The controversial topic of dark pools resurfaces every now and then, usually followed by ethical debates relating to their use. But what is a dark pool? And why are people talking about them this time? A dark pool is a special type of trading environment found outside of normal exchanges. The name comes from the fact that the buy and sell orders are invisible. The parties submitting the orders likewise remain hidden. Market depth is also a mystery. No order book. No order history. Total anonymity. Traders using dark pools are truly going in blind. A nightmarish scenario for the average trader, so why do such systems exist? The short answer is that dark pools were not created for retail, but for institutional money. Because the entire system operates in the shadows, it allows institutional investors to submit orders while remaining discreet. Dark pools also enable big players to fill large orders without having to worry about markets moving against their trades. Let’s imagine a firm wanting to buy a large amount of a certain stock. If they were to use a normal stock exchange, the trade would send shockwaves throughout the markets. Everyone would see the huge buy orders coming in and would want a piece of the action. Competing trading desks would be all over the books, pumping the stock and ultimately leading to the firm getting a worse price. On the other hand, if the firm were to use a dark pool, the order would reveal nothing to markets at large, resulting in a much more optimal execution. The buy order might even hit a massive but invisible sell wall, giving both parties the price they were looking for. Dark pools still require parties to disclose their trades to the public at some point, but they have much more time to do so. Firms will typically delay this process as much as possible within the limits of the law. By the time their trades are public knowledge, the orders have already been filled and adverse price action is no longer a threat. The groundwork for dark pools began in 1980, when the SEC enacted rule 19c-3, allowing securities to be traded outside of exchanges. Dark pools would come into being a few years later. While extremely useful for large financial institutions, such trading environments initially accounted for no more than 5% of the daily market share in the US. In the years and decades to come, further concessions by the SEC and a growing appetite for private trading would inevitably push this figure higher. To the salient point: as of the time of writing, half of all trading activity now occurs away from the public eye. Whether in dark pools or internally at major firms, January 2025 marked the third consecutive month where private trading volumes surpassed those on “lit” exchanges. This is not merely a blip or anomaly, this paradigm shift has been decades in the making. Most trading now happens in the shadows. Hidden trading environments provide obvious benefits to large institutional money. Dark pools would not have become so popular if this were not the case. Dark pools also have the added advantage of not being subject to the same regulations as public exchanges. The likes of the NYSE or the NASDAQ have to provide extensive trading activity data to the SEC whereas dark pools do not. Because dark pools are essentially private, they also have the freedom to exclude firms as they see fit. They are under no obligation to offer their services to the public at large, nor are they obliged to bill different entities at the same rate. This is when the conversation inevitably shifts to the issue of fairness. All these massive banks trading among themselves, with different prices to the rest of the market, using unaccountable pools? A sternly worded letter is surely in order. Before you can say “free market at work” – it gets worse. Nestled deep within the confines of these dark pools are the so-called private rooms. Private rooms are an even more exclusive trading environment because they are invite-only. Not only do they grant institutions the freedom to trade away from prying eyes, they also allow institutions to trade within extremely limited circles. A financial firm may set up a room for the sole purpose of trading one particular asset with just a handful of other parties. Some private rooms have as little as two or three participants within them. Such rooms are not generally used by the very large players because they have the technical, financial and legal resources to host their own alternative trading systems. For smaller trading desks however, a private room within an already established dark pool is an ideal alternative, and one that is trivially easy to set up. Dark pools are obviously not without their flaws. Perhaps the most valid argument against them is the fact that they siphon away liquidity from the lit exchanges. Lower liquidity will inevitably impact the bid/ask spread, leading to less efficient markets and a more expensive experience for retail traders. Should the problem really exacerbate, the shift towards a darker trading environment would have gravely negative effects on price discovery. After all, who can say what an asset is worth if no one knows what it is being sold for? The lack of transparency is also a major issue. Dark pools are not subject to anywhere near the same kind of regulatory scrutiny as lit exchanges. As such, this leaves them wide open to shady trading practices, predatory price manipulation and even outright fraud. With that said, these problems only affect those using the dark pools, so they are in effect self-contained. Dark pools are a very controversial element of the financial world and routinely draw their fair share of ire whenever the subject arises. The fact of the matter is that markets are always looking for efficiency. If that means interacting directly and exclusively with carefully selected counterparties then so be it. Is a farmer at fault for selling produce to a chain of restaurants instead of unloading everything at the local market? The growing popularity of dark pools and private rooms is a testament to their usefulness. The trend is pointing in an obvious direction. Institutional money is shying away from the light and reaching for the hidden liquidity below the surface.