Up until now, the increase in cryptocurrency trading volumes is said to be largely driven by retail investors. This has led to wild price swings and volatility. As institutional investors and hedge funds enter cryptocurrency markets, however, decentralized dark pools are expected to mop up a portion of the existing trading volume at cryptocurrency exchanges.
Dark pools are trading venues for holders of large institutional traders. In mainstream markets, they serve a unique role by offering holders of large blocks of shares a trading venue away from public markets. This helps ensure that slippage, or a significant price movement, does not occur at exchanges. While a number of cryptocurrency exchanges, such as Kraken, already offer dark pool services, Republic Protocol is aiming to become the first independent decentralized dark pool on the ethereum platform. The platform’s CEO Taiyang Zhang has already raised $34 million over two rounds and launched its dark pool – RenEx – recently.
How Does RenEx Work?
What does decentralized trading mean, especially within the context of cryptocurrency trading and Republic Protocol?
For starters, it means using Multiparty Computations (MPC), which break down information relating to an order in the pool into multiple fragments, as an order-matching engine. This makes it difficult to determine the number and liquidity of order pools within the system. According to Tai, this characteristic of decentralized dark pools makes it a “a lot harder” to hack them. The practice also obfuscates the actual contents of an order book. “Traditionally dark pools are manipulated because order books are very opaque,” says Tai, referring to the prevailing notion that exchange operators can manipulate orders because they are the only ones with access to an order book. Through the use of MPC, algorithms become responsible for breaking down and matching orders. The fragmentation of orders makes it difficult to guess the liquidity and order types and ensures that the order book becomes inaccessible to dark pool operators as well.
It also means incorporating nodes (or systems running Republic Protocol software) and tokens into the dark pool’s design. There are currently 60 operational nodes within its network and all of them are operated by Republic Protocol. But the plan is to allow anyone to run a node and build out a network of 10,000 systems. The incentive for running a node, in the latter case, is a 0.2% cut of the overall order. Tai says the fee percentage is not set in stone and could be revised later. Node operators will need to stake 100,000 REN tokens. Tai said the token count will be capped at 1 billion. As of this writing, REN was valued at $19.1 million in cryptocurrency markets, per coinmarketcap.com.
Finally, Republic Protocol also claims that RenEx can perform cross-chain atomic swaps or trading between cryptos on different blockchains. Currently this feature is absent on trading platforms and most such trades occur by either converting the token to a fiat currency or a stablecoin (a coin that trades at parity with a fiat currency) like Tether. Tai says future plans include stabilizing the volume of cryptocurrency pairs through cross-chain swaps.
Customers For RenEx
Tai has identified two groups of customers of RenEx. The first set is “Crypto Whales” or investors with large holdings of cryptocurrencies. While not much is known about them, cryptocurrency whales are supposed to have been behind large price movements within the markets recently.
The second group of customers for Republic Protocol is institutional investors, such as OTC desks and market making funds. San Francisco-based Wyre is the only publicly-disclosed OTC operator using RenEx so far. “The others (OTC desks and funds) involved require clearance to disclose their involvement, which unfortunately we don’t yet have,” stated Darren Toh, spokesperson for Republic Protocol. The company is planning to attract market makers to its platform through a slew of incentives and rebates. For example, it has a selective partner program in which 20% of the overall fee is put into a liquidity pool, which is then distributed between market makers.
Opening Up The Trading Platform
While most of the trading occurs through an interface, Tai says they plan to introduce Application Program Interface (API) keys, which are used to connect programs between different applications, soon so that trading algorithms can trade directly on its platform.
That might set up the decentralized dark pool for more problems down the road.
Algorithmic trading significantly increases the frequency and blocks of trading and has been blamed for price manipulation at exchanges. Scalping may become another problem. In this strategy, traders trade small slices of stocks, incrementally building up their profits from minimal price changes. Algorithmic trading can make scalping more effective and potent by automating it.
For now, though, Tai is not worried about these dangers. Because it is difficult to accurately identify liquidity and order numbers and price points at the exchange, Tai says the dangers of “pinging” (in which firms place repeated small orders to track order flow in a dark pool) are not present at their exchange. “The opportunities to scalp are also not very big because the exchange is not big,” he adds. Then there are the constraints placed on Republic protocol due to problems in scaling ethereum’s network. This means that the dark pool’s speed in processing transactions is dependent on the underlying ethereum network. According to Tai, it takes a minimum of 30 seconds for a trade to be matched and sold on the Republic Protocol platform currently.