High Frequency Crypto Trading: How Do Crypto Dark Pools Work and Who is Using Them?

Who Is Participating In High Frequency Crypto Trading? How Do Crypto Dark Pools Work?

High frequency trading activity has surged with the rise of the internet. Today, a growing number of cryptocurrency investors engage in high frequency crypto trading at both the retail and institutional level.

Brave New Coin recently decided to explore high frequency crypto trading activity, including who’s participating in high frequency crypto trading, how it works, and where they’re doing it. According to their research, Brave New Coin found that two trading tools – high frequency trading and the use of dark pools – “ventured into the crypto asset markets” early on.

Let’s take a closer look at how high frequency crypto trading works.

High Frequency Trading In Crypto

High frequency trading refers to the use of algorithms and software that allow traders to make thousands of high-speed trades in a fully automated way within the trading day.

You might buy $1 million worth of Litecoin in the morning, for example, in the hopes that it will increase in value by the afternoon.

High frequency trading became particularly popular as the internet grew. It became easier for not just institutions and hedge funds to participate in high frequency trading, but also ordinary retail investors sitting at home.

Moving forward, crypto might be the next big area of growth for high frequency crypto traders.

Institutions Are Engaging in High Frequency Crypto Trading

“This type of trading is particularly popular among hedge funds and proprietary trading firms,”

writes Brave New Coin in their analysis.

Meanwhile, the Financial Times also reports that several leading high-frequency trading houses like DRW, Jump Trading, DV Trading, and Hehmeyer Trading have jumped into high frequency crypto trading.

That same report claims that several newly launched hedge funds are also using algorithmic trading strategies to generate positive ROIs for investors in crypto markets.

Flow Traders, a Netherlands-based high frequency trading house, also recently branched into high frequency crypto trading according to a report from Bloomberg. The Amsterdam-based company is participating in the exchange-traded nodes (ETNs) industry for bitcoin and Ether “due to strong investor demand for crypto investments.”

All of these reports lead to a simple conclusion: high frequency crypto trading is already here, and firms that are good at it have been able to successfully generate high profits for users. Some of the biggest high frequency crypto traders on the market today are established hedge funds and other high frequency trading institutions.

Retail Investors Are Also Engaging in High Frequency Crypto Trading

It’s not just institutions who are jumping into high frequency crypto trading: retail investors are also taking part.

Stay-at-home crypto day traders are building their own high frequency trading strategies and algorithms without the need for established hedge funds and their high-end technology. These individual traders use algorithms with varying degrees of sophistication. However, thanks to the emergence of cryptocurrency trading bots, it’s easier than ever for retail investors to compete with established institutions.

Crypto Exchanges Are Competing To Attract High Frequency Traders

High frequency traders need special tools – like dark pools – to do their best work. That’s why a growing number of cryptocurrency exchanges are trying to offer those tools.

Leading bitcoin exchange Coinbase, for example, announced earlier this year that it’s happy to accommodate high frequency traders.

As high frequency crypto trading becomes more common, watch for a growing number of crypto exchanges to offer dark pools.

Why Are High Frequency Traders Attracted To Crypto Markets?

High frequency traders are attracted to crypto markets because of the volatility. Wild price swings can take place in not just a 24 hour period – but often in an hour or less.

Ether, for example, rose 25% yesterday and it barely made headlines in the cryptocurrency space. The day before, ETH had fallen by approximately that amount. High frequency traders who shorted on the way down and bought on the way up would have made a tidy profit even if they didn’t time it perfectly.

When compared to traditional markets, there’s no equal to crypto’s volatility. As Brave New Coin explains:

“One day of the average fluctuations in bitcoin’s price is nearly equivalent to the volatility of an interval of roughly 23 trading days for the S&P 500.”

How Do Crypto Dark Pools Work?

Dark pools and dark pools of liquidity are special trading tools used by high frequency traders. A dark pool is a pool of liquidity inaccessible to the general public. Using dark pools, high frequency traders can make substantial trades without alerting the rest of the market.

Dark pools allow traders to get the liquidity of a major exchange without the transparency. Trades are made out of sight of other investors. Meanwhile, traders who are making big trades can make those trades without the market moving against them.

Dark pools play a crucial role in high frequency trading in traditional markets. However, they’re not yet as prominent in crypto markets.

There’s only one major crypto dark pool project in development today: Republic Protocol. That protocol is still in the testnet phase. The long-term goal is to create an open source protocol powering dark pool exchanges, with the protocol’s native REN token fueling the system.

Republic Protocol stands a legitimate chance of being the biggest dark pool operator in the space. The company has received backing from Polychain Capital, Binary Financial, and Huobi Capital, among others, with all three major VC firms seeing huge potential in the crypto dark pool space.

Nevertheless, dark pool adoption in crypto markets continues to be slow, and crypto markets are lagging significantly behind traditional financial markets in terms of regulated, accessible dark pools.

How Will High Frequency Trading And Dark Pools Affect Crypto? Will It Be Good Or Bad For Crypto?

High frequency trading and dark pools will continue to have an impact on the future of crypto moving forward.

Regulators and critics have demonized high frequency trading because they see high frequency traders holding an unfair advantage over slower market participants. These same people claim that high frequency trading leads to more volatility in markets, although there’s limited data to support this theory.

Others argue that high frequency trading and dark pools are indisputably good for the industry. They add liquidity to markets, for example. High frequency traders can move the market short-term and get a brief advantage over smaller market participants, but their actions do not have a strong impact on long-term price movements, which means there’s ultimately limited impact on crypto investors.

What about dark pools? How will dark pools change crypto? Dark pools – particularly large-scale, regulated dark pools – will be beneficial for crypto markets because it makes it easy for institutional investors and high net worth individuals to participate in the industry.

Today, institutional investors, high frequency traders, and high net worth individuals still participate in the crypto markets, but they do so cautiously using OTC trading desks and similar platforms. Dark pools would give these groups another option, encouraging greater adoption across the crypto space.

Brave New Coin sums it up best when saying,

“While high-frequency trading and dark pools in the cryptocurrency markets may sound like a nightmare to regulators, it is more likely that these technologies will benefit the market and its participants than harm them.”