After a regulatory crackdown that significantly reduced market depth on controlled exchanges, cryptocurrency traders are turning to over-the-counter (OTC) venues to obtain illusive liquidity.According to Zahreddine Touag, head of trading at Paris-based market maker Woorton, OTC demand has been steadily increasing since the collapse of FTX in November. Subsequent spikes have been attributed to the failure of several crypto lenders last year and more recently, the SEC’s decision to sue Binance.
The substantial decline in market depth across exchanges has served as the driving force behind this need.By calculating the amount of capital needed to move an asset in either direction, or at a spread of 2%, market depth is a metric that evaluates liquidity. Two well-known market makers, Jane Street and Jump, declared last month that they were, at the very least, curtailing their trading activities.According to Kaiko, this made the liquidity problems that had been present since FTX’s demise worse, with market depth on exchanges declining by more than 50% between November and May.The market depth on Binance.US, the exchange at the core of the SEC’s case, had fallen by more than 76%, it was revealed this week.
Since order books are still weak, this practically means that traders attempting to complete larger transactions will have to contend with unavoidable slippage.As a result, it appears that the OTC market, which enables traders to complete sizable transactions without visiting an exchange, is spreading more widely.According to Touag of Woorton, “OTC demand” has increased significantly.“Spreads are tight due to daily recurring flow we have on both sides from payment providers, brokers, and algorithmic traders.”
This pattern is uncannily reminiscent of the period in 2014 following the hacking of Mt Gox, the biggest cryptocurrency exchange at the time, which led to the shutdown of its operations. Peer-to-peer markets on exchanges like LocalBitcoins emerged as the winners of the 2014 bear market, despite the major exchange’s collapse, since demand for digital assets persisted.However, as cryptocurrency made further inroads into the world of traditional finance, the stature of companies entering the sector started to noticeably rise.By 2020, counterparties on LocalBitcoins would no longer be an arbitrage trader, and publicly traded firms like MicroStrategy would deal directly with Coinbase, an exchange that is listed on the Nasdaq.
In an effort to establish a safe investment vehicle for funds and trading companies to increase their exposure to cryptocurrencies, BlackRock, the largest asset management in the world, filed for a spot bitcoin ETF this week.However, traders will have to return to OTC deals until that is allowed by the SEC, which is becoming more confrontational.