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What is cryptocurrency OTC trading?

bitcoin social trading

If you are a newcomer to cryptocurrency investing, then you have probably heard discussions about cryptocurrency OTC trading on forums and social networks. In this article, we will take a deep dive into the meaning of cryptocurrency OTC trading, its importance for the space, and some other interesting facts.

OTC trading stands for trades that happen “Over-the-counter”, meaning that they do not occur on regular cryptocurrency exchanges like for example Bitfinex or Binance. It’s important to note that this is not a term that is specific to the cryptocurrency market, OTC trading is wildly popular in traditional equities markets as well, with experts estimating that up to a 30% of the entire equities trading volume occurs via OTC trades. In the cryptocurrency space, this percentage is estimated to be even higher due to its illiquid nature.

Importance of cryptocurrency OTC trading

OTC trading is a crucial component of the cryptocurrency space. Digital assets are still a very young and small market, which often leads to liquidity issues. High net worth individuals and institutional investors can’t buy very large amounts of cryptocurrency without significantly moving the price of the asset. This phenomenon is called “slippage” and is an undesirable side effect of buying an illiquid asset since the investor ends up paying a premium.

Furthermore, trading on cryptocurrency exchanges also comes with considerable security issues. Most digital asset exchanges are not regulated, and in some cases, the founding team and legal structure are barely known. There have been several cases in the past of exchanges getting hacked or scamming its users, hence, most investors will probably feel uneasy about sending considerable amounts to them in order to conduct a trade.

Types of OTC trading

There are 3 main ways in which a cryptocurrency OTC trade can occur: P2P, through a trading desk, or on a decentralized dark pool. Let’s dive deeper into how exactly each of them works.

In a P2P OTC trade, the two individuals that are making the trade usually know and trust each other. They would simply agree on a price for the transaction, and then they mutually send each other the assets.

Example:

Investor A wants to buy $10M worth of Zilliqa (ZIL), and investor B wants to sell $10M worth of ZIL. Both investors are good friends and know each other. For this trade to occur, investor A would simply send investor B $10M (in BTC for example), and investor B would send $10M worth of ZIL to investor A.

The second option is to make use of an OTC trading desk, also sometimes referred to as a “dark pool”. When using an OTC trading desk the process is fairly similar to a P2P OTC trade, with the main difference that traders generally don’t know or trust each other, and the trading desk acts as an intermediary in the trade. OTC trading desks are compensated in the form of a % commission of the completed trade.

Example:

Investor A wants to buy $10M worth of ZIL, but doesn’t know anyone that wants to sell that amount. So he goes to an OTC trading desk and asks if the trading desk knows anyone interested in making this trade. If yes, then investor A sends $10M to the OTC trading desk, and investor B sends $10M worth of ZIL to the trading desk. After both amounts have been received, the OTC trading desk completes the trade by sending both amounts to its respective receiver.

Finally, there is also the concept of a “Decentralized Dark Pool”. This is still a very novel idea that is being pioneered by Republic Protocol. In a decentralized dark pool, buyers and sellers don’t have to trust each other, or a trading desk, since trades are executed automatically and anonymously by smart contracts. This not only comes with the benefit of reducing counterparty risk, but it also has the potential to make OTC trading more liquid and efficient by creating a shared liquidity pool that anyone can tap into, without paying significant fees to OTC desk providers.

On Republic Protocol, orders are matched by so-called “Dark Nodes”, which are users that run computations and stake REN tokens in order to obtain a portion of the fees generated by the protocol. At the time of writing, the project is still in its early beta stage, but it is definitely one to keep an eye on due to its potentially disruptive power to the current OTC and dark pool industry.

Controversies of OTC trading

Although the advantages of OTC trading in the digital asset space are many, this trading activity does not come without controversies. Large banks like Citi have been fined tens of millions of dollars for front-running their OTC trading clients and exposing them to trading sharks. This is a highly profitable, but also highly illegal practice. Due to the unregulated nature of the cryptocurrency space, it is not unlikely that similar activities are being performed by the operators of crypto OTC trading desks and dark pools.

Decentralized dark pools have the potential to permanently solve this problem.

Largest cryptocurrency OTC trading desks

Finally, now that you are familiar with the exact meaning of OTC trading and why it is important, it’s time to learn about some of the largest OTC desks:

  • Octagon Strategy (Hong Kong)
  • Genesis Trading (New York)
  • FBG Capital (Beijing)
  • Circle (Boston)
  • Kenetic Capital (Hong Kong)

Each of these OTC desks offers certain services and features that make them slightly different from their competitors. Some may offer lower fees, 24/7 support, international trading, and even custom algorithms for selling large amounts on regular cryptocurrency exchanges.

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