Crypto Over-the-Counter (OTC) Trading: Everything to Know
By Beluga Research June 15, 2023
- Crypto Over-The-Counter (OTC) trading allows traders to buy and sell large quantities of cryptocurrencies
- Many exchanges offer OTC trading to their clients
- OTC trading is a common practice in the cryptocurrency market
- Unlike exchange trading, OTC does not heavily impact the overall market price of cryptocurrencies
Crypto over-the-counter (OTC) trading is the practice of buying and selling large quantities of cryptocurrencies. This practice actually does not impact the market price of the cryptocurrencies due to the nature of how the trades are made. OTC trading is a phenomenon that has emerged over the past decade, as the cryptocurrency market has grown.
There are now over 10,000 cryptocurrencies in circulation. The cryptocurrency market is highly fragmented, with no single exchange dominating the market. This fragmentation facilitated the emergence of OTC trading.
A Brief History
Crypto OTC (Over-the-Counter) trading began as a natural response to the need for larger and more private cryptocurrency transactions. In the early days of cryptocurrency, centralized exchanges were limited in their liquidity and security, making it challenging to execute substantial trades. To address this, OTC trading emerged as a direct, off-exchange method for individuals and institutions to conduct large trades without affecting the broader market and with increased privacy. OTC desks and brokers facilitate these private transactions, helping to build a robust market for institutional investors and high-net-worth individuals seeking to buy or sell significant amounts of cryptocurrencies outside of traditional exchanges.
OTC trading was primarily conducted by early adopters who wanted to acquire large amounts of bitcoin. They hoped to do this without the scrutiny of traditional exchanges.
As the crypto market grew over time, so did the need for OTC trading. More traders sought to conduct large transactions without impacting the market price. Today, OTC trading is a common practice in the cryptocurrency market with many exchanges offering OTC services to their clients.
Update - OTC Desk Liquidity (2023)
OTC demand has been steadily on the rise since the collapse of FTX in November 2022, with subsequent spikes, some say, being attributed to the collapse of several crypto lenders last year and more recently the SEC's decision to sue Binance.
The catalyst for this demand has been the sharp drop in market depth across exchanges. Market depth is a metric that measures liquidity by assessing how much capital would be required to move an asset in either direction, typically measured at a spread of 2%.
Liquidity concerns have lingered since FTX's collapse, with some reporting market depth on exchanges sliding by more than 50% between November and May.
This could very well mean that traders looking to execute larger transactions will have to deal with inevitable slippage as order books remain thin. As a result, the OTC market, which allows traders to conduct large transactions without needing to go to an exchange, looks to be becoming even more prevalent.
This trend is a reminder of the time after Mt Gox, the largest crypto exchange at the time, got hacked and subsequently ceased operations in 2014. Despite the largest exchange falling almost 10 years ago, the demand for digital assets continued, with peer-to-peer markets on exchanges like LocalBitcoins emerging as the champions of the 2014 bear market.
What Is Crypto Over-the-Counter (OTC) Trading?
Crypto OTC trading is the process of buying and selling large quantities of cryptocurrencies outside of traditional exchanges. OTC trading can be conducted directly between buyers and sellers. There is no need for intermediaries, although usually there is a broker or "desk" that is facilitating these orders.
By contrast, in traditional trading, buyers and sellers place orders on an exchange. The exchange matches the orders based on price and quantity. The exchange acts as an intermediary, providing a platform for buyers and sellers to trade.
OTC trading allows the purchase and sale of large quantities of cryptocurrencies without big impacts on the overall market price. Since OTC trades are not reflected in the order book of traditional exchanges, they do not affect market prices very much.
OTC trading allows traders to negotiate prices directly with their counterparties. This can be particularly useful when trading large quantities of cryptocurrencies. Direct negotiation allows traders to get a better price than they would on a traditional exchange.
Since OTC trading takes place directly between two parties without the involvement of an exchange, the parties directly negotiate the price and quantity of the trade. The parties settle the transaction outside of an exchange order book. This allows for more flexibility in terms of trade size, timing and pricing.
A counterparty is required to participate in OTC trading. A person can find a counterparty through a broker or dealer who specializes in OTC trading. Such brokers and dealers have large networks of buyers and sellers. These parties can help a person match with a counterparty interested in the same trade.
The terms of the trade will include the price and quantity. This negotiation process can take time, but allows for more flexibility and customization than exchange trading.
Ability to execute large trades without affecting the market price. In exchange trading, large orders can cause the price to move. This can be disadvantageous for a trader. OTC trading allows parties to execute large trades without affecting the market price. This can result in better prices and execution.
Ability to customize trades. In exchange trading, traders are limited to the order types and trading pairs offered by the exchange. OTC trading allows traders to customize trades based on their specific needs, including trade size, timing and pricing.
Greater privacy and confidentiality. In exchange trading, all orders and trades are publicly visible on the exchange. Conversely, OTC trading allows traders to keep their trades private and confidential. This can be important for high-net-worth individuals and institutional investors.
- Privacy. OTC trades are typically private and confidential. Trades are negotiated directly between the buyer and seller without the need for a centralized exchange. This is particularly beneficial for high-net-worth individuals and institutional investors who may not want their trades to be public knowledge.
- High liquidity. OTC trading often involves large volumes of cryptocurrency, which means that there is a high level of liquidity. Buyers and sellers are able to negotiate directly with each other. They do not have to rely on the limited liquidity of a centralized exchange. This can be particularly beneficial for large trades. Buyers and sellers can quickly and easily execute trades without worrying about market liquidity.
- Reduced slippage. Slippage is the difference between the expected price of a trade and the actual price at which the trade is executed. In traditional exchanges, slippage can be a significant problem, particularly for large trades. OTC trading can help to reduce slippage. Buyers and sellers are able to negotiate directly with each other and agree on a price before executing the trade.
- Flexibility. OTC trading offers a high level of flexibility. Buyers and sellers can customize a trade to fit their specific needs and requirements. For example, buyers and sellers can negotiate the settlement date, the currency used to settle the trade, and other terms they deem necessary.
- Higher risk. There is a higher risk of fraud or scams with OTC. This is because buyers often deal directly with sellers they may not know or trust. Additionally, OTC trades are often settled using fiat currencies. This can pose a risk if the seller does not deliver the agreed-upon cryptocurrency. Escrow can help to reduce this risk.
- Lack of transparency. OTC trades are often private and confidential. As a result, there is a lack of transparency in the market. This can make it difficult for buyers and sellers to determine the true market value of the cryptocurrency they are trading. The lack of transparency can make it difficult to identify fraudulent or manipulative behavior in the market.
- Limited access. OTC trading is typically only available to high-net-worth individuals and institutional investors. This is because OTC trades often involve large volumes of cryptocurrency. Such volumes are often too expensive for the average retail investor. Additionally, OTC trading is often conducted using fiat currencies with these large amounts not being accessible to all investors.
- Insider exclusivity . Most OTC trading (in size) is done by institutional desks with known counterparties. However, for example, there was a large amount of OTC trading for Arbitrum claims before the token was even live earlier this year (2023) which was done almost exclusively with anonymous counterparties. This provides advantages to those in-the-know and those with advanced technical skills.