Adverse Selection
One potential problem with crossing networks is the so-called winner's curse. Fulfillment of an order implies that the seller actually had more liquidity behind their order than the buyer. If the seller was making many small orders across a long period of time, this would not be relevant. However, when large volumes are being traded, it can be assumed that the other side - being even larger - has the power to cause market impact and thus push the price against the buyer. Paradoxically, the fulfillment of a large order is actually an indicator that the buyer would have benefitted from not placing the order to begin with - he or she would have been better off waiting for the seller's market impact, and then purchasing at the new price.
Another type of adverse selection is caused on a very short-term basis by the economics of dark pools versus displayed markets. If a buy-side institution adds liquidity in the open market, a prop desk at a bank may want to take that liquidity because they have a short-term need. The prop desk would have to pay an Exchange/ECN access fee to take the liquidity in the displayed market. On the other hand, if the buy-side institution were floating their order in the prop desk's broker dark pool, then the economics make it very favorable to the prop desk: They pay little or no access fee to access their own dark pool, and the parent broker gets tape revenue for printing the trade on an exchange. For this reason, it is recommended that when entities transact in smaller sizes and do not have short-term alpha, do not add liquidity to dark pools; rather, go to the open market where the short-term adverse selection is likely to be less severe.
Read more about this topic: Dark Liquidity
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