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No.: PandaLY Security Knowledge No.030
As the cryptocurrency market matures, the secondary over-the-counter (OTC) market, as an important trading channel, has gradually attracted widespread attention from investors, project owners, and foundations. This market not only provides liquidity for assets that cannot be traded smoothly on public exchanges, but also facilitates the buying and selling of locked tokens in the cryptocurrency field. However, due to its privacy and customized trading characteristics, the secondary OTC market also hides a lot of risks and compliance issues.
What is the OTC market?
The OTC market, or Over-the-Counter Market, is a market where buyers and sellers of assets trade through direct negotiation rather than on a public exchange. This type of trading method is usually used to deal with assets that are not listed on standard exchanges, or when the trading volume is large and customized agreements and terms are required. Unlike traditional public exchanges, the OTC market is more flexible and traders can negotiate prices, transaction terms and time arrangements according to their own needs.
The secondary OTC market focuses on assets that have undergone a token generation event (TGE) but are still in the lock-up period. These tokens are usually not freely circulated in the public market during the lock-up period, so investors with high liquidity requirements can trade through the secondary OTC market. Buyers and sellers directly negotiate terms such as transaction price, discount and unlocking time to ensure transaction flexibility.
Seller Motivation Analysis
1. Venture Capital Firms (VCs)
feature:
Holding locked tokens: Venture capital firms usually invest in projects at an early stage and receive tokens with a certain lock-up period.
Market Strategy: These companies need to manage the portfolio and achieve profitability after the lock-up period.
motivation:
Risk management: VCs hold a large number of tokens and are vulnerable to market price fluctuations. Selling some tokens through the OTC market can lock in some of the profits in advance and reduce the risks brought by market fluctuations.
Achieving Profitability: Even if tokens are sold at a discount, VCs can still earn substantial returns through early investments, converting virtual assets into real income.
Avoid high valuation risks: If the projects FDV (fully diluted valuation) is too high, VCs may choose to sell tokens through the OTC market to avoid the greater market risks of high valuation sales in the public market.
Liquidity management: When market liquidity is insufficient, selling tokens through the OTC market can obtain more stable prices and avoid large-scale sell-offs that may impact the market.
2. Crypto Project Team
feature:
Operating costs: The project team needs funds to support daily operations, technology development and marketing.
Funding needs: As the project expands, the team may require additional funding.
motivation:
Funding needs: By selling tokens in the OTC market, the team can obtain the necessary funds to support the continued operation and development of the project.
Reduce market selling pressure: To avoid excessive selling pressure in the open market, the project team sells some tokens through the OTC market to balance market supply and demand and reduce the impact on prices.
Stabilizing the market: A prudent token sale strategy helps maintain market price stability and reduce the negative impact of price fluctuations on project development and reputation.
3. Foundation
feature:
Operational fund management: The foundation is usually responsible for managing project funds and promoting the long-term development of the project.
Token unlocking: Tokens held by the foundation are unlocked at a specific time, which may put pressure on the market.
motivation:
Funding requirements: The foundation needs to sell tokens through the OTC market to obtain funds for daily operations and project promotion.
Alleviate market pressure: When tokens are unlocked, the Foundation will gradually sell tokens through the OTC market to reduce market selling pressure and avoid drastic fluctuations in market prices.
Maintain price stability: The Foundation ensures the stability of market prices through a robust token sales strategy to prevent a large amount of unlocking from causing a sharp drop in market prices.
4. USDT Merchants
feature:
USDT buying and selling: U merchants will make profits by buying back USDT at low prices and selling it at high prices.
Anti-money laundering: When a buyer purchases USDT, U Commerce will check whether the buyers source of funds is compliant. If not, U Commerce will choose to stop the transaction.
USDT buying and selling methods: In order to ensure the compliance of USDT and the security of payment, most U merchants choose to transfer USDT on exchanges.
motivation:
Profiteering from price difference: Earning the difference by buying low and selling high.
Profiting from transaction fees: U Chamber of Commerce claims that the funds used to buy and sell USDT are clean, so it can charge more transaction fees.
5. Cryptocurrency middlemen
feature:
Pre-market trading of virtual currencies: Middlemen will make profits by using single or double pledges to guarantee transactions (to ensure the safety of funds of buyers and sellers) in pre-market trading.
Popularity: Since this type of middleman deals with large amounts of virtual currency, buyers and sellers will only feel comfortable choosing them after they have a certain level of popularity.
Transaction content: including pre-market trading of virtual currencies, trading of points obtained from primary market projects, project whitelist trading, etc.
motivation:
Profiting from handling fees: Using one’s own reputation to help buyers and sellers purchase virtual currencies and other assets, and earning a certain amount of handling fees.
Undertake project advertising for profit: After gaining fame, the middleman will undertake the project partys publicity and make a profit.
Buyer motivation analysis
1. Hodlers
feature:
Long-term investors: Hodlers are confident in the long-term growth potential of the token and tend to hold it for the long term without being affected by short-term price fluctuations.
Investment strategy: They focus on the long-term development of the project rather than short-term market fluctuations.
motivation:
Long-term returns: Hodlers hope to purchase tokens at a discount, hoping to get high returns in the future when the project grows and the token appreciates in value.
Discount Opportunities: The discounted prices offered by the OTC market attract Hodlers. By purchasing tokens at a discounted price, they can get higher returns when the market rises in the future.
Stable holding: Hodlers are not worried about short-term price fluctuations. They are willing to hold tokens for a long time and patiently wait for the appreciation opportunities brought by the success of the project.
2. Hedgers
feature:
Financial Instrument Users: Hedgers purchase tokens through the OTC market and use financial instruments such as perpetual swaps for hedging.
Strong market operation skills: They can accurately adjust trading strategies according to market fluctuations to obtain maximum profits.
motivation:
Arbitrage opportunities: Hedgers earn arbitrage gains by buying tokens at a discount and shorting them through financial instruments.
Risk Management: Through hedging operations, they are able to effectively manage market risks and ensure that they can maintain profitability even when the market is volatile.
Flexible strategies: Hedgers can flexibly adjust strategies in different market environments, obtain customized trading solutions through the OTC market, and capture trading opportunities.
3. Primary Market Traders
feature:
Pre-market trading of airdropped currencies: When buyers obtain the airdrop list and want to sell/buy the tokens they own in advance, they will choose a reputable intermediary to place an order to sell/buy.
Large amount of funds: Traders believe or know in advance that certain projects have high profit margins, and may purchase large quantities of tokens off-market in advance, and then sell them for profit after the token market emerges.
motivation:
Arbitrage opportunities: Traders buy tokens in advance at a low price and sell them for profit when the market emerges.
Risks of OTC Markets
1. Liquidity risk
OTC transactions are typically conducted without an open market price, with buyers and sellers negotiating prices in a non-public environment. This means that liquidity in the market may be limited, especially during periods of high price volatility, when there may not be enough buyers or sellers to execute trades quickly. According to 2023 CryptoCompare data, approximately 15% of cryptocurrency transactions are completed in the OTC market, most of which occur in situations of poor liquidity, resulting in significant price volatility.
2. Credit and counterparty risk
OTC transactions involve buyers and sellers who are usually anonymous, especially without third-party custody, and the credit risk is significant. If one party fails to fulfill the terms of the transaction as agreed, such as the seller fails to deliver the tokens, or the buyer is unable to pay the funds, the other party to the transaction will face huge financial losses. For example, a 2019 report showed that more than 30% of OTC crypto transactions involved non-performance or fraud.
3. Price Fluctuation Risk
The trading prices in the OTC market are usually different from those in the public market. Tokens listed on public exchanges tend to be more expensive, while in the OTC market, these tokens may trade at a significant discount due to the lock-up period. According to TokenData, early investors in 2022 purchased tokens that had not yet been unlocked through the OTC market at a discount of up to 70%. Due to the price difference, some investors hedge against price volatility risks by shorting, but this also increases operational complexity and capital requirements.
4. Compliance and regulatory risks
The regulatory status of OTC markets is often more complex and ambiguous. The legal framework for OTC transactions may vary significantly in different countries and regions, and some countries have adopted stricter regulatory measures for such transactions. In some cases, failure to comply with local anti-money laundering (AML) or know your customer (KYC) regulations may result in severe legal consequences and huge fines.
International Compliance
1. Anti-Money Laundering (AML) Regulations
Since transactions in the OTC market often involve large amounts of money and high-net-worth participants, the risk of money laundering is relatively high. Many countries have imposed strict anti-money laundering (AML) requirements on OTC trading platforms and cryptocurrency service providers. For example, in the United States, the Financial Crimes Enforcement Network (FinCEN) requires all OTC brokers to comply with the Bank Secrecy Act (BSA) and implement mandatory AML procedures and reporting mechanisms. In 2019, FinCEN fined a cryptocurrency OTC broker approximately $60 million for failing to report suspicious trading activities in a timely manner.
In the European Union, with the entry into force of the Fifth Anti-Money Laundering Directive (5 AMLD), all cryptocurrency trading and service platforms must conduct KYC (know your customer) procedures and report large or suspicious transactions to the relevant authorities. Data shows that in 2023, about 20% of transactions on EU OTC trading platforms were marked as potential money laundering activities and were subject to focused scrutiny by regulators.
2. KYC (Know Your Customer) Requirements
KYC is an important means to combat terrorist financing and money laundering. For OTC trading platforms, KYC requirements mean that the platform needs to conduct comprehensive identity verification of its customers to ensure the legitimacy of both parties to the transaction. For example, in 2022, Canadian regulators fined an OTC platform for failing to implement effective KYC verification for transactions exceeding $100,000.
In China, despite relatively strict regulation of cryptocurrency trading, there is still an active underground OTC market. According to a Chainalysis report, Chinas OTC trading volume in 2021 accounted for about 12% of the global total, a large part of which did not undergo KYC verification, increasing regulatory risks.
3. Compliance issues in cross-border transactions
The compliance challenges faced by cross-border OTC transactions are particularly complex because different countries have different regulatory policies. For example, in some countries, OTC transactions may be considered illegal activities, while in other countries, it may be considered a legal financial behavior. According to a 2022 survey, more than 40% of OTC transactions involve cross-border transactions, which further increases the complexity of taxation, exchange rate fluctuations and international anti-money laundering supervision.
4. Market manipulation and insider trading
Due to its opacity and lack of real-time price discovery, the OTC market is prone to market manipulation and insider trading. In 2023, an OTC trading platform was accused of engaging in large-scale market manipulation, causing the price of a specific token to rise rapidly in the public market and then collapse rapidly, causing huge losses to retail investors.
Typical case analysis
Case 1: Compliance failure of an OTC broker in the United States
In 2019, a well-known OTC broker in the United States was fined $60 million by the US FinCEN for failing to comply with AML/KYC requirements. The company failed to conduct the necessary identity verification for several cryptocurrency transactions exceeding $100,000 and failed to report suspicious trading activities in a timely manner. This case highlights the importance of compliance for OTC platforms and also shows the huge financial risks that may result from failure to comply with international and local regulations.
Case 2: An Asian foundation raised funds through the OTC market
In 2020, an Asian cryptocurrency foundation sold a large number of locked tokens it held at a discount through the OTC market to raise funds for operations. Although the foundation complied with most international compliance requirements, the large size of the transaction caused the price of the token to fall rapidly after unlocking, which brought huge selling pressure to the public market. This case demonstrates the role of the OTC market in large unlocking events and the challenge of balancing compliance with market response.
According to Chainalysis data in 2023, the volume of transactions in the OTC market has maintained significant growth against the backdrop of an overall decline in the cryptocurrency market, especially in low liquidity and bear market environments. For example, in 2023, the total volume of transactions in the OTC market increased by about 18%, with most transactions involving locked tokens or private transactions between high-net-worth investors. The data also shows that more than 30% of cryptocurrency fraud cases involve the OTC market, especially on trading platforms that do not implement effective KYC or AML procedures.
Future Outlook for the Secondary OTC Market
As an important form of transaction in the field of cryptocurrency, the OTC (over-the-counter) market has shown a rapid growth trend in recent years, especially in large transactions and high-net-worth investors. With the maturity of the cryptocurrency market, the development of technology and the gradual improvement of regulatory policies, the OTC market may undergo a series of changes in the future. The following is a detailed discussion of the future outlook of the OTC market, including market potential, technological innovation, regulatory trends and possible challenges.
Market potential and growth drivers
Influx of institutional investors: As cryptocurrencies are gradually accepted by mainstream financial institutions, institutional investors are increasingly participating in the trading of crypto assets. Since the OTC market can handle large transactions without causing excessive fluctuations in market prices, it has become one of the preferred channels for institutions such as hedge funds, family offices and wealth management companies. In the future, as more institutional investors join the cryptocurrency market, OTC trading volume is expected to grow further and drive further expansion of the market.
Increased demand from high net worth individuals: High net worth individuals (HNWIs) are also optimistic about the OTC market, especially for investors with high requirements for large transactions and privacy. Since the OTC market provides more flexible trading conditions and private customized transaction structures, the demand for high net worth individuals to allocate crypto assets may continue to grow in the future, further expanding the size of the OTC market.
Rising demand for cross-border transactions: The digital transformation of the global economy has led to a growing demand for cross-border transactions, especially in regions where funds cannot be transferred smoothly through the traditional banking system. The OTC market, as a flexible and efficient trading method, can meet such needs. In the future, as the worlds reliance on cross-border crypto transactions increases, the globalization trend of the OTC market will become more obvious, especially in emerging markets such as Asia, the Middle East and Africa, where there is huge potential for expansion.
Growth of tokenized assets: In the future, as the application of tokenization technology expands to more asset classes, such as real estate, art, stocks, bonds, etc., the OTC market is expected to become the main trading venue for these tokenized assets. The OTC market can provide customized trading solutions for these high-value and low-liquidity assets, attracting more investors to participate in the trading of tokenized assets, and further increasing market trading volume and depth.
Technological innovation and application of blockchain technology
Smart contracts and automated transactions: In the future, the application of smart contract technology in OTC transactions will become more popular. Through smart contracts, both parties in OTC transactions can pre-set transaction conditions to ensure that once the conditions are met, the transaction will be automatically executed. Smart contracts can not only improve transaction efficiency, but also enhance the trust of transactions and reduce the risk of default through the transparency and immutability of blockchain.
Transparency and security of blockchain technology: Blockchain technology brings higher transparency and security to the OTC market. Although the OTC market is essentially non-public, blockchain technology can provide auditable transaction records, making transactions more credible. At the same time, distributed ledger technology helps reduce dependence on centralized institutions, reduces intermediary fees and improves transaction security and privacy protection. In the future, as blockchain technology matures further, the transparency and security of the OTC market will be greatly improved.
Application of multi-signature and zero-knowledge proof technology: Multi-signature and zero-knowledge proof technologies will bring new security guarantees to OTC transactions. Multi-signature technology can ensure that transactions cannot be executed without the joint authorization of both parties, thereby increasing transaction security. Zero-knowledge proof technology can verify the validity of transactions without exposing sensitive information, further protecting user privacy. These technological innovations will inject new vitality into the OTC market, making the transaction process more transparent, secure and efficient.
Artificial intelligence and big data analysis: In the future, artificial intelligence and big data analysis will play an increasingly important role in the OTC market. By analyzing market trends, transaction history, and counterparty credit through AI algorithms, investors can make more informed trading decisions. At the same time, big data-based analysis tools can also help platforms optimize liquidity management and risk control. The intervention of artificial intelligence will help OTC trading platforms better match the needs of buyers and sellers and improve the success rate of transactions.
Regulatory trends and compliance requirements
Improvement of the global regulatory framework: At present, the regulation of OTC transactions varies greatly from country to country. Some countries have already issued regulations on cryptocurrencies, while the regulation of others is still unclear. In the future, as the cryptocurrency market matures, the global regulatory framework is expected to gradually unify. Countries may introduce stricter KYC (know your customer) and AML (anti-money laundering) policies, forcing OTC platforms to conduct compliance reviews. This uniformity of regulation will help reduce compliance risks in cross-border OTC transactions and enhance market confidence.
Regulation and impact of stablecoins: Stablecoins play an important role in the OTC market, especially in large-scale fund transfers and cross-border transactions. In the future, the regulatory policies of countries around the world on stablecoins may be further refined, including reviewing the compliance and transparency of their reserve assets. If the regulatory environment for stablecoins becomes more stringent, the OTC market may need to find new ways to cope with compliance pressures, such as turning to central bank digital currencies (CBDCs) or other forms of compliant digital assets.
Integration with mainstream financial markets: As cryptocurrencies gradually integrate into the mainstream financial system, the integration of OTC markets with traditional financial markets may become a trend. For example, traditional financial institutions may trade crypto assets through OTC platforms, and in turn, crypto asset trading platforms may gradually introduce OTC transactions of traditional assets. This integration will bring new participants and capital flows to the OTC market, making the market more standardized and transparent.
Market Challenges and Strategies
Liquidity issues: Although the OTC market is suitable for large transactions, liquidity issues remain an important challenge under certain market conditions. In the future, as more asset classes enter the OTC market, especially tokenized traditional assets, market liquidity management will become more complex. Platforms need to solve the problem of insufficient liquidity by cooperating with multiple liquidity providers and introducing innovative mechanisms such as automated market makers (AMMs).
Market manipulation and price manipulation: Since OTC transactions are not open and transparent, there is a risk of market manipulation and price manipulation. For example, certain transactions may affect price trends in the open market or mislead counterparties through false information. In the future, the market needs to crack down on market manipulation through stricter risk control and transaction review mechanisms, while strengthening the reputation management of the platform to ensure the fairness of transactions.
Technical security and hacker attacks: With the technological upgrade of the OTC market, the risk of hacker attacks is also increasing. In the future, the platform needs to continuously improve its network security capabilities to prevent data leakage and asset theft. The application of blockchain technology can improve security, but it is still necessary to guard against attacks against smart contract vulnerabilities. Through regular security audits, vulnerability detection and upgraded security protocols, the platform can effectively reduce the risk of being hacked.
Community Governance and Decentralization
The rise of decentralized OTC platforms: With the booming development of decentralized finance (DeFi), decentralized OTC trading platforms may occupy a certain market share in the future. These platforms use smart contracts and decentralized liquidity pools to achieve transactions without intermediaries, further reducing the trust risk in traditional OTC transactions. In the future, as decentralized finance matures, decentralized OTC transactions may become one of the mainstream trading models.
Community governance and token economic model: Some decentralized OTC platforms may use community governance to determine the platforms operating model, fee structure, and listing rules for new assets. By introducing a token economic model, the platform can incentivize liquidity providers and users to participate in platform governance. This model helps improve the transparency and credibility of the platform while also giving users more autonomy.
Conclusion
The OTC market provides investors with a unique way to operate outside the open market, especially when it comes to large, locked-token transactions. However, this market is also accompanied by significant risks, including illiquidity, credit risk, price volatility, and regulatory compliance issues. As the global cryptocurrency regulatory framework continues to evolve, OTC platforms and trading participants need to strengthen their understanding and implementation of international and local compliance requirements to ensure the long-term health and sustainability of the market. At the same time, with the development of technology and changes in the regulatory environment, the OTC market is expected to become an indispensable part of the cryptocurrency ecosystem in the future through greater transparency and security.
Lianyuan Technology is a company focused on blockchain security. Our core work includes blockchain security research, on-chain data analysis, and asset and contract vulnerability rescue. We have successfully recovered many stolen digital assets for individuals and institutions. At the same time, we are committed to providing project security analysis reports, on-chain traceability, and technical consulting/support services to industry organizations.
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