We are ten years into the Bitcoin revolution, but its global network of 200+ exchanges remains largely unregulated. Yes, there are money transfer agent regulations that must be complied with and KYC/AML rules that must be adhered to, but safety and security are large stumbling blocks. As for regulators, the industry must quickly deal with the anonymity issues of the blockchain world or governmental officials may get aggressive and soon. New edicts from the Financial Action Task Force (FATF) were adopted at the last G20 meeting in June, and the clock is ticking for an inevitable showdown.
In the meantime, brokers have clients, large institutional ones, that want to participate in cryptocurrencies, but the risks are such that they prefer to deal with their favored brokers, as they have in the past for other securities. The majority of brokers have opened their respective OTC (Over the Counter) desks to cryptos, although they may restrict support to Bitcoin and possibly a few other major altcoins. There is still a world where message apps are used to obtain quotes, especially for large transactions that might wreak havoc with low liquidity situations that pervade most crypto exchanges.
There are material differences between direct access to an exchange and using a broker, as explained by Bankrate.com:
Traditional brokers have the advantage of offering a wide selection of investible securities, though typically you can’t trade bitcoin directly, only futures. Meanwhile, crypto exchanges are limited to digital currencies, though you can own the currencies directly and can often buy several, rather than simply bitcoin or bitcoin futures, as you would with a general broker.
How large is the OTC market in Bitcoin?
There have always been issues in the crypto world with volumes being over reported by exchanges, but data analysis firms put daily BTC volumes at somewhere between $900 million and $3 billion on a given day. Brokers have estimated their OTC contribution to be in the neighborhood of 10% to 30%. It is by no means small. The use of informal communication tools to bring together disparate parties for rather large transactions sounds like a recipe for disaster. For this reason, the OTC industry is gradually shifting toward electronic automation.
In recent broker interviews, Reuters found that:
Trades involving hundreds of thousands, or millions, of dollars are routinely struck via brief chats on apps like Skype, WhatsApp, WeChat or Zoom, often with scant certainty over the identities of participants or the legal basis of agreements.
Kevin Zhou, co-founder of San Francisco-based OTC desk Galois Capital, told Reuters:
Doing stuff over Skype and over these voice chats is not really scalable.
Andrea Leccese, president of Bluesky Capital in New York, which often handles $5 to $10 million orders, elaborated:
I prefer to use electronic because all our algorithms are fully automated. If we can send our quote electronically to the OTC broker, it’s much better for us. It’s fair to say more or less half of OTC trading is going through technical innovation like making fully electronic platform, and that’s even better on our side.
Brokers understand their market and that an OTC desk, preferably an automated one, will always be in demand for several reasons:
- Exchanges lack liquidity;
- Price protection for large orders;
- Many exchanges do not trade in fiat;
- Slippage can be a problem with exchanges; and
- Exchanges have prohibitive trading limits.
The nature of the Bitcoin world also makes it a perfect fit for the OTC desk access and operating model. There will always be sellers in the market, primarily driven by miners that must convert their rewards to pay utility bills and other costs. For these sellers, the buyers are predominantly hedge funds, small asset managers, regulated broker-dealers, and crypto exchange OTC desks.
Are there problems with the crypto OTC world?
Surprisingly, many of the same issues that persist with exchanges affect risk in varying ways with OTC brokers. Settlement risk and the delivery of assets can be problematic. Custody solutions are also an issue, as is the need for monitoring software. KYC/AML rules can be difficult when multiple jurisdictions are involved, as well. There are software solutions in development for each of these issues.
As the crypto market evolves, so will the OTC market, as well. The general consensus is that automation, competition, and shrinking spreads will cause some consolidation, but there will always be a need for the service. Miners will always have a need, and institutional players will continue to use their internal OTC desks and infrastructure.