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

in hive-108451 •  6 months ago  (edited)

Good day steemians and happy new year, This is season 5 week 8 of the crypto academy and I'll be doing the advanced task assigned by crypto professor @fredquantum

TASKS

  1. Discuss Dark Pools in Cryptocurrency in your own words. How does dark pool works?
  2. Discuss any crypto exchange that offers a dark pool. How does its dark pool work?
  3. What are the supported assets on the dark pool mentioned in (2) above? 4. What are the requirements for getting involved in dark pool trading on the platform? Is there any fee attracted? Explain.
    For the chosen dark pool, give a brief illustration of how to perform block trading on the platform. (Screenshots required).
  4. What's your understanding of the Decentralized dark pool? What do you understand by Zero-Knowledge Proofs?
  5. State one decentralized dark pool in cryptocurrency and discuss it. How does it work?
  6. Compare a crypto centralized exchange dark pool with a decentralized dark pool. What are the distinctive differences?
  7. 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?
  8. 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).
  9. What are the advantages and disadvantages of Dark pool in Cryptocurrency?


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Image designed in canva

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


Dark pools in cryptocurrency are mostly used by big-time investors such as institutional traders to facilitate the trade between a large number of securities. This form of trading has been present since the 1980s and has over the years grown and developed to occupy a sizeable percentage of the global market. A dark pool as mentioned facilitates the exchange of financial instruments just like any public exchange but the major difference which single out dark pools from any traditional public exchange is the absence of order books. Due to this, trades made on the dark pool are not made visible to the general public unless executed.

This feature of anonymity has proven its importance to institutions because of the avenue to make and place trades without the need to reveal the intentions behind such orders. This allows them trade large amounts of assets without the disadvantage of suffering a potential inimical effect on orders before execution.

A sizeable percentage of all dark pool trades is done in block trading. These kinds of trade involve the attribution of a predetermined price to a transaction of large quantity.

How dark pools work

In dark pools, orders placed or made can only be matched with other dark pool orders because the order books here are not visible to the general public. Due to the invisibility of order books, its somewhat vague to allow orders to get placed at market price. This is because the absence of the order book is detrimental to placing orders at market and so only limit orders are allowed on dark pools.

These orders just like any other limit orders only execute when a corresponding order suffices and a cross occurs, for this reason darl pool orders are limited to large transactions to prevent traders from discovering where the others side of the order book lies. It's interesting to note that there is no such thing as margin or leverage trading in dark pools, therefore the orders have to be met using real balances.


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


One crypto exchange that offers a dark pool is the kraken exchange.
Kraken exchange is a cryptocurrency exchange that facilitates the purchase and sale of cryptocurrencies and this exchange proud itself as one of the oldest bitcoin exchanges founded in 2011 by Jesse Powell to facilitate trading between fiat currencies and cryptocurrencies as well as provide useful information relating to prices of instruments to Bloomberg terminal. Its dark pool allows traders to be able to place orders and trade without the need to divulge their interests to other traders.

To access the dark pool on the Kraken exchange, traders would have to meet certain requirements mentioned later in this post. Once these requirements are met, trades in the form of limit orders can be placed on the dark pool incurring certain fees which would then be matched with other orders on the dark pool until its executed. Trades cant be placed at market prices because of the absence of order books and to prevent slippage from occuring.

There is no way to determine if a trader is a market maker or taker on the kraken dark pool because the trading fee incurred are the same for both parties in a trading pair.


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3. What are the supported assets on the dark pool mentioned in (2) above? 4. What are the requirements for getting involved in dark pool trading on the platform? Is there any fee attracted? Explain.


The dark pool on the kraken exchange only supports asset transactions involving the bitcoin and ethereum currency pairs. Some of the tradeable assets include:

  • Cryptocurrency pairs - BTC/ETH only

BTC/Fiat pairs

  • BTC/USD
  • BTC/GBP
  • BTC/EUR
  • BTC/CAD
  • BTC/JPY

ETH/Fiat pairs

  • ETH/GBP
  • ETH/USD
  • ETH/CAD
  • ETH/JPY
  • ETH/EUR

Requirements for getting involved in dark pool trading on kraken exchange

  • Dark pools are restricted to only users who have completed verification up to pro-level on the Kraken exchange
  • 50,000 USD is the minimum order quantity tradeable for ETH pairs
  • 100,000 USD is the minimum order quantity tradeable for BTC pairs.
  • Lastly, as mentioned before due to the absence of the order book only limit orders are supported in dark pools.

Is there any fee attracted

Dark pool trading also attracts certain fees. The fees in dark pool are larger than rates of normal limit orders, ranging from 0.20% to 0.36% on the Kraken exchange dark pool. However, with consideration to execution and completion of orders on the dark pool, the fees eventually decline. Therefore the basis for determining the fee to incur while trading on dark pools is dependent on your 30-day trade volume and executed orders.

How to perform dark pool trading on kraken exchange

It's important to note that dark pool trading is only available to those who meet the requirements mentioned above, especially verification up to pro level.

Once the conditions are satisfied, on the order menu. Users are required to switch from the default simple mode to advanced mode.

  • In the advanced order menu, click on the drop-down menu icon beside the order pair.
  • The dark pool option will be listed at the bottom of the options as shown below.


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source


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


Decentralized dark pools are very similar to regular dark pools in that they are also anonymized means of facilitating trade between large trading organizations whereby no party can tell the identity of the other party, and neither can important information relating to the transactions be divulged. However, decentralized dark pools as the name implies, provide for better and more secure digital methods of verification. In decentralized dark pools, the maintenance of fair market prices for trade participants with the exclusion of avenues for price manipulation exists.

Here, orders received are fragmentized or broken down and matched using a protocol known as zero knowledge proof

zero knowledge proof

Zero-knowledge proof is a protocol used to verify the integrity of various transactions in a decentralized dark pool. This protocol was first discussed in an MIT research paper submitted by Shafi Goldwasser and Silvio Micali in 1985 proposing the possibility to prove some properties of a certain number without having to disclose the number instead.
This was eventually refined to serve as a secure certification procedure that takes place between a prover and verifier in a dark pool. The prover is required to be able to prove to the verifier that they possess the knowledge of a specified piece of information without having to disclose the information itself.

This protocol is also known as ZK protocol. This protocol must possess three necessary qualities

  • Completeness- If the information in deliberation is in the possession of the prover, he must the able to prove it by convincing the verifier.
  • Soundness - In a situation when the prover does not possess the information, the verifier must be able to remain unconvinced.
  • Zero-knowledge - The details of the information should be known by the verifier beforehand, all that is required is to verify whether the prover has access to this information.


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

Republic Protocol

Republic Protocol is an open-source decentralized dark pool exchange for the cryptocurrency space established in 2017 by Taiyang Zhang and Loong Wan to facilitate OTC trading as well as the exchange of ERC20, Ethereum and Bitcoin cryptocurrencies through a decentralized dark pool medium.
The main aim behind the republic protocol was to create a medium to facilitate trustless transactions and enable a decentralized node network to assist in matching orders. By using a protocol called the Shamir Secret Sharing Scheme, republic protocol is able to break down these orders into smaller orders and redistribute them throughout a network.

Since orders are broken down into fragments in a decentralized dark pool network, it's sometimes possible to reconstruct an order if enough fragments of these orders can be combined and reconstructed. To prevent this from happening, republic protocol makes use of a smart contract built around the ethereum network called the registrar to prevent such scenario from occurring by organizing nodes into a kind of network topology which makes it very difficult to acquire enough fragments of orders required to reconstruct an order in a network.

Having explained, the different protocols on republic protocol, when an order is placed on the dark pool, the Shamir Secret Sharing Scheme breaks down the order into fragments and distributes these fragments across the network, after which the smart contract "registrar" is used to reorganize nodes in the network to prevent any particular node from being able to gain enough fragments of an order to reconstruct the initial order. Thereafter, the integrity of the orders is verified with the use of the zero-knowledge proof before being matched with other orders on the network.


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

ParametersKraken Centralized dark poolRepublic protocol decentralized dark pool
participation requirementIn order to have access to the dark pool on kraken users need to attain the highest KYC verification levelParticipation in republic protocol doesn't require any KYC verification procedure
Order visibilityAlthough the order book is made invisible, the exchange can still view the orders placedNo visibility of orders
fragmentizationOrders are not broken down into smaller ordersusing the zero-knowledge proof, orders are broken down to fragments
smart contractsdoesn't make use of smart contracts for tradeMakes use of smart contracts for trade and organization of nodes


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7. 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?


On December 4 2021, there was a flash crash in the market caused by a total of 4000 BTC being sold.

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image from coindesk

The market began to decline slowly and it was reported that 1500 BTC was sold in less than a minute shortly after. This caused BTC to lose over $9,000 in less than an hour falling from $57,652 to $42,019.86. The BTC market lost over $15,000 that trading day and the impact also extended to USDT, the largest stablecoin by market value, due to the tradeoff against BTC, Tether spiked briefly to $1.025 as the BTC market kept dipping obliterating any hopes of getting to $100,000 anytime soon.

Now due to the magnitude of such transaction, the sale was placed all at once and retail traders who saw the order knew what was coming. Everyone began to sell of their assets causing the candlestick to splike further leading to BTC price falling further. If a dark pool had been used, the order wouldn't have been publicised and wouldn't be made visible to the general public therefore the reaction against the sale would have been very minimal. The trader would have had his order broken to fragments, matched and executed at a limit price on the dark pool and thus the price would have been sustained.


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8. In your own opinion, qualitatively discuss the impacts of trades carried out in the dark pool on the market price of an asset.

The impact of dark pools on the market price of an asset cannot be ignored. A common mistake would be to state that dark pool trading doesn't impact price however every trade that happens in the market either impacts price materially.

As a result of the fact that different market conditions would result in different reactions in the crypto market, as traders out of sentiment would do everything possible to prevent a loss on asset. When huge orders are put in the market, large buy orders for example. Most retail traders would take advantage of this and in order not to FOMO, buy more of the asset in question. Bullish pressures are increased in a market for which large buy orders are observed causing the price to be driven further up and the same applies to large sell orders also. Here, in an attempt to safeguard investment, traders would sell off the asset at the current price causing the price to drop further down.

This price manipulation doesn't occur in dark pool trading. why? This is simply because information pertaining to the trade such as the order book isn't made visible to the public which helps in the sustenance of price. This is because large orders that have the capacity to cause a major impact on the market placed on decentralized dark pools are broken into smaller orders and matched with other limit orders until they are executed.

If the orders cant be seen to cause a reaction, then how does it impact price?
With the advent of technology =, trading has advanced over the years from the traditional methods to computerized and more sophisticated ways. Most trading is done by mechanized computers and trading robots that analyze and interpret market conditions before taking trades. Every order filled in the market has to be reported somewhere, the information may not be disclosed distinctly in the case of orders executed on dark pools however by on-chain and off-chain analysis bits and pieces would be given up, with which these computers and robots would use in the analysis. Therefore, these would have a subtle impact on price of an asset in the long run.
Also, dark pool trading allows relevant information pertaining to the price of an asset to be disclosed to the exchange which in turn improves price discovery but at the expense of reduced market liquidity.


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


Advantages

  • Transactions here are anonymous providing privacy
  • No slippage as traders certainty of execution of trades at intended prices is sure
  • Matching of trades is done by taking the average of the best between the bid and the ask price, therefore this leads to improvement of price.
  • Far more secure digital verification procedures when compared to traditional public exchange trading.

Disdvantages

  • Constant usage and mass adoption of dark pools by large firms and big investors for trading would reduce the liquidity in the market.
  • Lack of transparency due to the absence of order books on dark pools.
  • It's sometimes abused and used for exploitative practices by hgh frequency traders.

Conclusion
Dark pools are very useful in performing large volumes of trades and transactions anonymously with minimal impact to price.
The crypto professor has done an excellent job of explaining the concept of dark pools and dark pool trading to the students. Thanks to the steemit team for the crypto academy, It's done far much in helping me tackle the markets one knowledge at a time.

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