Can a person trade bitcoin without going through any exchange?

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.

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“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 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.

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.

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”.

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, 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.