To avoid the risks of exchange hacks and price slippage, some wealthy cryptocurrency investors are turning to firms that facilitate over-the-counter (OTC) trade.
If I asked the average person to buy some bitcoin, chances are good that they would search "buy bitcoin" on Google. In an instant, they would be bombarded by advertisements for various cryptocurrency exchanges – Coinbase[1], Bithumb[2], bitFlyer[3], and so forth. Additionally, they might stumble across some questionable looking bitcoin ATMs.
However, one would have to dig deeper to find a third way of buying cryptocurrency: OTC trading.
Over-the-Counter
"OTC" stands for "over-the-counter." The term is perhaps more familiar in a pharmacy context. For example, Tylenol is an over-the-counter (non-prescription) drug.
It's a little bit different in the financial world. Here, OTC trading[4] refers to buying and selling that occurs outside of commodities or stock exchanges (e.g., the New York Stock Exchange[5]).
"Institutions and broker dealers don't necessarily want anyone to know what their trading strategies are. When large institutions or brokerage firms attempt to make block trades on an exchange, the market may react in such a way that pushes prices in a direction unfavorable to the institution or firm," says FINRA.
The self-regulatory organization goes on to explain, "When an institutional investor is making a large trade (think thousands of shares), they sometimes prefer to do so over the counter."
In the cryptocurrency world, OTC trading plays a similar role.
Exchange-Based vs OTC Cryptocurrency Trading
Say, for example, that Alice wanted to buy 200 Ether at $400 per unit. That's an $80,000 order.
Exchange
Alice could try to make her purchase through an exchange, but some platforms may not have sufficient liquidity[6] to support her order. In other words, there might not be enough people selling Ether for $400 (or less) for Alice to complete her purchase.
If Alice places a market order[7] (an order to buy or sell immediately at the current price) on a cryptocurrency exchange, she might also encounter slippage[8]. This happens when the executed trade price deviates from the expected price. Malicious traders might even design strategies to take advantage of price discrepancies when a large buyer or seller (like Alice) enters an order.
OTC
Instead of visiting a cryptocurrency exchange, Alice may seek the assistance of a cryptocurrency trading firm. These companies connect large cryptocurrency buyers and sellers, deducting a commission for the service.
For example, to process Alice's trade, Firm ABC might connect her with Bob, a bitcoin whale.
Note: A bitcoin whale is a person or group that owns a large amount of bitcoin.
By transacting with Bob via Firm ABC, Alice is guaranteed price certainty.
She knows that she will be able to make her purchase at $400 per Ether without impacting the overall market liquidity.
