How does OTC bring institutional investors to digital assets?

The number of users of cryptocurrency exchanges is increasing worldwide, but most of the large transactions still occur on the OTC market and are not linked to the exchange order books in any way.

Over-the-counter brokers seek to provide liquidity for the so-called “whales” making transactions of at least $100,000. Since there are very few individuals who hold their Fiat millions in cryptocurrency and regularly make large transactions, brokers are aimed at a new type of clients — institutional investors.

Institutional Bitcoin

Institutional investors gradually began to enter the cryptocurrency market last year, attracted by the fantastic profits from digital assets. Cryptocurrency hedge funds, foreign exchange funds, and mutual funds have begun to look at bitcoin and other cryptocurrency assets for their portfolios.

Despite the fact that the number of OTC services for cryptocurrency trading is rapidly growing, only a few brokers have been able to establish themselves as truly reliable counterparties in this market.

Over-the-counter markets allow to carry out transactions of a large volume without attracting too much attention, and in addition, allow brokers to take into account the needs of customers as much as possible. But to prepare OTC transactions, lawyers usually have to do complex technical work that takes many hours.

Does OTC affect spot prices on exchanges

Could millions and billions of dollars revolving outside exchanges have an impact on spot prices?

Ari Paul, CTO and managing partner at BlockTower Capital, says that such transactions should not affect exchange prices if, “a party either fully hedges its funds on the exchange for some period (for example, buys $100 million worth of bitcoins of the exchange and market makers buy them back within 48 hours)” or if buyers and sellers of the same $100 million in bitcoins meet on the OTC market and not on the exchange. Such schemes, he said, do not affect the price of bitcoin.

Of course, there may be an incentive for price manipulation between OTC and exchanges, and such a phenomenon — spoofing — has already been the subject of a CFTC investigation into the futures market. A player with a large sell order on the exchange can push the over-the-counter purchase price and sell bitcoins there for more.

Ari Paul says:

If someone lowers the stock price with a sale of $20 million and then buys $200 million worth of bitcoins off the exchange, they can profit from such manipulation.

Why institutional investors need OTC brokers

Institutional investors adhere to strict rules for the reason that their activities are regulated by law. For them, trading digital currencies, which can often happen overseas, is a risk they don’t usually take. Therefore, institutional investors usually use the services of OTC brokerage companies.

Brokers act as intermediaries and ensure that the parties comply with the KYC security standard. This approach can dramatically reduce the likelihood of fraud. In addition, investors are not required to keep their own funds in third-party accounts when conducting such transactions, which eliminates the possibility of losses due to hacking. One over-the-counter broker, who wanted to remain anonymous, told Reuters:

When there are major hacks on exchanges, our business grows.

Finally, OTC allows large investors to trade at more favorable prices, and the appearance of a major player on the exchange will somehow affect the price of the cryptocurrency without going unnoticed.

The over-the-counter bitcoin market has excellent opportunities for growth, as institutional investors who want to get a familiar and reliable service — as in traditional financial markets-enter the arena. In this sense, it is no different from the same trade in the stock market. Large traders trade directly with each other.

They can be carried out in several ways:

through intermediaries. Such transactions are the most frequent option. They are conducted by a broker who specializes in large transactions. Platforms offer personal service and fine-tuning for the client. Through them, you can directly reach the “liquidity providers”, that is, those who have a large amount of cryptocurrency for sale.

via live chat. The first major transaction outside the exchange for BTC took place through an IRC client in the chat #bitcoin-otc. This aggregator works through IRC and allows peer-to-peer transactions between traders.

through ATMs and exchanges. In fact, these platforms also work outside the exchange. When you buy cryptocurrency through an ATM, you actually take it from the broker’s wallet. But this option can rarely offer high liquidity without recourse to the exchange, so in this case, a favorable rate is a rarity.

buying on tokencache. The most profitable option (if the project is reliable) is a direct purchase of cryptocurrency from the project. This procedure is carried out without intermediaries through smart contracts, and for the volume, you can get a discount and a place in the project management.

through dark pools. On traditional exchanges, there are closed sections, where only whales get. For example, it is known about such a section on Kraken, TradeZero. The Republic Protocol project is generally developing such a Protocol with atomic trading.

Difference between OTC and exchange

Why think about over-the-counter trading when there are a huge number of cryptocurrency exchanges with favorable conditions? When a trader buys a currency for a very large amount, other circumstances open up. OTC is more profitable for a number of reasons:

• The exchange may not have sufficient liquidity. As a result, a large transaction should be divided into several sites and bought in several stages. At this time, the price will change due to demand, so a bargain will not work. The price of each subsequent order will increase. OTC trading allows you to buy a lot at once for one price.
• OTC brokers have a higher limit threshold. Most exchanges have a limit of the maximum amount per day for the purchase and withdrawal.
• Directly from the liquidity provider to buy faster. Large transactions through the exchange can take several days. In the case of OTC, the processing time is lower.
• It is also believed that OTC transactions are safer because they involve a broker and a large supplier.

Not without its drawbacks:

• The broker takes a higher commission for the transaction.
• Work on the exchange can be automated, for example, through the exchange API, and OTC-no. Some consider this a minus, but in fact, it is difficult to come up with an example of use. Usually, few people trade on the waves of a fortune of several million. And Yes, trading as a day trader on OTC platforms will not work.
• Really high entry threshold. For example, if you buy directly from a mining pool, you should buy the entire block reward at once.

How it works

The first step in any transaction is to find a counterparty. This can be done through the chat room, you can search on social networks, write to pools and so on. But more often it is done through a brokerage platform. With Hedgeblock a process of finding a counterparty is as easy as creating an order on a common cryptocurrency exchange. You create an order (“leg”).

The next step will be to discuss the terms of the deal. For example, you’re going to buy ETH:

• The amount by which you want to buy.
• Desired transaction date.
• The desired price per coin.

The specifics depend on many factors: how large your order is, and therefore, how desirable you are as a client, what is the spread on the coin and how many offers are available.

Once the price is agreed, the buyer sends the seller a Bank transfer to cover the purchase. The seller sends an appropriate amount of cryptocurrency or tokens to the buyer. Sometimes verification and verification of identity is required, which does not violate the requirements of the legislation.

Observing the total market capitalization shows whether the whales are in buy mode. The increase in market capitalization is usually associated with specific events: a new listing on the stock exchange, the release of a roadmap, something specific. When the capitalization does not have a specific event at the heart, it can be either a fraud of the creators or a really large investment outside the exchange.

Another way to identify OTC transactions is to observe the blockchain, track large wallets. For example, on the Bitcoin Rich List site.

Selling hundreds of millions of dollars worth of BTC on an exchange in a short period of time can lead to a market crash, especially if there are no purchase orders. So OTC is important to maintain a healthy market.

Even if you are not involved in over-the-counter trading, large movements are useful to follow because this is a fundamental factor for private investors and small traders.

Want to streamline your OTC experience with Hedgeblock? Contact us