After browsing for cryptocurrency exchanges or becoming familiar with traditional exchanges, you may have come across the term OTC, and wondered: “What is OTC in crypto?” OTC, as it is termed in financial markets, means “over the counter” trading. This trading option, unlike most exchanges, is discreet and deals primarily with trading in large amounts of cryptocurrency.
Exchanges offer order books for bid and ask prices. As all orders are visible, parties are able to view the volume being traded as it happens. Exchanges are great for individual market participants (i.e. bots, traders, small-scale investors).
However, institutions like Microstrategy that are looking to buy hundreds, if not thousands of Bitcoin run into a problem with the traditional exchange. Since institutions and large-scale investors seek to purchase large amounts of cryptocurrency, they stand to move the traditional exchanges by a significant order of magnitude (most usually against their favor).
Furthermore, institutions are likely to avoid exchanges for the following reasons: their order may cause reactions in the market, bots could manipulate the market against their favor, and others can view and report their market action. They may also want to avoid slippage, a term we will define later.
OTC significantly mitigates some of the risks that come with dealing with traditional exchanges. Depending on the type of desk that an institution would like to purchase from, an OTC broker operates in either one of two ways: a principal desk or an agency desk.
In OTC trading, a principal desk is one where the institution or individual approaches the broker with a price for the cryptocurrency in mind. When the institution and the desk agree on the purchasing price and size of the order, the principal desk goes to work sourcing the Bitcoin it needs to fulfill the order.
This might involve approaching large exchanges directly, engaging deals with miners, or perhaps other OTC desks. In OTC trading, a lot of the risk is weighted on the principal desk to source the cryptocurrency at first.
Let’s say that Brian wants to buy Bitcoin from an OTC broker that uses the principal desk paradigm. In practice, the principal desk, at first, takes on a lot of the risk when it begins sourcing the Bitcoin. They are in a race to source the Bitcoin at or below the agreed-upon price.
Once sourced and retrieved, the OTC broker then takes the payment from Brian. This necessitates a risk on the side of the purchasing party, Brian. Once the currency transaction for the BTC is confirmed by the OTC broker, the OTC broker then fulfills the BTC transaction to Brian.
An agency desk works a little differently. Instead of the desk sourcing the Bitcoin themselves. An agency desk finds the sellers of currency and acts as a middleman between the buyer and seller. For this service, the desk will charge a fee.
With an agency desk, the purchaser (let us use Brian from the last example) would pay the desk for 100 Bitcoin. Then the desk would have to find the 100 Bitcoin at the agreed-upon price. Here, the market risk is solely on Brian for the agency desk to source all the Bitcoin on his behalf before the price of the currency rises.
Meanwhile, the agency desk will source the Bitcoin much like the principal desk: from other OTC brokers, exchanges, and miners.
OTC trading is used for multiple reasons, one of which is to avoid slippage. Slippage is the deviation in expected price order and actual price order. Slippage primarily occurs when you have a market order in place, an order that sets its prices on the current market price.
If you have dealt with buying cryptocurrency on exchanges before, you have probably dealt with slippage in crypto before. On cryptocurrency exchanges, slippage will manifest in the slight deviation of the cryptocurrency or fiat currency you receive in return on the transaction.
Slippage is neither inherently positive nor negative. Sometimes slippage will occur in your favor depending on how the market is moving. But, in terms of large-scale orders by institutions that would traditionally use OTC, slippage would very rarely work out in their favor.
If you are wondering what type of desk is best for you, feel free to explore your options. There are a number of different crypto OTC brokers out there. OTC trading has become a hot topic in crypto Twitter and crypto news when it comes to understanding and anticipating the market actions of institutions.
So whichever crypto OTC broker you use, you are likely not to go wrong as long as you pick a desk that is reputable and active.
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