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Blue Fox Notes (ID: lanhubiji)
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Foreword: The amount of over-the-counter transactions in the financial market is huge, and many people are curious about how it works? This article explains simply and clearly how OTC trading actually works.
OTC (Over the Counter) plays a vital role in the crypto industry, but few people understand why they are important, how they work, and what is the difference between them. Next, we take an in-depth look at OTC (Over the Counter), including its relevance, institutions, and classifications.
Similar to the traditional financial industry, the amount of OTC (over-the-counter transactions) in the encryption industry is huge, and it is difficult to see the whole picture, which is usually out of the sight of ordinary people. The main purpose of this article is to clarify how OTC (Over the Counter) in the crypto industry actually works.
Exchange trading refers to traditional exchanges such as the NYSE or cryptocurrency exchanges such as Poloniex, which act as middlemen between buyers and sellers. Traders post prices at which they want to sell assets (asks), and others post prices they are willing to buy (bids). When the bid and ask prices match, the exchange matches to complete the transaction. All trades are made publicly, and the prices scrolling at the bottom of CNBC or on sites like Coinmarketcap are what the different assets are trading at.
exchange traded
exchange traded
The difference with over-the-counter trading is that the transaction takes place directly between two parties, one of which is usually a counter - a business dedicated to buying and selling a particular asset class. In an over-the-counter transaction, two parties first agree on a price and then transfer assets between the two. This direct medium of exchange is the main reason for the opacity of the OTC market - no one other than the participants can understand the transaction price and transaction volume, in which various assets will be traded off the exchange.
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OTC transaction
In traditional markets, more U.S. company stocks trade over-the-counter than Nasdaq and NYSE combined. Trillions of dollars in bonds, commodities, currencies, derivatives (such as the infamous mortgage-backed securities during the 2008 financial crisis), and many other complex financial instruments are traded off-exchange each year. The notional value of OTC derivatives alone is $600+ trillion per year.
In summary, the OTC market is where most of the transactions in the global financial system take place.
What is OTC (Over the Counter) in the crypto industry?
The over-the-counter transaction in the encryption industry is the direct transaction of encrypted assets between the two parties. Transactions can be token-to-coin (such as bitcoin to ethereum), or fiat-to-crypto (such as between USD and btc).
Like all other OTC markets, transactions always take place between a dedicated trading counter and another individual or institution called a counterparty. In 2018, billions of dollars worth of cryptocurrencies were traded off-exchange.
Why does over-the-counter trading in the crypto industry exist?
Mainly because of the difficulty of buying or selling large amounts of cryptocurrencies. For example, if you try to buy 500BTC, you will run into a bunch of problems.
If you try to buy the 500btc on an exchange, chances are no one is selling 500btc at any given time - you have to buy from multiple sellers. When you buy the first part of it, you might still be able to get it at the market price, but when you buy the last part, you end up needing to close the deal at a higher price. This is known as slippage.
Slippage occurs when you want to buy at a certain price and no one is willing to sell. In order to avoid slippage, youd better purchase 500 btc in multiple exchanges, and buy a small amount of btc on each exchange to achieve the best price transaction. However, doing so requires you to enter multiple exchanges, and even requires you to spend a lot of time executing each transaction, and each transaction also has a handling fee.
At this time, if you go to the OTC desk of cryptocurrency, they will give you an offer, and if you are willing to accept, then they will call you 500btc - it is very simple. Where and how they got the 500btc is their business and has nothing to do with you. Dealing with large amounts of cryptocurrency transactions is what cryptocurrency OTC desks are good at. Through them, you can buy 500btc in one go, with no fees and no frills.
How does the principal OTC desk work?
Principal comes from the term principal at risk. When you trade with a principal desk, they use their own funds to buy various assets that you would buy, and take the risk in doing so. This is the model adopted by Circle Trade.
Going back to the 500btc example, you make an offer via a chat app, and a trader at the desk will get back to you based on current market prices and conditions - say, $4000 per btc. At this point, you can reject, refute, or accept. The moment you accept the price through the chat app, the counter is obliged to send you 500btc at the price of $4000, according to the legal agreement signed during the process.
At this time, the counter enters the existing major exchange network and other OTC counters, and finds the best way to purchase 500btc. Now that the counters use their own funds to buy 500btc, and take the risk—that is, the risk of the price soaring to more than $4,000 before they purchase 500btc.
The goal of the counter is to make a profit by purchasing 500 btc at a price slightly below $4000 per btc. That is, there is a price difference between the average price purchased at the counter and the price sold to you.
Once the counter purchases 500 btc for you, you will receive instructions on how to transfer the money (at this unit price, the total amount is 2 million US dollars). The 500btc will not be sent to you until the money is received at the counter. In this sense, you also have the risk that the counter will run away with $2 million, which is why the reputation of the counter you work with is very important. Once the money is received at the counter, they will send you 500btc and the transaction is complete.
OTC agency model
There is also a second OTC counter model, called the proxy counter model. Different from the principal counter mode, the agency counter mode does not trade with its own funds, so it does not bear market risk. The agency counter mode is not a mode of earning price difference, it acts as a middleman and charges brokerage fees.
If you are buying 500btc through an agent counter, you will first fund them with the price range for the purchase. The agent counter will use your funds to try to buy 500btc at the agreed price. In this scenario, your risk is that the price of BTC suddenly spikes before your agent completes the purchase, and then cannot complete your order.
Many companies offer escrow services, which essentially store your cryptocurrencies and operate proxy desks as a value-added service. Since they already hold your funds, they can also buy and sell your assets on your behalf. This is in contrast to principal desks that typically only accept fiat or cryptocurrencies associated with a particular transaction.
Who Is Trading Cryptocurrencies OTC?
Simply put, anyone who wants to buy or sell large amounts of crypto assets quickly and easily. They may be high-net-worth individuals, institutions, VCs, and hedge funds investing in the crypto market. OTC desks also often trade with each other, for example, a counterparty of one desk wants to buy a specific asset, while another desk happens to have a matching seller.
With the growth of industries and asset types, the types of counterparties for OTC OTC transactions are becoming more and more diverse. With the development of the first token crowdfunding in 2017, many projects have integrated large amounts of ETH, and the founders of the projects usually use OTC counters to convert ETH into legal currency to pay for daily consumption.
Miners, who are rewarded for mining cryptographic tokens to secure the network, such as Bitcoin. Miners also use OTC counters to exchange cryptocurrencies for fiat currency to cover expenses. Similarly, exchanges that charge cryptocurrencies as transaction fees will also convert various cryptocurrencies into legal currencies through OTC transactions, or more and more, into stable currencies such as USDC.
The future of cryptocurrency OTC
