Finance 101: What Is OTC Trading?

Over-The-Counter buying and selling avoids exchanges in favor of trading directly between two participants.

What are the benefits of trading off-exchange?

OTC (Over-the-Counter) trading refers to the process of buying and selling financial assets directly between two parties in a private agreement. While the parties may use brokers or dealers as intermediaries, and any asset (stocks, bonds, commodities, crypto, etc) may be traded, the key feature of OTC is that the trade occurs without the use of an exchange.

Binance OTC screenshot
Binance OTC starts with a minimum trade size of $200,000.

OTC trading is common in the mainstream financial system, and also in the crypto space. There are various reasons for this, due to the advantages offered.

  1. Pre-determined, reliable price. Trading OTC involves agreeing a price for a certain amount of crypto (for example) ahead of time. This means participants can be certain to have their trades filled. When using an exchange, there is no guarantee that a limit order will be filled.
  2. No slippage. While a large market order on an exchange can move the price, OTC trades are not subject to slippage. This makes them popular among whales and institutions (for example, ETF providers), who do not want to end up chasing the price higher or lower.
  3. Privacy: OTC trading offers increased privacy and anonymity compared to exchange trading. Parties can negotiate trades off-market, which may be desirable for institutional investors or high-net-worth individuals seeking to keep their trading activities confidential. The crypto community watches exchange addresses, and large on-chain movements of crypto to exchanges are closely tracked.
  4. Flexibility: OTC markets offer greater flexibility compared to traditional exchange-traded markets. Parties can negotiate terms and prices directly, allowing for customized agreements that may not be available on public exchanges.
  5. Liquidity: OTC markets can provide liquidity for assets that may not be actively traded on public exchanges. This is particularly true for smaller or less liquid assets, where OTC trading allows investors to buy or sell without having to wait for matching orders on an exchange.
  6. Reduced Regulatory Burdens: OTC trading may involve fewer regulatory requirements compared to exchange-traded markets, which can reduce costs and administrative demands for participants. (However, regulatory oversight still applies to OTC trading to ensure transparency and fairness.)
  7. Access to Unusual Assets: OTC markets often facilitate trading of unique or illiquid assets that may not be available on public exchanges. This includes exotic derivatives, structured products, certain types of securities, or particular cryptos.

Limitations

OTC trading is generally best for high net-worth or institutional investors, who are trading large sums of crypto. There must be trust between the two parties, or else they must use a trusted third party as escrow. Regular retail investors are generally better off using exchanges.

OTC works best when users have access to a network of other high net-worth traders or institutional partners. For example, institutional bitcoin buyers may establish direct relationships with miners. This allows them to purchase large quantities of "clean" (coinbase) coins, privately. It also allows the miners to sell at a pre-determined price, enabling them to budget effectively in advance.

Overall, OTC trading offers a range of benefits including flexibility, liquidity, privacy, and access to unusual assets, making it an attractive option for certain types of investors and market participants. However, it's important to note that OTC trading also carries risks, including counterparty risk, lack of transparency, and potentially higher transaction costs. Investors should carefully consider their objectives and conduct thorough due diligence before deciding whether an OTC trade is the right option for them.


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