OTC Trading Explained

OTC Trading Explained

While crypto trading platforms are popular, with both the number of users and trading volume rising each year, OTC trading is often overlooked by cryptocurrency users. It has its own upsides that you can use to make a profit. Let’s take a look at what Over-the-Counter trading has to offer.

Over-the-Counter Definition

“Over-the-Counter” trading is a process when traders execute their deal outside formal platforms with no external supervision. Basically, two people exchange their assets directly. 

As it happens outside of a formalized platform with its own set of rules, traders can exchange anything they want. OTC traders also don’t need to publish prices of assets they trade, as it is a private deal. While the deal doesn’t happen on the exchange, it doesn’t mean that traders need to conduct the deal themselves. In fact, they can always seek help from the third party, like a broker, or OTC desk.

OTC desks trade securities that go unlisted on big platforms for various reasons. And those reasons could be radically opposite: while small companies are simply unable to follow listing requirements or to pay fees, huge corporations go to OTC to be able to trade with more freedom. After all, no oversight brings more opportunities to the traders that know what to do. 

Securities for OTC Trading

OTC Trading Securities

As it was mentioned earlier, the OTC market is not exclusive for small companies. Behemoths like Nestle SA, Danone SA, and Bayer A.G., also trade their shares on OTCQX. In terms of crypto, the biggest OTC traders are crypto whales, willing to sell large amounts of cryptocurrency, usually big investors and miners.

One of the most traded OTC securities is American depository receipts (ADR for short). They represent shares in equity that are traded on foreign exchanges. Those shares are such common OTC assets for a variety of reasons. The most common of those are strict regulations of trading platforms and rather punitive fees for the listing. With that in mind, a lot of companies prefer to hire a broker and try their hand at OTC trading.

A short explanation of OTC trading

Bonds are also a common sight on OTC markets, as banks do not trade them on usual exchange platforms. Instead, they market them through the broker-dealer networks. They are also considered OTC securities, since they are traded directly, with no oversight from a formal exchange platform. Banks are mitigating the costs, as there is no need for listing since they are using internal networks. Derivatives more often than not also fall under the category of OTC securities and are traded through the dealer network.

OTC Trading Advantages and Disadvantages

Along with a wider range of available assets (shares, ADRs, derivatives, cryptos, etc.), OTC trading offers a lot more advantages to its users. However, it also provides a set of challenges to any user, be it a huge company or a single trader. OTC trading is often described as “speculative”, and for a good reason. As such, investors with an interest in OTC trading should consider risks and mitigate them as much as possible. 

Now, let’s take a look at the advantages that OTC provides to the traders:

  • It allows traders to access assets not readily available on the general exchange scene. ADRs, derivatives, even some shares and cryptos can be traded on OTC desks, allowing you to significantly expand your trading portfolio.
  • With fewer regulations and no fees to pay, companies that couldn’t afford to list their assets on a formal trading platform can do that on OTC. While it is good for companies, it is also great for traders, as they will have a greater variety of assets to invest in.
  • While OTC is rather speculative and thus risky, it allows gaining greater returns by trading in the cheap stock, making your ROI that much higher. It is also great for companies, since their assets will be bought more readily.

Now, let’s take a look at the darker side of OTC trading, and what disadvantages and dangers it might bring:

  • Since most OTC trades are low-volume, assets that are traded this way have lower liquidity than assets traded on exchanges. While it is not a critical problem, it means wider bid-ask spreads and delays in executing the trade.
  • While fewer regulations allow for a wider range of assets, it also means that there is a higher risk of fraud happening. Check the details of a deal thoroughly, should you enter OTC trading.
  • The less-regulated market also results in less information about the deal available, both to the public and to traders. The information might be outdated, so be ready for a sudden change during the deal.
  • OTC assets are prone to volatility. It is especially so during the release of economic or political news/data. However, it is nothing new to crypto traders and enthusiasts. 

It is up to you to decide whether the pros outweigh the cons in this case. Still, as crypto traders can attest: risky ventures offer the best profit margin.

OTC Trading: Sealing the Deal

In the crypto world, as well as a real-world exchange, most deals are done either through the middlemen or OTC desk: a special platform that was created specifically for OTC trading. Direct buyer-to-seller deals are a rarity with cryptocurrencies, as there is more potential for fraud. 

When trading through the middlemen, the task to find a potential buyer/seller lies entirely on them. Brokers work personally with investors and lay their reputation on the stake in case the deal goes wrong. Once the buyer is found through the broker’s network, the deal is concluded and the broker gets his fee. The main problem with this way is how slow it is.

A faster but riskier way to trade crypto on OTC is through the OTC crypto desk. Recently, quite a few of them sprung up, including ones launched by Huobi and Bithumb. Here, buyers will be matched with sellers through the algorithms. Once the deal is concluded, the platform will take its fee as well. The main problem here is that you will need to have a significant amount of crypto to trade. There is always a hack possibility when trading on the OTC desk.

Summary

OTC trading is a risky venture with some treacherous waters to tread. Traders that go in without back-up plans, a solid trading strategy, and a general lack of information risk losing all their investments. To combat that, you need to conduct thorough research on both the basics, on general OTC market trends, and on a specific asset and OTC desk, after you find them. 

This post is only a part of this research, as it covers the basics of OTC trading, pros and cons, and a general overview of how it works in the real world. Even if you decide that OTC is not your type, you can always read about different types of trading on our blog. Stay tuned for more trading and crypto information!

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