By Natalie Lord
Financial markets are organised in two basic ways: on exchange or over the counter (OTC), with the traditional distinctions blurred slightly by some recent electronic facilities.
Exchanges started as physical locations where trading took place. Some of the most famous exchanges include the New York Stock Exchange (NYSE) which was formed in 1792 and the London Stock Exchange (LSE) which was founded in 1571. There are currently more than 100 stock and derivatives exchanges around the world.
Exchanges govern trading and related information and set institutional rules. They are closely linked to clearing facilities which deal with post-trade activities. An exchange will act as the central point for the communication of bid and offer prices to all direct market players, who will respond by agreeing to buy or sell at one of the prices quotes or by coming up with a counter offer. The medium of communication differs from exchange to exchange but can be voice, hand signal, electronic message or computer-generated electronic commands. When two parties reach an agreement on the price, the transaction is executed and communicated throughout the market.
Electronic trading has eliminated the need for exchanges to be physical places. In fact, many trading floors are now closing with the communication or orders and executions being managed electronically. The London Stock Exchange is now completely electronic.
Contrary to exchanges, over the counter (OTC) markets have never been physical localities. They are less formal networks of trading relationships that focus around one or a group of dealers. The way in which over the counter trading works is that dealers quote prices at which they will buy or sell to other dealers and to their clients. They don’t need to quote the same prices to dealers as they do to clients, and they do not have to quote all clients the same price. Dealers can withdraw from market making at any time which can disrupt the ability of participants to buy or sell. OTC markets operate with fewer regulations than exchanges and are less transparent.
In the world of crypto, Coinbase, the popular US cryptocurrency exchange, launched an OTC trading desk for institutions to get cryptocurrency exposure in November 2018. The start-up was recently valued at US$8 billion. Its OTC trading is done directly between two parties instead of on exchange, with Coinbase acting as an “agency” earning commission by executing client trades.
Christine Sandler, Head of Institutional Sales at Coinbase, said of the launch that the move was made in conjunction with an increased demand for OTC crypto trading from institutional investors. “We launched our OTC business as a complement to our exchange business because we found a lot of institutions were using OTC as an on-ramp for crypto trading.”
Elsewhere, cryptocurrency finance firm, Circle Trade, has an OTC desk with a minimum entry-point of US$250,000 and is backed by Goldman Sachs. Here principal trading desks utilise their own inventory to complete orders and provide liquidity for clients. Circle said it executed 10,000 OTC trades in 2018, accumulating US$24 billion in notional volume.
Last year, cryptocurrency exchange Bittrex launched an OTC trading desk allowing investors to trade up to 200 digital assets. Bittrex said it would offer guaranteed pricing for large block trades starting at US$250,000.
Bittrex CEO, Bill Shihara, said in a statement to the media that the OTC service would “further advance the adoption of blockchain technology worldwide, while providing high volume traders with much needed price certainty and a fast and easy way to trade large blocks of digital assets.”
Gemini, which was founded by Cameron and Tyler Winklevoss and Genesis Trading offer further OTC trading options for cryptocurrencies. US-based digital asset platforms, Bitfinex and Poloniex, also have OTC trading desks dedicated to large volume traders.
OTC trading is popular with institutional investors who trade substantial volumes of cryptocurrencies. The upside being that OTC trades are often handled via brokers who offer high-volume traders an option to execute large trades with lower fees and a faster settlement.