There has been a lot of buzz circulating about institutional investors entering the global cryptocurrency market. Announcement after announcement has broken of enormous hedge funds allowing their offices to begin cryptocurrency trading, while established investment firms and banks are opening over-the-counter (OTC) desks to the public.
But what exactly is OTC trading?
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Who uses it and why are we only just starting to hear about it now, or have the cryptocurrency markets operated in this way the whole time without us knowing?
OTC trading simply refers to any exchange of assets – be it stocks, bonds, derivatives, securities, structured products or currencies – that occur off exchange. It is mostly prevalent in the foreign exchange market.
Foreign exchange (forex) markets, much like cryptocurrencies, can be quite volatile, trade around the clock and can be heavily reliant on geopolitical factors and localized economic conditions.
While the entire foreign exchange does trade twenty-four hours a day, certain exchanges may be restricted to limited opening hours, so OTC trading desks can act as a means of accessing various currencies at any time.
Foreign exchange traders can also run into regulations of a specific country or centralized authority that may negatively impact the dynamics of trade.
There may be laws and restrictions on the trade of currencies that exchanges simply must adhere to. The use of OTC trading in forex is a way to ensure that the dynamics of a trade are unhindered.
This aspect of OTC trading became absolutely relevant to cryptocurrency investors in China following the sweeping ban of digital asset trading in February.
This article, published just last month, details how Bitcoin smugglers have become a real thing in the cryptocurrency world, with one trader “in her 20s in Shanghai [saying] she buys bitcoins in the United States to sell over the counter in China” – US$40,000 worth at a time.
Also, the fees are much, much lower for OTC trades, but as many cryptocurrency exchanges have quite low fees, and some none altogether, this particular aspect is almost a moot point.
The stock and equity markets also use OTC trading for stocks that are not listed on traditional exchanges.
We can compare this to the buying of small-cap coins on exchanges like IDEX and Cryptopia, and seeing as though this kind of investment is quite common, this particular advantage does not quite apply to us.
Where OTC trading begins to make sense for cryptocurrencies are the dark pools that they create.
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Dark pools are ad-hoc networks of institutional and deep-pocketed investors (read: whales) who are interested in buying and selling large amounts of cryptocurrencies without affecting the market as a whole.
Most of us have seen what happens to a cryptocurrency market when large investors create walls – either to buy or sell.
A snowball effect begins which either skyrockets the price temporarily or causes weak hands to dump their stack into the hands of the whale manipulating the order books. This is a liquidity problem – and one that OTC trading solves. Institutional investors can use OTC trades to executive massive plays, all without sending any signals across the public markets.
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This is the advantage of OTC trading that is most relevant to the cryptocurrency markets and has been playing out behind the scenes far longer and more often than most realise.
An article published by Reuters in early April reveals that trading firms have been buying, selling and even lending cryptocurrencies over Skype as a means to avoid broadcasting their involvement in the markets.
And it’s been happening for over five years.
Hundreds of millions of dollars worth of volume every day have been moved by wealthy individuals, payment processors, mining magnates and even hedge funds – all through instant messaging.
The minimum trades for these groups are allegedly between US$75,000 and US$250,000.
It has also been reported that in December last year, when Bitcoin was at its peak, one OTC trading firm, Genesis Trading Group, processed a monthly volume of somewhere between US$1.5 billion and US$2 billion.
So when we read headlines such as “Brazil’s largest investment firm to launch OTC cryptocurrency desk” or “Goldman [Sachs] Is Setting Up a Cryptocurrency Trading Desk”, we infer that the Skype groups are no longer cutting it.
It’s news that hedge funds and investment banks want to become the hosts of the massive trades that have been shaping our markets behind the scenes for the past five years.
It’s also confirmation that the volume on the exchanges we all frequent are not the be-all-and-end-all of market activity, but represent just a small fraction of the trades happening around the world.
It might just also be proof that there are more bulls than bears in 2018.
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