Over-the-Counter or OTC are markets where assets not listed on major exchanges can be traded. OTC desks play a crucial role in the crypto industry, yet there is little understanding of why they’re important and how each is differentiated from another. Crypto OTC desks are similar to their brethren in traditional finance, dealing with immense volumes of trade in a relatively opaque manner and out of the gaze of the public eye. In this article, we will take a closer look at OTC markets and trading in crypto in an effort to provide a better understanding of how they work.
Key Points
- Over-the-counter (OTC) assets can be traded without being listed on an exchange.
- OTC trading acts as a facilitator to help investors access financial instruments and equity that would generally be unavailable to them.
- Crypto OTC desks allow traders to execute trades with relative ease.
What Is OTC Trading In Crypto?
First, let’s get a brief understanding of OTC markets. Financial markets are organized in two ways, exchanges and over-the-counter. Exchanges, such as the New York Stock Exchange (NYSE) or any cryptocurrency exchange equivalent, essentially fulfill the role of mediators between buyers and sellers. A trader posts a price they are willing to sell for, known as the “ask,” while others post the price they are willing to purchase those assets at, known as “bids.” If a bid matches an ask, then the exchange facilitates the transfer. These trades happen in the open market, with the prices of all assets being traded visible to all traders, irrespective of whether they are party to the trade or not.
OTC markets operate slightly differently because trades happen directly between two parties, with one party being a “trading desk.” A trading desk is a business dedicated to purchasing and selling an asset or asset class. During an OTC trade, the transacting parties agree on a price before completing the transfer between themselves. OTC markets are notoriously opaque, with only the transacting parties privy to the agreed-upon volume and price.
Should You Look Into OTC Trading?
Private traders primarily prefer OTC trading as it generally involves large transactions and offers better flexibility and pricing than crypto exchanges. However, it is not limited to deep-pocketed private individuals. OTC trading can also be utilized in regions where there are challenges in accessing cryptocurrency.. OTC trading can also be used when the size of the trade is such that it may adversely impact the market or the price of the asset being traded. Additionally, OTC is ideal for trading assets not listed on conventional crypto exchanges, which means the trade is not available to the general public.
Despite numerous advantages, OTC trading generally has higher counterparty risks when compared to exchanges. It also suffers from low liquidity when the trade is highly valued. OTC trading can be a direct crypto-to-crypto swap, such as swapping BTC for ETH or fiat-to-crypto.
Why Do We Need Crypto OTC Desks?
OTC desks are required because of the difficulty involved in buying and selling large amounts of crypto. For example, if you wanted to purchase 1000 or 2000 BTC, you would face a litany of issues. Let’s assume you attempt to purchase it through a single exchange. The chances of someone selling such a high amount of BTC at a given time are next to impossible. Instead, you would have to purchase them from multiple sellers, which means you could purchase the first tranche at the market price. However, subsequent buys would be at a significantly higher price due to something called slippage. Slippage is when you cannot find traders selling at your desired price, leading you to “slip” further from the original price.
You can avoid slippage by spreading your purchase across multiple exchanges, purchasing smaller chunks at the best price at each exchange. However, this would require you to onboard with multiple exchanges and spend considerable time on each trade. Additionally, you would also be charged for every transaction.
How Does Over-The-Counter Trading Work?
Over-The-Counter trading does not have a user interface like in regular crypto exchanges, and neither does it have a set method or process. Over-The-Counter trading generally takes place through trust. A requirement is posted, and a quote is given. Once the transacting parties agree on a price, the transaction is completed. Two types of OTC desks can help you complete your trade. The first is the principal desk, while the second is an agency desk.
Principal Desks
A principal desk uses its own funds to purchase the asset you are buying and takes on the risk when doing so. Let’s look at an example. If you are buying 500 BTC, you would have to first request a quote through the chat application. Once you request a quote, one of the traders on the desk will respond, quoting the current price in the market. For simplicity’s sake, let’s assume the price of one BTC is $2000. At this point, you can either accept, counter, or decline the trade. If you accept the trade, the trading desk is obligated to fulfill the trade and deliver 500 BTC at $2000 per BTC.
Once the trade is accepted, the trading desk taps into its network of exchanges and other OTC desks to procure the BTC in the most efficient manner. Because principal desks use their funds to purchase the BTC, they are assuming risk because the price of BTC could spike before they can secure all of the BTC. Ideally, the desk aims to purchase the BTC at a price lower than $2000 BTC to make a profit. Once the trading desk has secured the BTC, you must wire the funds to them. It is important to remember that the desk will only transfer the BTC to you once they receive the funds. Once they receive the funds, the desk transfers the BTC to you, and the trade is completed.
Agency Desk
An agency desk does not utilize its own funds, which means it does not assume any market risk. Instead, agency desks charge a fee and act as a middleman to facilitate trades between parties. Suppose you are buying 500 BTC from an agency desk. You would first be required to fund an account and then disclose a price range you are willing to purchase the BTC. The desk will then look to purchase 500 BTC within your desired price range. However, there is a risk that the price of BTC could increase before the order can be fulfilled.
Advantages Of OTC Trading
OTC Trading has several advantages:
Direct Transactions
OTC trading allows you to buy directly from the seller or sell directly to the buyer, removing third parties that inflate the transaction cost.
Negotiations
Generally, trading does not leave any room for negotiation. However, because OTC trading enables you to purchase directly from the seller, you can negotiate a price acceptable to both before the trade.
Avoiding Price Fluctuations
If you purchase a large number of BTC from a regular exchange, the transaction would take hours to complete. There is also the possibility of other traders getting wind of the trade and purchasing BTC, leading to a spike in the asset price. This leads to a phenomenon called “slippage,” where the asset price moves away from the intended purchase price. OTC trades are private transactions between the buyer and seller, and all the tokens are purchased simultaneously at the agreed-upon price.
Disadvantages Of OTC Trading
OTC trading also has a couple of drawbacks, with the biggest one being trust. Regular cryptocurrency exchanges are regulated and have oversight from regulatory authorities, eliminating the risk of unethical conduct or potential loss of funds. However, OTC trading does not have that level of security. An OTC dealer can withdraw from a transaction at any time, which can cause liquidity to dry up, disrupting the ability of market participants to buy or sell.
Who Trades In Crypto OTC
Any individual that wishes to trade large amounts of crypto can use OTC trading. This can range from VCs, high net worth individuals, institutions, and hedge funds investing in crypto. OTC desks also trade with one another if they want to purchase a specific asset. OTC desks have seen their clientele grow and diversify considerably over the years. In 2017, with the surge in ICOs, we saw a large amount of funding raised in ETH, and founders regularly took the OTC route to convert their crypto into fiat. Miners also use OTC desks to convert their crypto into local currencies to pay for their expenses. Exchanges also use OTCs to convert fees collected in crypto into fiat or stablecoins such as USDC.
In Closing
OTC trading has come a long way over the past few years. Multiple OTC desks are currently operating globally, with billions traded between them. While this pales in comparison to the volume of trade handled by traditional exchanges, there is tremendous potential for growth as existing crypto-assets continue to grow while newer ones continuously enter the markets. OTC trading gives traders an alternative to the traditional method of trading. However, as with any aspect of crypto and finance, it is important to thoroughly research before zeroing in on an OTC desk.
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