As the entrance of institutional players into the crypto space continues to draw nigh, the market for a murky off-exchange form of trading known as over-the-counter is becoming an increasingly critical lynchpin to the cryptocurrency ecosystem.
While most people looking to buy or sell cryptocurrency can do so through standard exchanges, large institutional investors and high-net worth individuals who transact in large volumes of Bitcoin must look to the relatively uncharted world of OTC markets to execute these trades.
Because cryptocurrency exchanges typically lack the technological infrastructure and the liquidity required to execute large block orders, big buyers and sellers are effectively forced to find one another by venturing into Skype chatrooms hosted by proprietary trading firms like Cumberland, private messaging platforms like Telegram and even public forums like LinkedIn.
“The big deals have to go OTC. A lot of the exchanges limit the order size, so you have to break up your orders, and that’s just fatal,” explained Monica Summerville, director of fintech research at Tabb Group, a U.K.-based market research firm.
Breaking up a large sell order of, say, 1,000 Bitcoins, could send an adverse signal to the market and trigger what’s known as slippage – whereby the price of a trade at execution is different than the expected price.
The appeal of OTC for traders, miners and the like, is that it provides a much-needed offramp from crypto into fiat – necessitated by the fact that most of the largest crypto exchanges don’t deal in fiat currency.
“We prefer to hedge into fiat when we want to liquidate. Others go into (stablecoins), but there’s a lot of shadiness out there, so we prefer not to diversify,” said one trader, adding that simply transferring assets to a fiat-compatible exchange isn’t always a ready solution either:
“A lot of exchanges use banking services in different countries and geographies that aren’t necessarily respected. Just because you can get fiat into an exchange doesn’t necessarily mean you can get it out.”
These markets have grown significantly more popular and competitive over the last 12 months, according to participants, as more sophisticated investors and traders enter the space. Many of these players have begun trading through brokers like Octagon Strategy, Genesis Trading, Circle, though the exact size and scope of this market remains difficult to quantify.
A report earlier this year produced by the Tabb Group estimated daily Bitcoin OTC volumes at $12B globally. Summerville reckons that this figure is two to three times larger than the daily average traded across standard crypto exchanges globally, though this is comparison is difficult to quantify because the volume figures reported by exchanges can be of questionable veracity:
“There is nobody checking the volumes that are being reported, and there are suspicions that exchanges are doing various things to increase their volumes that would not be legal for a normal regulated exchange.”
Still, estimates of the actual size of the Bitcoin OTC market vary widely. Lucas Nuzzi, director of technology at Digital Asset Research, pegs the total daily volume at around $250M.
“This is very different from other figures we see out there,” he said. “Our estimation is based on things we can see and people we interact with that are actively participating in those markets.”
Institutional Stumbling Block?
While an influx of new institutional money into crypto has been a topic of endless discussion and speculation over the last 12 months, the lack of exchange infrastructure has pushed many of the players brave enough to venture in to the OTC realms.
“Structurally, for a lot of institutional investors, OTC is really the only way they can trade the most liquid assets,” said Nuzzi.
However, a general murkiness and lack of sophistication in OTC markets hasn’t created an environment that institutionals can be fully comfortable participating in.
Somewhat paradoxically, crypto OTC trading requires a heavy degree of trust when cashing out into fiat is the end objective.
“Currently, some parts of the cryptocurrency industry are organizing six figure trades over Skype and Telegram – very similar to how old-school Wall Street brokers and traders would call clients to bring buyers and sellers together,” explained Frank Wagner, founding partner of INVAO – an artificial intelligence-enabled investment vehicle for crypto assets.
“Clearly, this can’t be the most secure and effective way to execute these trades and may be a reason that many institutional investors are deterred from getting involved.”
In particular, crypto OTC trading brings with it several unique forms of counterparty risk. One aspect is that, because of anti-money laundering rules, many financial institutions are still averse to the idea of…