What Is Over The Counter (OTC)?

Over-the-counter (OTC) trading plays an essential role in the crypto industry, but few people understand why they are important, how they work, and what separates one from another. As part of our mission to provide you with knowledge of Blockchain and Cryptocurrency, we put together an in-depth look at the relevance, structure, and taxonomy of crypto trading desks.

Similar to their counterparts in traditional finance, crypto OTC desks deal in immense volumes with seeming opacity outside the periphery of the public eye. In this article, we will aim to bring clarity to how crypto OTC actually works.

What Are OTC Markets?

There are two basic ways of organizing financial markets — through an exchange and also “over the counter”, or OTC.

In an exchange, traders post prices they are willing to sell assets for (asks) and others post prices they are willing to buy assets for (bids). When a bid and an ask overlap, the exchange facilitates the trade. All trades happen out in the open and the prices that different assets trade for are what you see scrolling across the bottom of CNBC or on a website like CoinMarketCap.

OTC differs since this trade happens directly between two parties, with one of those parties typically being a “desk” — a business dedicated to the buying and selling of a particular asset class. In an OTC trade, two parties agree on a price and then work out the transfer of assets between themselves. This direct medium of exchange is the precise reason such opacity exists within OTC markets — no one beyond the parties involved is privy to the price and volume in which various assets are trading at “over the counter.”

In short, OTC markets are where the majority of trade within the global financial system takes place.

What Is OTC in Crypto?

Crypto OTC is simply the trading of crypto assets directly between two parties. A trade can be crypto-to-crypto (swapping Bitcoin with Ether for example) or fiat-to-crypto (swapping US dollars for Bitcoin and vice versa). OTC trading is often used by large investors or institutions to buy or sell large amounts of cryptocurrency without causing significant price fluctuations on the open market. OTC trading is also sometimes used to facilitate trades of cryptocurrencies that are not listed on formal exchanges.

As with all other OTC markets, the trade always occurs between a dedicated trading “desk” and another individual or institution, referred to as a counterparty. In 2018, billions of dollars worth of crypto changed hands over the counter.

On Gate.io, users can safely trade OTC through the P2P Trading page. We provide more than 10 different OTC fiat markets with high-volume cryptocurrencies, such as BTC, ETH, USDT and DOGE. Users can view the sellers and buyers’ reputation to determine who to trade with as they feel comfortable and confident to do so.

Why Do Crypto OTC Desks Exist?

The OTC desks exist mainly because buying or selling large amounts of crypto is difficult. For example, If you were to try to buy 500 BTC, you would have many issues.

If you attempted to buy it all on one exchange, not a single person would be selling 500 BTC at any given time — you would have to buy it from multiple sellers. You would 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. Doing this, however, would require you to be onboarded with multiple exchanges, and you would still 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 will 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.

Who Trades Crypto OTC?

Simply put, anyone who wants to quickly and easily buy or sell large amounts of crypto. This can be high net-worth individuals, institutions, VC and hedge funds that invest in crypto markets. OTC desks also frequently trade with each other, when for example, one desk has a counterparty looking to buy a particular asset, and another desk has a seller.

With the growth of the industry and asset class, the types of counterparties OTC desks trade with has become more diverse over the years. As ICOs took off in 2017, a large number of funds were being raised in Ether, and project founders commonly used OTC desks to convert Ether into fiat to pay day-to-day expenses. Miners — the people who get paid in newly minted crypto to run computers that secure networks like Bitcoin — use OTC desks to convert crypto into their local fiat currencies in order to pay expenses. Similarly, an exchange that collects fees in crypto will trade OTC to convert back into fiat or increasingly, into stablecoins like USDC.

Pros and Cons of Crypto OTC

Some potential pros of OTC trading of cryptocurrency include:

• The market price is not affected: Because trades do not need to be executed on a formal exchange, this means that they can be completed without affecting the market price of the cryptocurrency, which can be useful for investors who want to buy or sell large amounts of cryptocurrency without causing significant price fluctuations.

• Greater privacy: OTC trades are conducted directly between two parties, which can provide greater privacy compared to trades that are executed on a formal exchange.

On the other hand, there are some potential cons of OTC trading of cryptocurrency, which include:

• Less liquidity: OTC trades are not executed on a formal exchange, so there may be less liquidity available for a particular trade. This can make it more difficult to find a counterparty to trade with, and it could be harder to reach an acceptable trade price.

• Counterparty risk: OTC trades are conducted directly between two parties, so there is a risk that one of the parties will not fulfil their obligations under the trade.

The Future of Crypto OTC

Five years ago, crypto OTC desks did not exist with the structure and scope that they have today. Now there are multiple desks operating on a global scale, trading billions of dollars a year — a reflection of how much this industry has grown since the Bitcoin network launched over a decade ago.
While the billions of dollars that crypto OTC desks handle annually pale compared to the trillion dollar volumes of traditional OTC counterparts, there remains tremendous room for growth. As existing crypto assets grow and new ones are introduced, OTC desks like Circle Trade will be behind the scenes, keeping the markets moving.
Barring stringent regulations that would mean a major setback for the OTC crypto market, the trend seems to be growing. The regulatory environment for OTC trading of cryptocurrency varies from country to country. In some countries, it may be subject to the same regulations as other types of OTC trading, such as the requirement to register as a broker-dealer. Other countries or jurisdictions may have less stringent laws or none at all regarding OTC trading of cryptocurrencies.
In the United States, OTC trading of cryptocurrency is generally subject to federal and state securities laws, as well as regulations from the Financial Industry Regulatory Authority (FINRA) and the Commodity Futures Trading Commission (CFTC), while in Europe the regulation of cryptocurrency OTC trading is generally overseen by the European Securities and Markets Authority (ESMA) and the the European Systemic Risk Board (ESRB). These institutions provide guidelines on how to manage this type of business, and in some cases require an industry operator to register as a broker-dealer, maintaining record-keeping and reporting obligations.

Conclusion

It is clear that OTC trading brings much needed liquidity to cryptocurrency markets which ultimately enables increased institutional involvement.People have been negotiating since the dawn of humanity. Trying to get the best price for a product or service is possibly just the nature of the human beast.

Over-the-counter could mean a decentralized international marketplace or simply making a deal with your neighbour.

OTC as a market has many benefits and use-cases, but is still sometimes associated with bad actors and risks. A bad actor is a person or organisation whose actions are harmful, illegal or just morally wrong, and of course they exist.