Bitcoin OTC trading

As much as half of all crypto trades take place in secret, behind closed doors.

The trades are executed quietly, with billions of dollars worth of crypto changing hands outside the main exchanges. According to many experts, including Binance CEO Changpeng Zhao, this means the crypto trading market is twice as big reported.

Welcome to the mysterious world of OTC crypto trading, or “over-the-counter” trading where bitcoin “whales” buy and sell ludicrous amounts of crypto between each other.

Very little is known about OTC trading, how it works, or its true effect on the market. 

During my research, I spoke with OTC expert Mark Sapolinski, who has organized bitcoin OTC deals since 2012 and currently manages an order book worth about $2 billion. 

During our energetic conversation, I gained several precious insights into the mysterious world of over-the-counter trading that I’m now about to share with you.

What Is Bitcoin OTC Trading?

In a nutshell, OTC, or “over-the-counter” trades are private deals for buying and selling cryptocurrencies. They are not done through regular exchanges and are therefore not displayed in any public order book, which means increased privacy for both the buyer and the seller.

Some estimates suggest that the volume of crypto traded on OTC markets is two-three times larger than regular exchanges.

OTC Transactions are Private and Have Lower Impact on Market Price

Apart from the improved anonymity, another reason to trade in this way is to minimize the impact on the market itself.

Trades worth millions or even billions of dollars would inevitably move the price in the opposite direction of your need. Nowadays, it appears that a large share of the OTC volume comes from only a few hundred massive transactions. 

As a result, many “whales” seek private deals that will not affect the market as much as deals on regular exchanges.

Further reading: Who are the Bitcoin Whale? (Criminals, Traders, & Early Adopters)

How are OTC Trades Executed?

At the moment, there are two different ways to handle OTC transactions: through a middleman or by using big online platforms. 

OTC brokers, the men in the middle, have their very own network of crypto investors and cryptocurrency sellers. They constantly keep themselves up to date with who wants to sell or buy coins, how much they want to deal with and when they want to pursue the deal.

It’s a very personal, bespoke service.

In the end, they want to match a crypto buyer with a crypto seller and take a commission for the service. Unfortunately, dealing with OTC brokers usually takes a lot of time. Establishing trustful relationships is a key element of conducting business in this way.

… Or Through an Online Platform like Circle

On an OTC platform, the intermediary will be replaced by a software platform. Think of it like Coinbase for the uber-rich. Perhaps the best-known crypto OTC platform is Circle, but even Coinbase has quietly opened an OTC trading desk.

Circle OTC bitcoin trading

In this method, algorithms will match buyers and sellers, and trades will usually be conducted over the platform. Just like with OTC brokers, the platform will take a fee for setting up the deal. 

The main downside of using a platform instead of a broker would be the omnipresent risk of a hack, as we have seen in the past. 

Additionally, one should always make sure that the platform is compliant with the current regulations, such as KYC and GDPR, since authorities might crack down on it otherwise.

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The History of Bitcoin OTC Trading

Many crypto people believe that engagement in OTC deals requires them to be a high net-worth individual, or, in other words, a whale. 

You might be surprised to know that one of the most popular and oldest OTC markets is actually for the small fishes: LocalBitcoins. The popular platform matches local bitcoin buyers and sellers since 2012 and still serves more than four million users worldwide, as recent reports have shown.

Especially in the first few years of Bitcoin’s life, OTC transactions appeared to be the most common way of trading the digital currency. “At this time, OTC deals were done completely different than now,” says Sapolinski. 

localbitcoins logo

From Small Trades to Multi-Million Dollar Deals

From 2013 to 2016, the number of Sapolinksi’s clients ranged from 1,000 to 2,000 clients a month, but with rather small order sizes of $1 to $50,000 dollars. As Sapolinski later explained. “I remember a general negative stigma for doing Bitcoin transactions in these years. There were not many questions asked.” 

2017 would be the year that brought change to the cryptocurrency market. Easier methods of buying and selling small amounts of bitcoin cropped up, like Coinbase and Binance.

Meanwhile, with continuously rising prices of bitcoin, there was suddenly a greater need for larger purchases, larger amounts. The new, vastly wealthy bitcoin whales needed a place to trade.

The OTC space changed from quantity to quality. Fewer clients, bigger transactions. However, with great power comes great responsibility. “As Bitcoin was now traded in unbelievable monetary value, it also became a liability to report big transactions to banks and financial authorities,” Sapolinski mentioned.

How Does a Bitcoin OTC Transaction Work?

As explained, the most popular way of conducting large OTC transactions during the past few years was using OTC brokers. 

According to Sapolinski, bitcoin and other cryptocurrency OTC trades usually follow a traditional discount model. Using an example name of “Bob,” here’s how it works:

Bob wants to sell a large amount of bitcoin. He’ll offer a discount of about 3% against the market price to do so. In order to make such a transaction, Bob will first look for an intermediary, an OTC agent, that he can personally trust. 

Bob needs to provide his trusted intermediary with a proof that he actually owns the bitcoin he wants to sell, which is also known as a “Satoshi Test.” Satoshi Tests can be done by conducting a small transaction from a wallet with the alleged funds.

At the same time, there is a buyer somewhere hoping to find a person willing to sell their precious coins or tokens. 

That person, let’s call her Alice, will also find a trusted intermediary herself. She will also provide proof of funds. Both intermediaries will now find each other through their complex black book of contacts. They’ll start negotiating with each other. 

However, there is still an inherent problem with every OTC deal that is done through two different middlemen: the buyers and sellers are often not able to trust each other.

Can You Trust an OTC Deal?

This is where the “OTC Tango,” as Sapolinski calls it jovially, starts. Both parties are expecting the information they need from the other party, which could either be a proof of coin or a proof of funds. 

The problem is: they will only provide each other with this highly private information if they feel absolutely comfortable in trusting each other. 

In many cases, buyers and sellers are separated by several thousand miles, sometimes there’s even a language barrier. It is now the time to find a base of trust, which can be pretty hard if you are not able to properly meet. 

This can usually be achieved by leveraging the network of colleagues that brokers already have a trustful relationship with. Otherwise, trust can also be established through honesty, transparency and the documentation that is provided.

What About OTC Platforms Like Circle?

Although working with intermediaries has been the crypto OTC method of choice for most of the last decade, it seems like OTC platforms are steadily gaining more influence and power.

This may be due to the fact that large institutional investors would most probably prefer using an OTC platform rather than working with middlemen. 

Many financial heavyweights fear the severe trust issues that come with regular cryptocurrency OTC deals. In order to provide a suitable solution for such clientele, many companies started working on fully regulated and secure electronic bitcoin OTC exchanges. 

As explained, Goldman Sachs-backed Circle is probably the best-known cryptocurrency OTC desk. In April this year, Circle Trade told Business Insider that their minimum transaction size moved to $500,000, with the average trade being valued around $1,000,000.

Another interesting project is Republic Protocol. The team is currently building the world’s first decentralized dark pool, which aims to be a fully anonymous OTC platform, expected to work with smart contracts, and hence eliminates any possible trust issues for its users.

Republic Protocol bitcoin OTC trading

What Impact Do OTC Transactions Have on Bitcoin Price?

While unlisted transactions should theoretically not affect prices of cryptocurrencies, the past has clearly shown that it doesn’t work that way in the real world. 

Imagine a whale that is sitting on thousands, if not tens of thousands, of bitcoins that he wants to sell. Due to the incredible amount of bitcoin he wants to sell, he will contact multiple OTC brokers to find him one or more trusted buyers. 

The word about this deal will slowly spread and some bigger investors might now start to sell their bitcoins in order to participate in that deal and obtain bitcoin at a steep discount. 

As you see, OTC deals might have an impact on the price of bitcoin, but they could also be completely excluded from it. 2018 was undoubtedly a year that brought many innovations to the world of crypto over-the-counter trades and it remains to be seen how the space develops in the years to follow.

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Bitcoin whales

Bitcoin whale is the term given to those with huge amounts of bitcoin. And if they were to suddenly sell all their coins at once, it would cause an enormous splash on the markets.

It’s estimated that only 1,000 “whales” own about 40% of all bitcoin.

To put it another way, 61% of all bitcoin is owned by just 0.07% of wallets.

But who exactly are these crypto millionaires with gigantic bitcoin wallets?

A few names spring to mind:

Satoshi Nakamoto Bitcoin’s mysterious founder is estimated to own one million bitcoins. He mined them in the early days and has never moved them since.

The Winklevoss Twins – The arch nemeses of Mark Zuckerberg, the Winklevi poured much of their Facebook legal settlement into bitcoin. They’re estimated to own 1% total bitcoin supply. 

There are others too. Early adopter Charlie Shrem, for example. Then there’s billionaire Tim Draper and Barry Silbert, both of whom bought bitcoin in a 2014 auction.

However, a recent Chainalysis report dug deeper into bitcoin whale activity. Analyzing the 32 biggest bitcoin wallets, here’s what they discovered:

chanalysis bitcoin whales
Credit: Chainalysis

A Third Are Active Traders

Nine of the 32 largest whales were actively buying and selling in the last year or so. They could be individuals or institutional crypto hedge funds.

As for their activity, these holders were generally “buying the dips.” In other words, they were waiting for bitcoin to decline before buying more.

As Chainalysis explained: “they have, on net, traded against the herd, buying on price declines.” So, despite media claims, bitcoin whales aren’t necessarily the ones crashing the price. Instead, bitcoin whales are stabilizing the market, buying at the low points to prop up the price.

Chainalysis also estimated that most of these active whales splashed into the market in 2017 so they are relative newcomers.

Early-Adopters 

Chainalysis uncovered a handful of wallets dating back to the early days of bitcoin. These are early-adopters and miners that amassed a large wallet when bitcoin was in its infancy.

Trading activity is “extremely low” among this group, however, a fair number appeared to “cash out” during the bull runs of 2016 and 2017, making a fortune in the process. 

Criminals

Of the 32 largest bitcoin wallets, three have been linked to criminal activity. Those three wallets contain 125,000 coins, worth $800,000,000 at today’s prices.

Two of the wallets are linked to the infamous Silk Road black marketplace, where users could buy drugs and weapons with bitcoin. Chainalysis concludes that the third wallet was involved in money laundering.

Further reading: Black Markets, Fraud, and Money Laundering: How Much Is Bitcoin Used For Crime?

Lost Wallets

The remaining largest wallets have lain dormant since 2011. We assume the private keys to these wallets are lost for good which means these whales no longer have access to their vast fortune.

These lost wallets contain 212,000 bitcoins, or approximately $1.35 billion worth of bitcoin.

It’s estimated that a total of four million bitcoins have been lost over the years.

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