OTC Crypto Exchanges Enable Trading In Banned Jurisdictions

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OTC crypto exchanges provide a means to trade cryptocurrency between individuals. The stock market is heavily regulated, no matter where you live: and although crypto was intended to circumvent regulations, flashy headlines about massive price increases quickly drew governments to the industry.

American credit card companies banned the purchase of cryptocurrencies, while banks in India are banning transactions, and South Korea bans government officials from the trade.

Cryptocurrency is not the first investment vehicle to exist in a regulatory gray area. The cannabis trade is also volatile – since Colorado voters decriminalized cannabis in 2012, hundreds of cannabis businesses started seeking public funding. The number of cannabis businesses grows with each state that legalizes medical and/or recreational weed.

But no matter what a state law says, cannabis is still federally illegal, meaning federal entities like the SEC, Department of Treasury, and FDIC won’t touch them. The only way buy stock in a cannabis company is through an OTC market. Similar OTC markets are starting to pop up in places around the world where crypto exchanges are banned, like China.

You may be unfamiliar with the term ‘OTC’ trades, but you’ve seen them in action before when you watched Leonardo DiCaprio toss midgets and snort coke off his girlfriend’s ass in The Wolf of Wall Street. While inherently risky, these ‘Over The Counter’ markets are the key to sustaining crypto trading as governments increasingly declare war on exchanges.

Seeing Through Wall Street’s Bull

An OTC market is a decentralized market without a central physical location like the New York Stock exchange. The other main difference between OTC markets and a centralized market like NASDAQ is that because volume is so low (and individual pricing so small), trades don’t affect the general market. Generally, stocks for smaller businesses are traded on this market, so information about the companies isn’t publicly available.

These differences make investing in penny stocks a risky business. Let’s use Intel to illustrate the point.

Because it’s a publicly traded company, Intel releases earnings statements every quarter. In addition, every year, it publishes a 10-K annual report. This is all required by federal securities law and the information for the past seven years is easily found on Intel’s investor relations site. Before choosing to buy Intel stock, you can read through its reports or simply browse the work of analysts who already did for outlets like CNBC, Forbes, Crain’s, The Wall Street Journal, etc.

When a large volume of Intel stock is sold (which happened last year), it raises eyebrows. This causes a chain reaction that affects the entire global market, and you’ll see a lot of moves made against that company, such as Apple replacing Intel chips in Macs and analysts advising investors to dump Intel for AMD. This is all despite Intel’s price being as high as it’s been since 2000.

Intel is part of the S&P 500 Index, Dow Industrial Average, and other indexes, so its performance affects a large part of the market.

Dancing With Wolves

OTC markets are very different. You’ll notice in Wolf of Wall Street that Jordan Belfort is peddling penny stocks over the phone. He essentially built a call center staffed with top-notch sales people trained to find buyers for pink sheet stocks. This is because trading activity is much less common on OTC markets, so you could put in a sell order and sit on it for weeks before finding a buyer. During that time, the value will fluctuate wildly.

Adding to the problem, most OTC trades are insolvent, meaning you may never get your money out. This is the problem Belfort’s customers faced when investing their retirement funds into his penny stocks thinking their money was safe. This pump and dump scheme would artificially inflate prices (set by the OTC broker) and leave the end-holder with what ends up being worthless stock.

However, despite these problems, the OTC market does have advantages, especially in already-volatile markets like cryptocurrency and cannabis. For example, OTC markets can be used to trade high volumes of cryptocurrency without affecting the market price in exchanges. Also, because the trades bypass crypto exchanges, OTC markets can be used to buy or sell cryptocurrencies in a market like China that banned local exchanges, and which is attempting to block cryptocurrency websites.

It’s a loophole on-par with the Japanese Pachinko parlors. When gambling was generally criminalized in Japan, these parlors allowed players to instead win prizes, which could then be sold in the shop next door. It’s still gambling – just a clever way of doing it without breaking the law.

OTC Crypto Exchanges Are Already Here

The major difference is that Japan could have changed the law to get rid of Pachinko machines altogether. It’s not certain, in an era of decentralization, that jurisdictions could eradicate OTC trading privately or through intermediaries as a new breed of OTC crypto exchange emerges.

Genesis (owned by Digital Currency Group) has been operating since 2013, and explains on its website that “Settlement occurs on a post-trade basis. This means all digital and fiat currencies are exchanged after a trade is agreed upon. Once you “accept” the trade terms, you and Genesis will exchange USD and digital assets to complete the trade settlement.”

It some ways it might be seen as a Pachinko parlor – it doesn’t break the law, simply enables transactions between individuals with an escrow service.

The upcoming OTC crypto exchange Themis, focused on the Chinese market, takes the concept a stage further by completely decentralizing the entire escrow aspect of the business – theoretically meaning that it could act as a borderless P2P payment system for any digital currency without fear of a centralized point of failure.

Right now, many OTC trades (especially in heavily-regulated markets) are made via email, social media, or messaging apps like Skype, which bypasses any government firewall. Money is sent to a “trusted” intermediary, who holds it in escrow, bypassing credit card and banking restrictions. But clearly, intermediaries found via Skype – even on referral – carry extra risk.

Is it shady? Perhaps a little.

Is it legal? Sure. (For now.)

But despite the risks, these OTC crypto exchanges are necessary so long as crypto remains such a volatile market in the crosshairs of regulators worldwide. And anyway, the blockchain will keep transaction histories for anyone willing to dig them up.

OTC markets are indeed risky, but no riskier than trusting your money to an exchange like Mt. Gox or Bitfinex. Some would argue it’s no riskier than purchasing Intel stock. And some (cynics) might say it’s safer.

Where there is money, there is always danger. We don’t remember the Lamb of Wall Street… for a reason.

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