Cryptocurrency OTC (over-the-counter) INSIGHT
How Does OTC Crypto Trading Actually Work?
Over-the-counter (OTC) markets saw a massive uptick in cryptocurrency trading volume in the past year as brokers are competing to get institutional money that started entering into crypto markets. The OTC Bitcoin market generally operates in the same way the global financial OTC markets do. In fact, established crypto exchanges have also launched their own OTC trading desks to capitalise on increasing demand both from retail and institutional investors.
North America and Asia are the leaders when it comes to OTC crypto trading volume, with market participants include major hedge funds, family offices, broker-dealers, cryptocurrency miners, investment funds, high-net-worth individuals, and private banking institutions.
At the end of 2020, one of the largest over-the-counter digital asset platforms reported a 50% growth in its trading volume from the past year period. The OTC trading platform also claimed that crypto loans to institutional clients reached a $1 billion mark in less than a year of launching its lending arm.
Why do crypto OTC desks exist?
Buying or selling large amounts of crypto is difficult. For example, If you were to try to buy 500 BTC you would run into a host of issues.
If you attempted to buy it all on one exchange, odds are that no one person is selling 500 BTC at any given time — you would have to buy it from multiple sellers. You’d likely be able to buy the first chunk at the going market rate, but would end up buying the last chunk at a significantly higher price — this is known as slippage. Slippage occurs when you run out of people selling at your desired price, causing you to “slip” further from the original market price.
To avoid slippage, you would be better off spreading your purchase of 500 BTC around multiple exchanges, buying smaller chunks of BTC at the best price available on each exchange. Actually doing this however, would require you to be on-boarded with multiple exchanges and even then you would spend a great deal of time executing each individual trade, all while getting charged a transaction fee per trade.
If you went to a type of crypto OTC desk known as a principal desk, they would quote you one price and if you accept, they’ll send you 500 BTC — simple as that. Where and how they get it from is not your problem — it’s theirs. Dealing with the problem of sourcing large amounts of crypto is exactly what crypto OTC desks excel at. Through them, you can buy your 500 BTC all in one shot with no fees, and without doing any of the legwork.
How a principal desk works
Principal is derived from the term, “principal risk.” When you trade with a principal desk, they use their own funds to purchase whatever asset you are buying, assuming risk in the process. This is the model employed by Circle Trade.
Returning to our 500 BTC example, you would start by requesting a quote through a chat application. Next, one of the desk’s traders will respond with a price based on current market rates and conditions — let’s say, $4,000 per BTC. At this point, you can decline, counter or accept. The moment you accept via chat, the desk is obligated to deliver you 500 BTC at $4,000 a piece, per a legal agreement signed during the on-boarding process.
At this point, the desk taps into its existing network of major exchanges and other OTC desks and figures out the optimal way of sourcing 500 BTC. Since the desk is using its own funds to buy the 500 BTC they are assuming risk — the risk that the price of BTC will start spiking above $4,000 before they can source all 500 of it.
The aim of the desk is to source the 500 BTC for an average price slightly under $4,000 per BTC in order to make a profit — the difference between the average price the desk obtains it for and the price it sells it to you for is known as a spread.
Once the desk sources your 500 BTC, you’ll receive instructions on where to wire your funds ($2M in this case). The desk will not send the BTC until they receive the wire. In this sense, you risk the desk walking away with your $2M, which is why the reputation of whatever desk you’re dealing with is of critical importance. Once the desk receives the wire, they’ll send you 500 BTC and the trade is complete.