Original Author: David C, Bankless

Original Title: Demystifying Crypto 'Dark Pools'

Original Translation: Ismay, BlockBeats

Editor's Note: This article focuses on the seemingly traditional yet increasingly crucial trading mechanism of "dark pools," outlining its current development, technical path, and real-world challenges in the crypto field. From Renegade to Penumbra, from CZ's visionary outlook to the game of privacy and verifiability, dark pools serve as both a shield against on-chain "liquidation hunts" and a redefinition of the boundaries of the crypto ethos. In the current landscape where public chains are increasingly becoming PvP-oriented and institutional funds are entering continuously, perhaps we have to confront a question: Does true decentralization also require a bit of "invisibility"?

Last week, the well-known DeFi "degen" player James Wynn faced a liquidation on Hyperliquid, resulting in losses of up to $100 million.

This loss included 949 bitcoins (approximately $99.30 million) and 9.825 billion kPEPE tokens (approximately $11.60 million). The trigger was Bitcoin dropping below $105,000, which liquidated his long position leveraged at 40x. Interestingly, Wynn does not attribute this solely to bad luck. He firmly believes he was "targeted."

"One thing is certain, and that is I exposed the level of corruption in this market," Wynn wrote, claiming that someone deliberately orchestrated a so-called "liquidation hunt" targeting his large visible on-chain position, briefly driving the price down to trigger the liquidation and then swiftly pumping it back up.

Regardless of the veracity of this accusation, this incident revealed a significant flaw in decentralized trading: everyone's positions are public. Just like in a game of poker, everyone lays their cards on the table.

Following the incident, Binance founder CZ proposed a solution on June 1st: establishing a "Dark Pool Perpetual Contract DEX."

His logic is simple—if no one can see each other's positions, no one can engage in "hunting." By hiding the order book through zero-knowledge proofs, it is possible to protect large traders from targeted attacks while maintaining decentralization.

Below, we quickly recap the origin, pros and cons of dark pools, and the current dark pool projects or proposals in the cryptocurrency field.

The Origin of Dark Pools

The term "dark pool" may sound mysterious, but it is not actually something new, nor is it inherently equivalent to a "black curtain."

As early as the 1980s, dark pools appeared in the traditional financial sector, aiming to solve a very practical problem: how can institutions conduct large stock trades without affecting market prices?

Imagine this: you are a pension fund that needs to sell 10 million shares of Apple stock. If you place a sell order directly on the public market, the price may plummet before you even finish selling half of it. The market seeing this large sell order may panic-sell or front-run, ultimately resulting in your transaction at a much lower price than anticipated.

The U.S. Securities and Exchange Commission (SEC) noticed this issue and formally approved the legal status of "Alternative Trading Systems" (ATS) in 1979. These private exchanges allow institutional investors to match large trades without disclosing the orders, only revealing the results to the market after the trade is completed.

By the spring of 2017, dark pools accounted for nearly 40% of trading in the U.S. stock market, a significant increase from 16% in 2010.

The basic mechanisms of dark pools include:

Order book opacity, trades matched privately

Trade prices negotiated between parties or based on the midpoint of bid and ask prices

Trade results disclosed only after completion

Participation limited to institutional investors

These mechanisms ensure the privacy and market stability of large trades. However, in the cryptocurrency field, replicating this model requires overcoming the challenges posed by on-chain transparency while finding a balance between decentralization and transaction protection.

Why the Crypto World Needs Dark Pool Trading

If dark pools are already crucial in the traditional financial markets, their importance in the cryptocurrency market will only increase. The ultimate transparency of blockchain, in some scenarios, becomes a burden—when every address and every transaction is exposed, and the market increasingly resembles a "player versus player" (PvP) style competition, transparency equates to vulnerability.

In traditional finance, at least your broker won't expose your position to the public; but in DeFi, your wallet address is your "asset history," publicly visible and transparent. This transparency has given rise to various "predatory" behaviors:

MEV (Maximal Extractable Value): This is one of the most critical issues in current on-chain transactions. Bots listen for pending transactions, conducting front-running to capture the profits that should belong to regular users. It's like someone secretly looking at your cards and then placing bets with precise timing.

Copy Trading: Why bother researching your own strategy when you can simply copy those impressive wallet addresses? This "parasitic" trading behavior compresses the profit margins of sophisticated traders. However, more and more experts are learning to exploit copy traders in reverse, using them as their "liquidity exit."

Liquidation Hunting: As demonstrated by the Wynn case, leveraged positions visible on-chain can easily become targets. Traders can accurately calculate liquidation prices and collectively create volatility to trigger them.

Quote Fading: When a market maker anticipates a large order entering the market, they often retract their orders, widen the bid/ask spread, causing traders to incur higher costs at the most unfavorable moment.

To address these issues, encrypted dark pools are now developing an "invisible" trading system through a series of privacy protection technologies, such as:

Zero-Knowledge Proofs (ZKPs): Allowing users to prove the validity of a transaction without revealing the specific transaction details.

Multi-Party Computation (MPC): Allowing multiple trade requests to be matched without any party having full control, thereby ensuring privacy.

Trusted Execution Environments (TEEs): Establishing a secure "black box" for transaction execution. For example, Uniswap's L2 network, Unichain, uses TEEs to build blocks, preventing MEV bots from accessing transaction information. Its "Rollup-Boost" system locks transactions in an encrypted memory pool, providing near-dark-pool privacy protection for the entire DeFi application.

The ultimate result is: transactions are both private and verifiable, anonymous and auditable—while maintaining the trustless nature of blockchain, providing traders with true privacy protection.

Practical Implementation of "Dark Pool Trading" on-chain

Currently, several projects are implementing the concept of dark pools in the crypto space:

Renegade: An MPC (Multi-Party Computation) dark pool DEX built on Arbitrum, focusing on privacy protection and zero-slippage trading. The platform facilitates large trades with peer-to-peer matching and supports token trading based on Binance's mid-price matching, eliminating front-running and price manipulation. This means that large trades can be executed privately without affecting market prices.

Silhouette: This is a privacy transaction solution built on Hyperliquid, integrating a hidden order matching system into Hyperliquid's own deep liquidity and high-performance infrastructure. Currently still in development, there is no online schedule yet, but one of its major advantages is the lack of a dedicated wallet, significantly reducing the barrier to entry and making privacy transactions more accessible.

Penumbra: This is a new blockchain project in the Cosmos ecosystem that focuses on privacy, providing dark pool trading functionality for spot markets. It uses zero-knowledge proofs to hide all transactions, balances, staking activities, and even governance processes. Its DEX adopts a batch auction mechanism to prevent front-running and achieves comprehensive privacy protection through encryption.

sFOX: This is a U.S.-based crypto exchange service provider catering to institutional investors, with its dark pool service under FinCEN and Wyoming regulation. By accessing liquidity from over 30 exchanges, sFOX offers hidden order functionality to help institutional users discreetly execute large trades.

Why Hasn't Dark Pool Trading Become Popular Yet?

Although dark pools help mitigate issues such as MEV, liquidation hunting, and front-running, they are still scarce in the crypto world, mainly for three reasons:

1. The Privacy vs. Verifiability Dilemma

To ensure transactions are fair without revealing specific details is technically challenging. While technologies like ZKP, MPC, and TEE provide a direction, implementing them is far more complex than imagined. Simply "hiding data" is not enough; indirect inference of transaction information must also be prevented. For example, if anyone can query an AMM's price at any time, it is not a true "privacy market."

2. Liquidity Conundrum: Which Comes First, the Chicken or the Egg?

For dark pools to function, there must be sufficient trading volume. However, without initial liquidity, traders will not come in. This "cold-start" problem is particularly severe in perpetual contract markets, as they require higher fund depth and real-time trading activity.

3. Trust Paradox and Price Discovery Mechanism Risks

The privacy features of dark pools bring about inherent opacity, thus easily causing a trust crisis. In the crypto industry, "trust but verify" is a fundamental tenet. If transaction details are not visible, how can one confirm fair pricing? Furthermore, dark pools may distort the price discovery mechanism of the public market. Institutions obtain better prices through dark pools, while ordinary users can only trade on the public market with poorer liquidity and greater volatility, resulting in a de facto "dual-track market."

Traditional finance has already learned from this. For example, Barclays was fined $70 million for falsely representing how its dark pool operated, and institutions like Credit Suisse have also faced penalties for unfair practices in their dark pools.

4. Regulatory Hurdles Are Particularly Complex

Launching a dark pool that supports perpetual contracts on-chain is not only technologically challenging but also incredibly difficult from a compliance perspective. The combination of derivative trading, privacy-preserving technology, and cross-border liquidity creates a compliance labyrinth for project teams with almost no clear path to follow.

Reflections on the Wynn Incident: Transparency is the Foundation of Trust, Yet it Can Also Be a Weapon

Whether the Wynn liquidation event was truly "hunted" or not, it revealed a core contradiction: we are building an extremely transparent system to achieve "trustlessness," but this transparency itself can be maliciously exploited.

Dark pools offer a remedial path, but they walk a fine line—balancing privacy protection while maintaining verifiability and fairness. Projects like Renegade prove that dark pools in the spot market are viable. Through encryption, they achieve "proof of honesty" without revealing any details.

However, the envisioned "perpetual contract dark pool DEX" by CZ has not yet been realized, with Silhouette currently making strides in that direction.

As the crypto industry matures and institutional capital flows into on-chain markets, infrastructure must evolve to protect large-scale traders without excluding retail participants. While the technical barriers are high, they are not insurmountable. Dark pools are not a perfect solution, but they are increasingly necessary in today's landscape.

Original article link: Link to the original article

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia