This week the bitcoin exchange Tradehill launches dark liquidity, or dark pools, for client institutions and individuals that do not want to reveal their trading size and identity. In trading on dark pools, market participants have the ability to execute large block trades without adversely impacting the price in either direction.
Based in San Francisco, Tradehill Inc. has relaunched successfully as a business-to-business bitcoin exchange for institutional investors and individuals qualifying as accredited investors. The original Tradehill founded by CEO Jered Kenna in 2011 had operations in the U.S. and Chile and maintained a consistent second position in daily trading volume after Mt. Gox.
Offering both a transparent open order book and a dark order book, the Tradehill service Prime will be critical for both large investors on the buy side, such as funds and institutions, and commercial participants on the sell side, such as merchant processors and bitcoin mining operators.
As “liquidity” and “market impact” can be synonymous in many cases, the market impact, especially on price, is a key consideration for those larger institutions that are regularly shifting assets between financial markets. If a large trade is executed incorrectly, the market impact can be several percentage points in addition to the typical transaction costs of commission and/or spread.
“Whether you’re trying to sell a large amount of bitcoin above market, or trying to buy without losing your shirt to slippage, dark orders on the Prime platform provide an important tool for larger traders,” said Kenna.
In one week, over 100 new accredited investors signed up for Tradehill Prime. The company requires a $10,000 minimum initial deposit (in bitcoin equivalent or U.S. dollars) and dark orders will be priced in BTC, trading inmicro-lots of $1,000. New clients also receive a $75 account credit to test the integrated trading platform on the open order book.
Tradehill is a U.S-based exchange that falls within the definition of FinCEN’s regulations for virtual currency exchange operators. “Bitcoin’s primary use is value transmission and financial technology in the U.S. is a very regulated space,” according to Tradehill COO Ryan Singer. The company has anticipated this regulation and the recent guidance from FinCEN “really helps the startups in the space build a compliance game plan,” he added.
In offering dark pools of bitcoin liquidity within an exchange infrastructure, institutional clients gain the benefits of anonymity and non-display of orders but without losing any of the efficiencies associated with trading on an exchanges’ public order books. With bitcoin, it is difficult to gauge how much large-block trading occurs off a publicly visible exchange. By comparison, research firm Tabb Group estimates that off-exchange and dark pool trading in the U.S. equity markets accounted for 32% of trades in 2012.
Emma Quinn, AllianceBernstein’s Head of Asia Pacific Trading for equities,says ” We use dark pools to access liquidity for orders we would not normally place in the central limit order book. I think dark pools aid price discovery. There has to be post-trade transparency but once that happens you’ve actually got more transparency on a market than you normally would.”
MIT Professor of Finance Haoxiang Zhu agrees with that assessment writingthat “dark pools can improve price discovery in open exchanges.” He also said, “Adding a dark pool alongside an exchange tends to concentrate price-relevant information into the exchange and improve price discovery. Improved price discovery coincides with reduced exchange liquidity.”
This is precisely where the Bitcoin market needs to be heading and it is a necessary prerequisite for Bitcoin’s evolving role in global trade. Wholesale trading exchanges like Tradehill Prime represent an evolution from the floating-rate and fixed-rate retail exchanges. They can also be considered a precursor to bitcoin-based forex markets as well as more sophisticated derivatives markets for bitcoin futures and options.