Since emerging from relative obscurity, bitcoin has seen a meteoric rise, a subsequent collapse, and a recent re-emergence. This trajectory has been closely followed by countless altcoins. Through ongoing volatility, bitcoin continues to set the tone in the ecosystem while the adoption of crypto assets accelerates.
According to a report released by the Cambridge Centre for Alternative Finance, there were 35 million verified crypto users at the end of 2018, a 94% increase over 2017.
Besides crypto enthusiasts, retail investors, traders, venture capital firms, family offices, and accredited investors continue to add digital assets to their portfolios in search of diversification and future growth. An increasing number of companies are also offering to compensate their employees in crypto. And as prominent financial institutions like Fidelity and Goldman Sachs forge ahead with blockchain initiatives, it’s evident that mainstream adoption is underway.
But amongst these new market participants, many early adopters manage substantial crypto portfolios. These enthusiasts were big on Bitcoin when it was trading at $20 USD, or invested in other token offerings at inception. Some of the savviest investors often hold thousands of digital coins, equating to substantial value in their portfolio. For these investors, crypto trading involves a more complex set of considerations. Most importantly, how do they make a significant trade at a fair rate - without losing too much of their value in the process?
Considering the applicable fees and market spread, trading digital currencies and converting them to fiat is challenging to navigate. And although cryptocurrency exchanges typically garner more attention, Over-the-Counter (OTC) trading desks should not be overlooked. But what are the main differences between exchanges and OTC desks, and why choose one over the other? Let’s delve into what you should consider when exploring both options.
Deciding Between An Exchange and OTC Desk
Exchanges are most often the choice of retail investors that want to make a profit via regular trading or market speculation. Typically, these investors trade in quantities equivalent to hundreds or thousands of dollars. Exchanges usually support many different coins and show the current market prices of those they list. These platforms often facilitate direct crypto asset swaps and the trading of digital assets for fiat. Exchanges also enable the act of “trading pairs” wherein investors trade one digital asset that is worth more in fiat for another, generating a profit.
Using an OTC desk, a broker sets up a direct crypto exchange between an investor looking to trade in far higher volumes than can be accommodated by an exchange. Although minimum trade values fluctuate between OTC desks, they often start at $25K, with $100K being more common. While OTC desks mainly facilitate the conversion of crypto to fiat and vice versa, some OTC desks support crypto asset swaps if liquidity is adequate.
Because of their higher trade values, OTC desks are popular with sophisticated investors, institutional investors, or whales - substantial digital asset holders. These individuals prefer to make large trades more anonymously, without affecting crypto asset markets. For those investors wanting to sell or trade larger quantities of digital currency in a single transaction, an OTC desk is usually the best option.
Slippage and Liquidity
Slippage and liquidity are the primary considerations when deciding to trade on an OTC desk or exchange. Slippage often occurs on exchanges when placing a market order - one that executes when the best price to buy or sell emerges. If during the exchange the asset you're trading increases or decreases in value, the market order will automatically make the trade. As a result, your trade may result in more or less than initially expected.
Source: IG Australia
When large trades occur on exchanges, they can also affect the liquidity of the asset you're trading. The large trade will likely be broken up, changing the value of the asset on the exchange. Separated orders will be sold at a lower and lower cost until the trade is complete.
On OTC desks, trades take place independently of the market, so they don’t directly affect the liquidity of the asset you’re trading. When trading on an OTC desk, a fixed price is agreed upon and the broker is responsible for executing the trade at that value. Because a price is agreed upon prior to the trade occurring, liquidity and slippage are not considerations when trading on an OTC desk.
Exchanges apply various fees when executing a trade. Trading fees average 0.2%, while wire transfer and withdrawal fees hover near 0.1% of the total trade value. There are also trading amount limits that can dramatically increase the fees paid by investors. These limits dictate that you can only exchange so much crypto before larger trades are broken up and charged individually. Although these charges may be negligible when conducting smaller trades, costs could be substantial for large transactions.
In contrast, OTC desks have a single fixed rate for all trades. These rates can range from 0.35% to 0.4% of the trade amount. By trading off of the market, OTC desks can provide fixed prices, thus protecting investors from volatile market swings. This difference in infrastructure is why OTC desks are the preferable option when making large trades.
When you put your crypto assets on an exchange, they are technically no longer yours. Until you remove your crypto from the exchange or execute a trade, you essentially receive an "IOU." This arrangement is problematic in circumstances where exchanges are hacked, or close unexpectedly.
Because exchanges are known to hold so much crypto in an online environment, hackers have made a habit of infiltrating them. In 2018 alone, a record $865 million was stolen from six exchanges as a result of hacks. This amount was more than double that taken from exchanges in 2017. Understandably, the history of hacks has made exchanges less favourable platform for making large trades. It’s essential to remember that, once your funds are on an exchange, they are no longer in your control.
With an OTC desk, you own your crypto assets throughout the entire trade. You are only transferring ownership upon the actual exchange, which can happen instantly. In the absence of an exchange intermediary, investors are solely responsible for each trade. While this can be considered a benefit, investors must ensure their chosen broker is reputable and trustworthy. Unfortunately, it’s impossible to ensure that the other trader will follow through with the trade, but carefully vetting trading partners can help prevent potential issues.
ID Verification Processes (KYC)
Many crypto exchanges that originated before 2018 have established very stringent, widely used rules for the Know Your Customer (KYC) process. This validation process is necessary to ensure the authenticity of an investor’s identity and address while also complying with anti-money laundering regulations. Both validation components are required by regulators overseeing exchanges and OTC desks.
The KYC process varies between each exchange and OTC desks, but for a typical individual, it requires a few quick submissions. While some exchanges request two forms of ID, such as a passport or driver’s license, others also require that you submit a photo of yourself holding identification. Additional documents may also be needed depending on the specific compliance policies set by each exchange or OTC desk, and how it applies to a specific investor.
Verifying one’s identity for an OTC desk is usually more thorough. This is because large trades in excess of $100K are commonly made through OTC desks. Such trades are often executed by a family office, fund manager or business. Institutions or businesses are subject to a more rigorous process consisting of checks and documentation that must be completed to verify the business. For substantial trades, a phone interview may even be necessary to make sure a fit exists between the institution’s trading needs and the OTC desk’s trading network.
Choosing the Best Crypto Exchange Service
Coinchange is an innovative Canadian financial services company helping people and companies navigate the new digital asset economy. We offer a fast, transparent and digital OTC (Over-the-Counter) exchange service for buying and selling digital currencies for trades as low as $3K (during our Beta launch period). Fees are so yesterday, keep more of your money by using Coinchange - Sign-up today!