Smart money and OTC trading — how the 1 percent buy crypto

So who exactly are the ultra rich and what is the smart money? As detailed in Credit Suisse’s 2017 global wealth report, the ultra rich are the 150,000 people worldwide who sit at the very top of the international wealth pyramid, with a net worth in excess of US$50 million.

These ultra rich keep a diversified portfolio for a variety of reasons. One of them is that they understand that the markets always move in cycles and knowing where you are in a cycle is the key to profiting, handling risk — and staying sane.

There are fortunes to be made during both the booms and the busts. The smart money knows that — quietly buying at the bottom while everyone else is panicking, and selling high before the cycle turns again. Their money, invested strategically at the right time and with appropriate information about its future playout should be thought as smart money.

However, as mentioned, one of the keys to profit-making is scooping up the cheap assets without too much noise. Big moves or sudden shaking will attract unnecessary attention and competition. So the ultra rich need to cover their direct exposure, which requires a sophisticated network of dealers, brokers, intermediaries and middlemen.

Global wealth and bitcoin markets

When venture capitalists start betting on cryptos then it's safe to say that the big money is about to arrive on the scene. The important question to ask then, is, how will it get there? In 2017 the world’s total wealth was estimated to be US$280 trillion. The entire crypto market cap as of 7th January 2017 was approximately US$17 billion.

Now imagine if even 0.1% of global wealth at that time (i.e US$280 billion) had tried to come into the crypto market — it would have created a massive shakeup. Hence it cannot happen all at once or all in the same place. That’s not quiet. Now, though, with the crypto market cap sitting around US$770 billion, there is more liquidity to absorb such disruptions, at least for selected assets.

Even so, very large orders through exchanges would still cause problems. Slippage, for example, where the spot price shifts in a direction unfavourable to the trader. As a result, buying costs more — and selling yields less. Even with a total market cap of $770 billion, the regular crypto exchanges may still not have sufficient liquidity so this isn’t the best access point.

Enter over the counter trading (OTC).

OTC trading and intricate networks

OTC trades are not made in regular exchanges. Imagine if a billionaire wanted to put 1 percent of their net worth into crypto. A typical exchange would struggle to handle it. Now imagine 10 billionaires and multimillionaires all trying together. That dog simply wouldn’t hunt.

What happens instead is they opt for OTC and the right intermediary. They find a guy who knows a guy. The second guy is willing to sell a few million worth of bitcoin, but his price is going to be higher than what’s happening on the exchanges. This doesn’t faze the billionaire, though, because they’ve got money to burn. 

The trade goes ahead, outside the regular market so the volume activity doesn’t show up on an exchange. So who are the ‘guys’ (or stakeholders) in these transactions? Typically they are hedge funds, private wealth managers, high net worth individuals and family offices.

Has OTC surpassed exchange traded volume?

Accurately quantifying OTC trading is nigh on impossible because the details aren’t made public. Some OTC facilitators do have a public profile, though, including, Itbit, Cumberland Mining and Genesis (which has a minimum US$75,000 transaction amount). Their websites are recommended reading.

These brokers and OTCs are selling trust and settle for a fee anywhere from 1 to 5 percent — for which high net worth individuals and others get privacy and security. The Mt.Gox, Bitfinex and Youbit hacks are not a distant memory. So for the ultra rich, it makes sense to stay away from public exchanges.

These days eight-figure trades are common in OTC transactions, and it is quite possible that the value of OTC trading has already surpassed regular exchanges. In fact, some of the numbers are staggering. As far back as 2013, for example, a single customer bought US$15 million worth of bitcoin (25000 in total) and this one trade increased the BTC price from $527 to $753. Trades of 500-700 bitcoin are common and trades of 2000-5000 bitcoin to hedge positions are not unheard of.

Long story short? What you see in regular exchanges and general media is only part of the story and the fully informed trader should always try to keep an eye on what the ‘smart money’ is doing.