberty to execute large trades without any intermediary to facilitate the trade and everything about the trade execution remains unrevealed.

RenEx has something known as ZK-Snarks which acts like a zero-knowledge proof in the virtual machine of the RenEx. I already explained what the zero-knowledge proof is in the previous question.

The Dark nodes of the virtual machine of the Republic protocol connects one another to boost the storage capacity and the computational power of the virtual machine to provide robust level of comfort to traders. It also have the Anti-money laundering (AML) compliance integration which help secure the funds of traders while trading with the other anonymous party.

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How it works

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The Republic protocol was developed in such a way that it uses network of dark nodes that are completely decentralized to match up orders. This is done by segregating the orders into cryptographic fragments which are later shared to the entire network. The sensitive datas concerning the segregated orders are kept unrevealed. Then the dark nodes now begin to communicate with each other to match up the segregated data, having the reconstructed orders connect with each other. As soon as matching orders connect with each other, Atomic swap will now be introduced amongst two trading parties in a P2P manner.

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7. Compare a crypto centralized exchange dark pool with a decentralized dark pool. What are the distinctive differences?

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Centralized	Decentralized
There are series of verification required	There are little or no verification requirements.
Nodes do not interact with each other	Nodes interact and connects with each other
Orders are not completely private because the exchange has a way of seeing them	Not even the exchange can view the orders that has been executed.
The exchange sometimes could act as third parties to facilitate the trade	No third party is needed for the facilitation of trades.
It is limited to just two crypto asset which are ETH and BTC	More crypto assets can be traded in the decentralized dark pool exchange
It could be easily hacked	Hackers will find it more difficult to break through network of nodes, as such it is not easy to hack the Decentralized dark pool.

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8. Research any recent huge sale in any market in the crypto ecosystem and how it has affected the market. What difference would it have made if the dark pool was utilized for such sales?

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Just today, a huge transaction was made in the Bitcoin network which pushed the price of Bitcoin down.

Screenshot taken from Tradingview

At about 6pm of today, a huge sell of 21.5 BTC was made which was worth $889,030.90. That huge sell pushed the price of Bitcoin from $41,385.56 to $40,587.62

Screenshotshot taken from Block explorer

I went on to Blockchain explorer to see more details about the transaction. The transaction hash is 9c5b2242fe2200dc5d6719270fcf0d2d5bcf28de6237169b6dc8e6bf0641b7e3.

From the way I am seeing the current situation now, there might be more sell off by average investors and the price might likely still be pushed down the more.

Had this trade of 21.5 Btc been done in the dark pool, the fear of selling off will not really reach the average investors because the transaction would have remained undivulged. But as it is now, it has been disclosed to the public, therefore average investors might think of also selling off there holding to avoid more loss and that will even push down the price even more.

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9. In your own opinion, qualitatively discuss the impacts of trades carried out in the dark pool on the market price of an asset. (At least 150 words).

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The main reason of executing large sell trades in the dark pool is to avoid influencing the market by getting the average investors into fear or panic.

Similarly, large purchase can cause price of an asset to spiral because if average investors observe that financial institutions or whales are making big purchases, they will also want to follow suit, assuming that the whale or institution have a plan towards some acquisition. This could inturn send the price of that asset right through the roof.

But dark pool will not let the general public know if large purchase or large sell has been made in the market mainstream, that way the degree at which the price would have been pushed down will be curtailed.

But then, if majority of trading volume are being concealed, that is if majority of trades are being executed in dark pools, it will affect price on public exchanges because the price may not give a reflection of the actual market. And ofcourse, that is not an healthy property for any market because a greater amount of trading or investments directly depends on the availability of information flow.

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10. What are the advantages and disadvantages of Dark pool in Cryptocurrency?

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Advantages

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• It helps to hide the intentions of traders who wish to trade large volume of assets.

• Traders can execute their trades at the price which they intend without slippage.

• Price can be considerably improved in that the buyer and the seller can trade in a more favorable condition than they would in the open market.

• It help to cushion the level of price volatility.

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Disadvantages

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• Dark pools hinder the availability of information free flow which is an ideal factor in trading or investing.

• It bridges the transparency attribute of the blockchain, thereby causing an average traders to poorly execute their trades.

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Conclusion

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Dark pools are great trading strategies which could help reduce the level of panic, slippage and price volatility in the market. But it is of great disadvantage for average traders because it lets make decisions which they feel is right but on the normal sense of trading, they are actually towing the wrong direction because actual market price is not what is reflected on public exchanges.

Therefore, in my humble opinion, I feel dark pool should be just for institutional investors and not just for anyone meeting the requirements because too much of dark pool trading is not healthy for the market.

Thank you Prof @fredquantum for the awesome lecture.