Exchanges are the most popular way to dispose of bitcoin holdings for fiat currency, with thousands of coins being traded daily. However, when one cryptocurrency startup founder needed to cash in his bitcoin quickly, he didn’t log on to an exchange to do it.

Instead, the entrepreneur started asking around for a broker who could settle the issue with an over-the-counter (OTC) trade. The broker he found, through mutual friends, was Jonathan ‘Jonny’ Harrison, who runs London bitcoin ATM firm Satoshipoint. The two struck up a conversation on Skype and soon agreed to do a deal.

“Someone told me that he wanted to sell 12 grand-worth, we had a chat on Skype and entered an agreement, and so that was the deal done,” Harrison said, recounting the trade.

Harrison charges a 5% fee for an OTC trade. Although he says he arranges such trades only occasionally, other brokers specialising in OTC trades have found a lucrative niche in the market. As the bitcoin price surged last year, wealthy holders eschewed exchanges and turned to brokers to lock in their gains with a single big trade.

Tricks of the OTC trade

Trading over the counter offers several advantages over placing an order on an exchange. For one thing, traders get to protect their capital from the effects of price slippage.

Slippage is what can happen when an investor sells a large block of coins on an exchange all at once. If the sell order is large enough, it can cause the price on the exchange to fall as it is filled. As a result, the seller can lose a substantial chunk of the proceeds by the time the entire order is filled.

Just how much of a trade is lost to slippage is difficult to quantify, according to George Samman, a co-founder of BTC.sx and a former portfolio manager at a New York investment firm. In a hypothetical trade where an investor sold 100 BTC on BitStamp at today’s price of about $490, he or she would stand to lose up to 10% to slippage.

“When someone is trying to put a block trade through and there’s not enough takers at a certain price level, then the price keeps dropping as bids keep getting lower and lower,” he said.

Other factors can come into play. Traders could be laying in wait with ‘false’ orders on the exchange to feel for large blocks coming to market. When some of those orders are filled, savvy traders could cancel the rest of their original orders, sensing that a big block is being traded, and quickly place new orders at lower prices, Samman says.

“Other traders will just snap it away and the price could drop $10, $15, off of 20 coins being traded in a 100-coin block. And they will keep snapping it up because it keeps slipping and slipping,” said Samman.

Trust in a trustless environment

Speed and privacy are the other advantages that OTC block trades offer. Sellers needing fiat currency in a hurry might turn to a broker, as would investors who prefer not to entrust their trading data with a large exchange.

In an ironic inversion of bitcoin’s trustless protocol, OTC trades are a throwback to markets operated by trusted intermediaries. Mark Lamb, chief executive at London-based exchange Coinfloor, who regularly conducts large OTC trades for clients, charging a fee of up to 1% of the traded amount, said:

“What you’re selling is trust. This OTC broker knows what they’re doing, vets the participants and knows the participants are going to settle and the trade is going to go through.”

When a call comes in to sell a block of coins, Lamb hits his address book to look for buyers. When a match is found, Coinfloor draws up contracts between itself and each party. The buyer and seller deal with Coinfloor, not each other. After the contract is signed, both parties must transfer their funds to Coinfloor immediately. Once the broker has received the funds from both sides, the assets are then sent to the appropriate counterparty.

While most of the OTC brokers for big blocks CoinDesk spoke to keep identification documents to comply with know-your-customer rules, OTC traders may believe that they enjoy a greater degree of privacy with their brokers.

“Customers want to do trade with someone they can trust; someone they trust more than an exchange. They might come to a broker because they may not trust the top few exchanges,” Lamb said.

Cashing in big blocks

Brokers are most in demand when prices are volatile. Investors are either rushing to lock in gains by selling a big block, or to accumulate more coins when the price plunges.

Harry Yeh, managing partner at hedge fund and venture capital firm Binary Financial, is a regular OTC broker and only carries out trades of at least 50 BTC. He recalled one episode of manic selling, as clients wanted to turn their bitcoin profits into millions of dollars of fiat, and quickly:

“When the price goes up, the demand for blocks goes through the roof. When the price crashes, everybody wants to sell. Around December 5th, when the whole China thing happened, we had people who wanted to sell $2m–$3m of bitcoin right away.”

Yeh was coy about who his OTC clients were, saying only that he has dealt with “high net-worth individuals and institutions”. When pressed, he gave up precious little information, saying that clients included “hedge funds, family offices and private wealth managers”.

According to Yeh, private wealth managers have been contacting him of late as they seek to diversify their clients’ holdings to include cryptocurrencies. Lamb was similarly vague about OTC clients, saying only that he served “high net-worth individuals”, adding:

“There are people who put a lot of value in executing a full block of 1,000 or 5,000 coins at once.”

OTC trades and the wider market

What effect does all this OTC trading have on the wider market? Brokers say that OTC trades protect the market from exacerbated volatility.

“The whole goal of the broker is not to disperse the coins into the market. It’s to move it between one seller who has decided to sell, to ideally one buyer who would like to get in to hold,” Lamb said. “It reduces volatility.”

Samman, of BTC.sx, said OTC brokers have a role to play because bitcoin investors are too green about managing their trading risk. Instead of using a sophisticated combination of trading orders to reduce price slippage for a big block, for example, traders may try to offload a big chunk of coins with a market order, which is filled at the prevailing price.

“Some of the traders are very inexperienced […] they’re throwing in market orders and thinking that just because they see the price at one level, they’re going to get that price,” he said.

While many exchanges, including the current top exchange by volume, Bitstamp, offer stop-loss orders which can help mitigate slippage, one exchange has gone further. LakeBTC has released a ‘hidden’ orderbook feature that it calls its “darkpool”, designed to protect investors against ‘financial predators’ waiting to exploit the price distortions created by big trades.

LakeBTC’s darkpool works by hiding big trades of 50 BTC and up from the public order book. Although the rest of the market can’t see the trade, the exchange continues trying to fill it with outstanding orders on the market at the time, the firm’s communications director Lisa Li said, adding:

“You might buy 100 BTC in a single order, but it may get matched with multiple smaller orders, or one single big sell order – it really depends on the sell orders at the time.”

OTC is here to stay

In the opaque world of OTC trading, it’s unclear just how much money is changing hands each day. One gauge might be the activity on LocalBitcoins, which essentially functions as an OTC market.

According to Coinometrics data, LocalBitcoins accounted for up to 5% of daily traded volume in the last year. Contrast this with Bitstamp, has accounted for up to 40% of daily traded volume at times this year.

Physical markets, like the Satoshi Square events, and the Bitcoin-OTC IRC channel are other platforms where OTC trading takes place.

As the bitcoin markets continue to mature, it appears OTC trading is here to stay. As Samman points out, trading volumes have shrunk, even in the established equity and commodities markets, as big trades are increasingly done over the counter.

“The problem with OTC trading is that they are private. People get upset about that and they think there is some kind of manipulation going on. But in the markets today, there is less and less volume. Even in the equity markets, institutions are trading with each other and taking trades offline.”

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