What is OTC cryptocurrency trading?

April 02, 2019

What is OTC cryptocurrency trading?

If you are interested in learning more about Kaiko cryptocurrency market data and OTC reference rates (sourced from trueDigital), please reach out at hello@kaiko.com or visit our website.

As cryptocurrency markets evolve, over-the-counter (OTC) trading has become an increasingly popular means by which market participants can exchange large amounts of cryptocurrency anonymously. This article will provide a broad summary of OTC trading, explaining: What exactly it is, who are the major brokers, what are the benefits and risks, what is the market size, and who are the buyers and sellers.

In traditional financial markets, OTC brokers facilitate the exchange of securities that are not listed on formal centralized exchanges, such as the New York Stock Exchange. An over-the-counter trade relies on a dealer network facilitated by OTC brokers who negotiate directly with buyers and sellers over a computer network or the phone.

In cryptocurrency markets, OTC trades are also facilitated by OTC brokers who negotiate directly with the buyer and seller. The job of an OTC broker is to find natural buyers and sellers for a trade. The main difference between a centralized exchange-based trade and an over-the-counter trade lies in the anonymity provided by an OTC desk. OTC desks do not provide a public order book listing all trades, which allows large sums to be moved quietly without the potential to disrupt markets.

Why trade over-the-counter?

Liquidity on cryptocurrency exchanges is often low or volatile, thus making it difficult to exchange large amounts when needed. If a large buy or sell order appears on a centralized exchange’s order book, it is unlikely to get filled immediately at the price requested. The order may even be broken up into smaller orders at different prices, an unfavorable phenomenon called price slippage. OTC brokers eliminate slippage and provide liquidity to cryptocurrency markets by matching buyers and sellers through their developed networks at a mutually agreed-upon fixed price.

OTC desks also provide anonymity that is often impossible to achieve on a centralized exchange. For example, if a large buy order of 1,500 BTC were placed on an exchange such as Coinbase, this could alert other traders and move the price of the asset. The anonymity of a large over-the-counter trade prevents such unwanted price movements.

Centralized exchanges also make it difficult to trade large amounts due to order limits or the lack of fiat on-ramps. OTC desks enable customizable direct trades between buyers and sellers, without the restrictions present on exchanges.

Who are the buyers and sellers?

OTC brokers often only work with high-net worth traders. Because the identity of these traders are kept private, it is impossible to know which individuals or institutions are using OTC desks. However, it is evident that buyers and sellers are frequently hedge funds, asset management firms, and professional high-volume traders, who are often required to trade minimum $25,000-$75,000. Cryptocurrency miners are also frequently on the sell end of an OTC transaction, hoping to quickly offload large amounts of mined crypto. In short, institutional traders benefit the most from OTC trading and avoid the limits of exchange-based trading. It is predicted that the majority of these institutional traders are located in Asia and North America, due to the large number of OTC brokers concentrated in these markets.

Who are the OTC brokers?

It seems that new OTC brokers are popping up left and right these days. Some of the better known brokers include Cumberland, Genesis Trading, Enigma Securities, and Circle Trade. Recently, many exchanges have launched their own OTC desks for institutional clients who don’t want to trade large amounts on a centralized exchange. In the previous few months, Coinbase, Binance, Bittrex, Bithumb, and Poloniex all quietly launched their own OTC desks. This indicates that there has been significant demand among institutional traders for this type of trading.

What is the market size?

The exact market size of the vast world of OTC trading is impossible to accurately state. However, recent estimates indicate that OTC desks may facilitate a majority of all cryptocurrency transactions. Especially considering the ever-increasing number of OTC desks, it is clear that OTC trading is attractive to a large number of high-net worth professional investors.

What are some problems associated with OTC trading?

The main risk of OTC trading involves settlement. On a centralized exchange, funds are held by the exchange and distributed to the buyer and seller once a trade has been executed. Thus, the centralized exchange is solely responsible for the transfer of funds. Because OTC desks often facilitate the direct exchange of currency between a buyer and seller, settlement involves a degree of risk. While there is no guarantee funds will be delivered, part of an OTC broker’s job is to verify the identity and reliability of the transacting parties. However, many OTC broker’s utilize third-party escrow accounts to serve as an intermediary to reduce operational risk.

Another risk of OTC trading involves the legality of cross-border payments. OTC transfers must undergo KYC to be complete. Thus, there are often multi-jurisdictional issues between buyers and sellers.

How does an OTC trade work?

First, an OTC broker either reaches out or you contact the desk, expressing interest in being on the buy (or sell) side of a transaction. After undergoing KYC procedures, the broker must locate a ‘qualified’ counterparty for the trade. Then, the seller and liquidity-seeker will begin negotiation processes for the size and asking price of the trade, often with the help of the OTC broker. These negotiations typically occur in online chatrooms or on the phone. The price negotiated is typically lower than that on an exchange, to entice a buyer from taking the over-the-counter trading route. OTC broker fees are also frequently less than an exchange’s fees.

Once a price and trade size is confirmed, the buyer will transfer fiat to the seller or to a third-party escrow account held by the broker. Many brokers have invested in regulated custodians to offset security risks arising from both the transfer of funds and the trustworthiness of counterparties. Once both amounts have been transferred to a custody provider, the broker will distribute funds accordingly. Exchanges typically take days or weeks to settle funds, but OTC desks often settle within maximum 24 hours.

Conclusion

It is clear that OTC trading brings much needed liquidity to cryptocurrency markets which ultimately enables increased institutional involvement. However, one issue is the near complete lack of data about OTC trades. Trade data is important because it indicates overall market interest and can drive investment decisions.

At Kaiko, we understand the importance of reliable and transparent cryptocurrency market data. Thus, we are excited to have partnered with trueDigital to distribute their OTC cryptocurrency reference rates, the first such data partnership in the industry. Institutional investors will now be able to gain further insights into the murky world of OTC trading. trueDigital aggregates OTC price data from 11 OTC desks: Altonomy, Blockfills, Circle, CMTDigital, DVChain, Genesis, Hehmeyer, QCP Capital, Tilde, Wyre, and XBTO. Kaiko will distribute this price data through our data distribution channels.

If you would like to learn more about our OTC data partnership with trueDigital, please reach out at hello@kaiko.com.


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