Vinny Lingham: the OTC market for Bitcoin is bigger than the exchange market

Vinny Lingham is an entrepreneur who previously founded the bitcoin based digital gift card platform Gyft, which was acquired by First Data in 2014. Since then Lingham has moved on to a new venture, co-founding Civic. Lingham has been very vocal in the bitcoin space when it comes to price speculation, where his predictions tend to pan out.

In a recent article penned by Lingham, he said that “The 1% don’t use Bitcoin Exchanges.” He explains that the bitcoin market has changed quite considerably since two years ago, recapping that back in March 2014 consumers were ‘spooked’ with bitcoin exchanges, mainly due to the Mt.Gox implosion. At the time, exchanges weren’t as wide spread as they are now, with only a dozen or so well known exchanges and even less that were reliable. At the time, he also said investors would buy and sell bitcoin “off-book” and use over-the-counter (OTC) markets to invest instead of using exchanges.

Fast forward to now, the market has changed substantially. Bitcoin has become more accepted globally, from banks and financial institutions, to venture capital firms, bitcoin exchanges have been flourishing. There are over 170 bitcoin exchanges and it’s growing rapidly. More exchanges are seeking regulatory approval and getting licensed.

In an update from Lingham, he says that the OTC market has continued to grow also. He says,

Many of the very wealthy individuals that I know who are looking to get into Bitcoin are not going to the exchanges. The limits are not significant enough for them. If a High Net-Worth Individual (HNI) has a net worth of $100m and wanted to place just $1m of that into Bitcoin as a hedge against market disruption, it would be imprudent of him to place that order on the open market. That is a single trade of over 1,000 BTC and it would push his price up (called slippage) significantly.

Instead, he would call a broker, agree on a price (typically a few dollars above market spot price), and then perform the trade outside the market. The broker would match buyers and sellers and the exchange volume would not reflect the buying or selling activity for that trade. Now, imagine if a billionaire wanted to allocate 0.5% of his or her assets to Bitcoin. That is simply not possible on exchanges.

In speaking with a couple of OTC traders, Lingham says the largest OTC purchase he was able to discover was around $50 million, and regular 8-figure purchases are now commonplace. Due to the OTC order sizes, orders are filled in smaller blocks, as to not disrupt the market. Because of the off-book trades, Lingham says that exchange volume doesn’t represent true market based bitcoin demand and supply. Traders are technically trading on only a portion of the deals being transacted.

Lingham speculates that a lot of the current trading on the exchange market is back and forth arbitrage trading, not true demand. We often see this with Chinese bitcoin exchanges, whose volume is almost always overly inflated, in part due to the zero trading fees which makes them susceptible to bot trading (wash trades) and arbitrage.

Bobby Lee, the CEO of Chinese bitcoin exchange BTCC, said in an interview last year,

“There is a lot of mining that goes on in China. However, I caution you: do not read too much into the high trading volumes. China has decent high volumes but unfortunately two of my competition exchanges – I never like saying this – but they are artificially inflating their volumes through the technique of wash trades.

They use it for bragging purposes. They try to outdo each other. It’s not regulated yet so they don’t get slapped on the wrist for doing that. China does have big trading but we are not talking about orders of magnitude higher. If you were to believe the numbers you would think the world is 95% Chinese.”

Lee said Okcoin and Huobi are known for inflating trading volumes artificially, basically selling from left hand to the right hand. Lee’s exchange BTCC has also been accused of wash trading in the past as well.

This overly inflated exchange volume can easily be visualized when compared to other exchanges across the globe. See for example below how in a single 24-hour trading period how Huobi’s trading volume dwarfs the rest of the market.

exchange-volume-pie-chart-june-2016

According to Lingham, bitcoin exchange market data although somewhat reliable, doesn’t tell the whole story on bitcoin supply and demand. High Net Worth Individuals are not buying through exchanges, they need brokers for the amount that they are buying. He also speculates that if OTC market trades are higher volume than what’s known, it infers that exchanges are thinly traded and prone to market manipulation, which introduces market volatility.

Market volatility is a problem now because in terms of globally traded assets, bitcoin is still on a much smaller scale, with a current market cap of $9.8 billion USD. Once there is more liquidity to handle large OTC trades, exchanges should be able to process them without disrupting the entire market, and big investors won’t need OTC brokers to manage their trades.

Recently BitX a South African based bitcoin exchange added OTC trading to their exchange which will reduce slippage for larger trades and attract institutional investors who are looking to diversify into bitcoin using the South African Rand. There are also other existing OTC trading firms that handle large transactions off the books such as Cumberland Mining and Genesis.

For example, Cumberland Mining specializes in trades with a minimum purchase of at least 25 BTC; the current market value equates to over $15,000 USD. Every day users and speculators don’t trade anywhere near this type of volume. Cumberland does have a maximum trade quantity of 25,000 BTC ($15 million).