Compared to retail investors, institutional investors often impact the market due to the large volume of their trades. In traditional financial markets, to prevent large trades in commodities, stocks, and forex from significantly influencing market prices, institutional investors typically turn to “dark pools” for assistance.

Unlike public trading markets, a “dark pool” is a more private alternative trading system that allows buyers and sellers to anonymously match trades without immediately disclosing transaction details. This model provides numerous advantages for its primary clientele of institutional investors.

With the rise of decentralized finance (DeFi), the concept of dark pools from traditional finance has also been introduced into crypto markets, especially as the demand for privacy protection and liquidity has surged. The on-chain dark pool sector has seen significant growth. This article provides an overview of the development, advantages, core technology, and challenges facing this sector, along with a brief review of notable blockchain-based dark pool projects.

What is a Dark Pool?

Dark pools originated in the United States in traditional financial markets as early as the 1980s. At that time, the rise of high-frequency trading, facilitated by high-speed computers, led to a situation where excessively frequent trades within short periods disrupted the normal functioning of the market, causing significant price volatility, including sudden spikes or crashes.

Source: stockprices.com

In response, dark pools emerged as alternative trading systems designed for private transactions. They allow institutional investors or affluent traders to execute large-scale trades (valued at no less than $200,000 or over 10,000 shares) while minimizing their impact on market prices. By keeping transactions anonymous and not disclosing trade information in real time, dark pools offer lower transaction costs.

Advantages of Dark Pools

For institutional investors, the primary advantages of dark pools include the following:

• Confidentiality
  Confidentiality provides two main benefits. Firstly, anonymous operations ensure that institutional investors do not reveal information to competitors, helping protect their trading strategies or intentions and preventing market manipulation. Secondly, before trades are executed, details such as order prices and trade volumes are not disclosed to the public in real-time, reducing price fluctuations in the secondary market and minimizing market impact.

• Liquidity
  When institutional investors trade in large volumes, the market may struggle to absorb these trades quickly. Dark pools increase the likelihood of finding and matching suitable trading counterparts, offering a more favorable trading environment.

• Cost Efficiency
  By trading in dark pools, investors can avoid causing severe price fluctuations in public markets, allowing them to achieve more favorable trading prices. Additionally, dark pool transactions involve fewer intermediaries, reducing transaction costs and facilitating transactions at more advantageous prices.

Thanks to these benefits, institutional demand for dark pools has grown steadily. Data shows that over 60 dark pools are registered with the U.S. Securities and Exchange Commission (SEC), including those operated by broker-dealers, agency brokers, or exchanges, as well as those provided by independent operators. In terms of trading volume, dark pool transactions now account for 30-50% of stock trading volume.

Trends and Challenges in Dark Pool Development

Over the past few decades, dark pools have experienced significant growth. This expansion has brought about new trends and heightened scrutiny from the market and regulators.

Firstly, an increasing number of countries are supporting dark pool trading.

Dark pools originated in the United States; in 1986, Instinet launched the first dark pool called “After Hours Cross.” Initially, dark pool trading accounted for only a small portion of the market. In 2007, however, the SEC passed the NMS (National Market System) regulation, which allowed investors to bypass public venues for trading.

As more participants entered dark pool trading, dark pools began to dominate securities markets in the U.S. and Europe, spreading to Asia as well. Singapore announced its dark pool plans in 2009, followed by Hong Kong’s first dark pool trading platform in 2010, and Japan and South Korea also began allowing dark pools.

Secondly, dark pools are shifting from large trades to smaller trades.

Originally, dark pools were designed to conceal large trades to reduce market volatility, and some dark pool platforms even filtered out smaller orders. However, in recent years, as institutions increasingly break large orders into smaller trades to improve liquidity, the average trade size in dark pools has gradually declined to under 150 shares.

Although dark pools are legal and regulated by the SEC, their opaque nature constantly attracts skepticism from the market and regulators.

The most controversial aspect of dark pools is their potential to distort price discovery—the process by which market participants determine an asset’s price through trading. Institutional investors, who generally have access to more information and resources, may influence prices more. Dark pools enable these investors to hide specific trade details before execution, and any post-trade disclosure may be delayed or partial, which can easily lead to misleading information and hinder price discovery.

Additionally, as dark pool trading volumes grow, they draw more liquidity away from public exchanges, potentially increasing transaction costs for retail investors and decreasing market efficiency.

Despite traditional dark pools’ emphasis on privacy, information leakage remains a persistent issue, especially when financial incentives are involved. Dark pool operators are often accused of misusing the dark pool data they control for insider trading. According to The Wall Street Journal, securities regulators have collected over $340 million from dark pool operators since 2011 to resolve various legal charges.

The opacity of dark pools is a “double-edged sword”—it is both their signature feature and the source of significant controversy. Lack of transparency raises concerns among retail investors and complicates regulatory oversight. In 2022, the SEC proposed a regulation requiring dark pool operators to execute market orders in the public secondary market instead of in private markets, except where the dark pool offers a clear price advantage.

Overview of Crypto Dark Pools

Crypto dark pools are similar to dark pools in traditional financial markets; they also match buyers and sellers for large orders while maintaining confidentiality by not making order books public, thus minimizing market impact.

More importantly, crypto dark pools benefit from blockchain’s decentralization. Through smart contract interactions, buyers and sellers can trade without intermediaries, effectively addressing the trust issues in traditional dark pools. For example, decentralized exchanges (DEXs) like Uniswap use automated market maker (AMM) mechanisms to facilitate and match token trades for users.

As the scale of cryptocurrencies continues to expand and more mainstream institutions enter the market, the growing demand for crypto liquidity has significantly driven the development of over-the-counter (OTC) markets, including dark pools.

On the other hand, blockchain’s inherent transparency presents new challenges to maintaining privacy in dark pool transactions.

In the crypto world, users can easily use tools like blockchain explorers to access detailed transaction information. Addresses associated with institutions and large holders (“whales”) are often tagged and tracked, allowing others to attempt trade replication or even engage in MEV (maximal extractable value) attacks, front-running transactions for potential profit.

Core Technologies of Crypto Dark Pools

To address the above challenges, crypto dark pools adopt privacy-enhancing technologies (PETs) such as zero-knowledge proofs (ZKP), secure multi-party computation (MPC), and fully homomorphic encryption (FHE) to build their core technology framework.

• Zero-Knowledge Proofs (ZKP)

Zero-knowledge proofs allow one party (the prover) to prove to another party (the verifier) that a statement is true without revealing any additional information about that statement. In trading scenarios, ZKP can be used to verify that a trader has sufficient balance to complete a transaction without disclosing the exact balance or transaction amount.

Beyond trading, zero-knowledge proofs are widely used in infrastructure, L1/L2 protocols, and various decentralized applications.

Source: Coinbase

• Secure Multi-Party Computation (MPC)
  Secure multi-party computation achieves privacy by dividing input data into multiple parts and distributing the computational tasks among multiple participants. With MPC, each participant only knows their input and the final result, without knowing other participants’ input data.

• Fully Homomorphic Encryption (FHE)
  Fully homomorphic encryption is a cryptographic technique that allows computations to be performed on encrypted data without decrypting it. This enables calculations (such as addition and multiplication) to occur while data remains encrypted, ensuring transaction privacy.
  These encryption technologies complement each other, providing strong privacy protection for transactions, and are increasingly being implemented and promoted in real-world applications.

Overview of Crypto Dark Pool Projects

Blockchain dark pools, as an emerging trading solution, show great potential in privacy protection and censorship resistance. However, they are not without challenges, such as the lack of clear regulatory frameworks, potential misconduct by mining pool operators and block producers, and balancing blockchain transparency with privacy protection.

With the advancement of decentralized technology, more innovative solutions have emerged, continuously developing and enhancing on-chain dark pool functionality. Here is an introduction to some blockchain dark pool projects for reference.

Source: Delphi Digital

• Renegade
  Renegade is a new on-chain dark pool based on MPC and ZKP, launched on the Arbitrum network. It primarily serves market makers, liquid token funds, AMM traders, and privacy-conscious crypto users.

Source: Renegade

Unlike other exchanges, Renegade’s core distinction lies in its state management. All Renegade states are maintained by individual traders rather than having balances and orders kept on a central server or across thousands of distributed servers. This means only users can access their balances or transaction details, effectively safeguarding transaction privacy while minimizing MEV risk.

Founded in 2022, Renegade raised $3.4 million in seed funding in February 2023, led by Dragonfly and Naval Ravikant, with participation from Balaji Srinivasan, Lily Liu, Tarun Chitra, Marc Bhargava, and Lev Livnev.

• Penumbra
  Penumbra is a privacy-focused cross-chain network built on Cosmos, allowing users to trade, stake, swap, or market-make while protecting personal information.
  Penumbra transactions use end-to-end encryption and ZK proofs, so information is visible only to the sender and recipient (and any party they choose to disclose to), not to the public. Penumbra supports private IBC (inter-blockchain communication) and transfers any IBC assets to its cross-chain shielded pool. Inspired by Zcash, Penumbra’s shielded pool has been upgraded for seamless interoperability and cross-chain support.
  The project launched its mainnet and raised $4.75 million in seed funding in November 2021, led by Dragonfly with participation from Lemniscap, Robot Ventures, Figment Capital, Volt Capital, ZKValidator, Interchain Foundation, Informal Systems, and Strangelove.

• Panther Protocol
  Panther Protocol is an end-to-end solution that builds on-chain privacy infrastructure for VASP-compliant entities, enabling users to trade, stake, and interact while preserving privacy. Panther supports multiple networks, including Ethereum, Polygon, Flare, Near, and Avalanche.
  Panther offers a modular, decentralized architecture allowing block administrators to simplify the creation of regulated trading zones. It uses zero-knowledge and MPC-based data security to build DeFi solutions that offer users enhanced privacy. Panther also provides developers with ZK primitives and trust proofs for building privacy-preserving identity management solutions, voting systems, and data validation services.
  Currently in the testnet stage, Panther was founded in 2020 and raised $8 million in a private round followed by a $22 million public round in 2021. The private round included investors such as GenBlock Capital, Moonwhale Ventures, Alphabit Fund, Kosmos Ventures, Dutch Crypto Investors, Skynet Trading, and CSP DAO.

• Railgun
  Railgun is a smart contract system that uses zero-knowledge proofs to provide users with privacy when trading, leveraging, or adding liquidity through decentralized applications (dApps).
  Railgun users can set up non-custodial wallets with private zk addresses, shielding any ERC-20 tokens or NFTs to their chosen zk address. Once shielded, tokens, balances, and transactions are fully encrypted, allowing anonymous DeFi access and interactions. Railgun supports multi-chain privacy and can be easily integrated with dApps on Ethereum, Polygon, BNB Chain, and Arbitrum.
  Established in 2021, Railgun received a $10 million investment from DCG in 2022.

Conclusion

As an alternative solution, dark pools hold significant importance in traditional financial markets and cryptocurrency. Their existence offers numerous benefits to institutional investors, including privacy protection, reduced market impact, minimized manipulation risks, and lower transaction costs.

Although dark pools face notable challenges, such as regulatory risks and technical complexity, the continued development and refinement of decentralized solutions are expected to provide more privacy options for crypto users and institutional investors while also driving value growth in the entire decentralized finance sector.


References
[1]https://reports.tiger-research.com/p/onchain-darkpool-eng?r=aaog1&utm_campaign=post&utm_medium=email&triedRedirect=true
[2] https://en.wikipedia.org/wiki/Dark_pool
[3] https://foresightnews.pro/article/detail/46245
[4] https://docs.renegade.fi