OTC Brokers & Localbitcoins

When you buy on an exchange, you are buying from another customer of the exchange in quantities and prices agreed between you and the other customer. The exchange is only involved with the deal insofar as it acts as an escrow agent and has custody of your money and the other person’s bitcoins, until they become your bitcoins and the other person’s money. Every trade is shown to all other participants, and the order book moves in real time in response to the trading activity. One characteristic of exchange trading that a large trader may wish to avoid is that transparency. Sometimes you want to trade large amounts without other traders knowing, or without moving the market.

Enter the brokers. These are people or companies with whom you establish a relationship. Instead of showing a transparent order book of customer orders (as the exchanges do), the brokers will buy and sell directly with you, negotiating a price for the full amount that you want to transact, in what are known as ‘block trades’. Trade details are not published to the public. They are private transactions in bulk and there is nothing illegal about this - this also happens in the traditional financial markets. Legitimate brokers also apply know-your-customer processes to establish your identity and may be bound by local disclosure requirements.

When you trade with a broker, there are two modes: the broker could act as principal to the trade, or as agent. When the broker acts as principal, the deal is just between you and the broker. They are the counterparty to your trade. You tell them what you want to do (buy or sell) and in what amount, and they will tell you their best price and you can say yes or no. It is like a large wholesale trade, and the broker needs to have enough money or cryptocurrency to complete the deal. In accounting jargon, the trade is on the broker’s balance sheet because the broker itself is trading with you. This is the case, for example, when you buy foreign currencies at an exchange desk at an airport.

When the broker acts as agent, the deal is between you and someone else with whom the broker is in touch. The broker acts as an intermediary who serves to provide anonymity to both parties. In accounting jargon, this is off the broker’s balance sheet - it’s not their money, they are just matching buyers and sellers. Generally the way this works is that you contact the broker and tell them what you want to do, then the broker will try to find another customer who wants to do the opposite to you (the other side of the trade). The broker will communicate price and amount information to both sides until the deal is agreed. The broker takes a fee from one or both customers for providing this service. Due to the large amount of manual overhead and small margins, brokers usually have a minimum trade size below which, they won’t pick up the phone. This can be anything from $10,000 to $100,000 per trade and seems to be increasing as the market matures.

What if you don’t want to go to an exchange or use a broker or provide any sort of identification? There is a website, localbitcoins.com, which acts a bit like eBay for people wanting to buy and sell cryptocurrencies. People post prices at which they are willing to buy and sell bitcoins. You can browse the list to find someone nearby, and you then agree to send them money in return for bitcoins, either by meeting physically with fistfuls of banknotes, or by making bank transfers to their bank account. It is a bit like a bulletin board or eBay, and there is a reputation system with ratings and feedback comments. It also has an escrow function for the temporary custody of cryptocurrency.