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As the cryptocurrency market gradually matures, the secondary over-the-counter (OTC) trading market, as an important trading channel, has gradually attracted widespread attention from investors, project parties, and foundations. This market not only provides liquidity for assets that cannot be easily traded on public exchanges but also facilitates the trading of locked tokens within the cryptocurrency field. However, the secondary OTC market, due to its privacy and customized trading characteristics, also hides a large number of risks and compliance issues.

What is the OTC market?

The OTC market, or over-the-counter market, refers to a market where asset buyers and sellers conduct transactions through direct negotiation rather than public exchanges. This type of trading is usually used to handle assets that are not listed on standard exchanges or when there is a large trading volume and a need for customized protocols and terms. Unlike traditional public exchanges, the OTC market is more flexible, allowing traders to negotiate prices, trading terms, and timing according to their own needs.

The secondary OTC market focuses on the trading of assets that have undergone a Token Generation Event (TGE) but are still in a lock-up period. These tokens are usually unable to freely circulate in the public market during the lock-up period, so investors with high liquidity requirements can trade through the secondary OTC market. Buyers and sellers negotiate directly on trading prices, discounts, and unlock times to ensure the flexibility of the transactions.

Seller Motivation Analysis

1. Venture Capitalists (VCs)

Characteristics:

• Holding locked tokens: Venture capitalists typically invest in projects early and obtain tokens with a certain lock-up period.

• Market strategy: These companies need to manage their investment portfolios and realize profits after the lock-up period ends.

Motivation:

• Risk management: VCs hold a large number of tokens, making them susceptible to market price fluctuations. By selling some tokens through the OTC market, they can lock in some profits in advance, reducing the risk of market fluctuations.

• Profit realization: Even when selling tokens at a discount, VCs can still obtain substantial returns from early investments, converting virtual assets into actual profits.

• Avoiding overvaluation risk: If the project's FDV (Fully Diluted Valuation) is too high, VCs may choose to sell tokens through the OTC market to avoid greater market risks from overvalued sales in the public market.

• Liquidity management: In times of insufficient market liquidity, selling tokens through the OTC market can obtain more stable prices, avoiding market shocks from large-scale sell-offs.

2. Cryptocurrency Project Teams

Characteristics:

• Operating costs: Project teams need funding to support daily operations, technical development, and marketing.

• Funding needs: As the project expands, the team may require additional funding.

Motivation:

• Funding needs: By selling tokens in the OTC market, the team can obtain the necessary funds to support the ongoing operation and development of the project.

• Alleviating market selling pressure: To avoid creating excessive selling pressure in the public market, project teams sell some tokens through the OTC market to balance market supply and demand and reduce price impacts.

• Market stability: A cautious token sales strategy helps maintain price stability, reducing the negative impact of price fluctuations on the project's development and reputation.

3. Foundations

Characteristics:

• Operational fund management: Foundations are usually responsible for managing project funds and driving the long-term development of the project.

• Token unlocking: Tokens held by foundations may exert pressure on the market when unlocked at specific times.

Motivation:

• Funding needs: Foundations need to sell tokens through the OTC market to obtain funds for daily operations and project promotion.

• Mitigating market pressure: During token unlocking, foundations gradually sell tokens through the OTC market to reduce market selling pressure and avoid drastic market price fluctuations.

• Maintaining price stability: Foundations ensure market price stability through a prudent token sales strategy, preventing a sharp market price drop caused by a large number of unlocks.

4. USDT Merchants

Characteristics:

• USDT trading: Merchants profit by buying USDT at a low price and selling it at a high price.

• Anti-money laundering: When buyers purchase USDT, merchants check the legality of the buyer's funds. If the funds are not compliant, merchants may choose to stop the transaction.

• USDT trading method: To ensure the compliance and security of receipt, most merchants choose to transfer USDT on exchanges.

Motivation:

• Price difference profit: Profiting from buying low and selling high.

• Fee profit: Merchants claim that the funds used for buying and selling USDT are clean, thereby charging higher fees.

5. Virtual Currency Intermediaries

Characteristics:

• Pre-market virtual currency trading: Intermediaries profit by providing trading guarantees through single collateral and double collateral in pre-market trading.

• Reputation: These intermediaries, due to their large exposure to virtual currency, gain a certain level of reputation, making buyers and sellers feel confident in choosing them.

• Trading content: Includes pre-market virtual currency trading, point trading obtained from primary market projects, and whitelist trading for projects, among others.

Motivation:

• Fee profit: Using their own reputation, intermediaries help buyers and sellers purchase virtual currencies and other assets, earning certain fees.

• Project advertisement profit: After gaining reputation, these intermediaries profit by undertaking project promotion for project parties.

Buyer Motivation Analysis

1. Hodlers (Long-term Holders)

Characteristics:

• Long-term investors: Hodlers are confident in the long-term growth potential of tokens and tend to hold them for the long term without being affected by short-term price fluctuations.

• Investment strategy: They focus on the long-term development of projects rather than short-term market fluctuations.

Motivation:

• Long-term returns: Hodlers hope to purchase tokens at a discount and expect high returns when the project grows and the tokens appreciate in the future.

• Discount opportunities: The discounted prices offered by the OTC market attract Hodlers, allowing them to gain higher profits when the market rises in the future by purchasing tokens at a discount.

• Stable holding: Hodlers are not concerned about short-term price fluctuations and are willing to hold tokens for the long term, patiently waiting for opportunities for value appreciation brought by project success.

2. Hedgers

Characteristics:

• Users of financial instruments: Hedgers purchase tokens through the OTC market and use financial instruments such as perpetual swaps for hedging.

• Strong market operation skills: They can accurately adjust trading strategies based on market fluctuations to maximize profits.

Motivation:

• Arbitrage opportunities: Hedgers buy tokens at a discount and short them using financial instruments to profit from arbitrage.

• Risk management: Through hedging operations, they can effectively manage market risks, ensuring profitability even during market fluctuations.

• Flexible strategies: Hedgers adjust strategies flexibly in different market environments, capturing trading opportunities through customized trading solutions obtained from the OTC market.

3. Primary Market Traders

• Airdrop Coin Pre-market Trading: When buyers receive the airdrop list and want to sell/buy tokens in advance, they will choose reputable intermediaries to place orders for sale/purchase.

• Large amount of funds: Traders believe or have advance knowledge of the high profit margins of certain projects, and may purchase large quantities of tokens off-market in advance, waiting to sell for profit when the token market appears.

Motivation:

• Arbitrage opportunities: Traders buy tokens at a low price in advance and sell for profit when the market appears.

Risks of the OTC Market

1. Liquidity Risk

OTC trades are usually conducted without public market prices, with buyers and sellers negotiating prices in a non-public environment. This means that market liquidity may be limited, especially during periods of significant price fluctuations, where the quantity of buyers or sellers may be insufficient, leading to slow execution of trades. According to 2023 CryptoCompare data, about 15% of cryptocurrency trades are completed on the OTC market, with most occurring in situations of poor liquidity, resulting in significant price fluctuations.

2. Credit and Counterparty Risk

OTC trades typically involve anonymous buyers and sellers, especially in the absence of third-party custody, leading to significant credit risk. If one party fails to fulfill the terms of the trade, such as the seller failing to deliver the tokens or the buyer being unable to pay the funds, the other party faces significant financial losses. For example, a 2019 report showed that over 30% of OTC crypto trades involved non-performance or fraudulent behavior.

3. Price Fluctuation Risk

OTC market trading prices are often different from those in the public market. Tokens listed on public exchanges often have higher prices, while in the OTC market, these tokens may trade at significant discounts due to lock-up periods. According to TokenData statistics, in 2022, early investors purchased tokens at discounts of up to 70% through the OTC market. Due to price differences, some investors hedge price fluctuation risks through short selling, but this also increases operational complexity and capital requirements.

4. Compliance and Regulatory Risk

The regulatory status of the OTC market is often more complex and ambiguous. In different countries and regions, the legal framework for OTC trades may vary significantly, with some countries imposing stricter regulatory measures on such trades. In some cases, failure to comply with local anti-money laundering (AML) or know your customer (KYC) regulations may lead to severe legal consequences and hefty fines.

International Compliance

1. Anti-Money Laundering (AML) Regulations

Due to the high volume of funds and high-net-worth participants involved in OTC market trades, there is a relatively high risk of money laundering. Many countries impose strict anti-money laundering (AML) requirements on OTC trading platforms and cryptocurrency service providers. For example, in the United States, the Financial Crimes Enforcement Network (FinCEN) requires all OTC brokers to comply with the Bank Secrecy Act (BSA) and implement mandatory AML procedures and reporting mechanisms. In 2019, FinCEN imposed a fine of approximately $60 million on a cryptocurrency OTC broker for failing to timely report suspicious transaction activities.

In the European Union, with the implementation of the Fifth Anti-Money Laundering Directive (5AMLD), all cryptocurrency trading and service platforms are required to conduct know your customer (KYC) procedures and report large or suspicious transactions to relevant authorities. Data shows that about 20% of trades on OTC platforms in the EU in 2023 were flagged as potential money laundering activities, drawing scrutiny from regulatory authorities.

2. Know Your Customer (KYC) Requirements

KYC is an important tool in combating terrorist financing and money laundering. For OTC trading platforms, KYC requirements mean that the platform needs to conduct comprehensive identity verification of its customers to ensure the legitimacy of both trading parties. For example, in 2022, Canadian regulatory authorities penalized an OTC platform for failing to conduct effective KYC verification for transactions exceeding $100,000.

In China, despite relatively strict regulation of cryptocurrency trading, there is still an active underground OTC market. According to a report by Chainalysis, in 2021, OTC trading volume in China accounted for approximately 12% of the global total, with a significant portion not undergoing KYC verification, increasing regulatory risk.

3. Compliance Issues in Cross-Border Trades

Compliance challenges in cross-border OTC trades are particularly complex due to varying regulatory policies in different countries. For example, in some countries, OTC trades may be considered illegal activities, while in others, they may be viewed as legitimate financial activities. According to a 2022 survey, over 40% of OTC trades involved cross-border transactions, further complicating tax, exchange rate fluctuations, and international anti-money laundering regulatory complexities.

4. Market Manipulation and Insider Trading

Due to its lack of transparency and real-time price discovery, the OTC market is susceptible to market manipulation and insider trading. In 2023, an OTC trading platform was accused of engaging in large-scale market manipulation, leading to a rapid increase in the price of specific tokens in the public market, followed by a rapid collapse, resulting in significant losses for retail investors.

Case Studies

Case 1: Compliance Failure of a US OTC Broker

In 2019, a well-known US OTC broker was fined $60 million by the US FinCEN for failing to comply with AML/KYC requirements. The company failed to conduct necessary identity verification for several cryptocurrency transactions exceeding $100,000 and did not timely report suspicious transaction activities. This case highlights the importance of compliance for OTC platforms and also demonstrates that non-compliance with international and local regulations can lead to significant financial risks.

Case 2: Fundraising by an Asian Foundation through the OTC Market

In 2020, a cryptocurrency foundation in Asia sold a large quantity of locked tokens at a discount through the OTC market to raise operational funds. While the foundation complied with most international compliance requirements, the large-scale trades led to a rapid price drop for the token after unlocking, creating significant selling pressure in the public market. This case demonstrates the role of the OTC market in large unlocking events and the balance challenge between compliance and market response.

According to 2023 Chainalysis data, OTC market trading volume has maintained significant growth against the backdrop of an overall decline in the cryptocurrency market, especially in low liquidity and bear market environments. For example, in 2023, the total OTC market trading volume increased by approximately 18%, with most trades involving private transactions between locked tokens or high-net-worth investors. Data also shows that over 30% of cryptocurrency fraud cases involve the OTC market, especially on trading platforms that have not implemented effective KYC or AML procedures.

Future Prospects for the Secondary OTC Market

The OTC (over-the-counter) market, as an important form of trading in the cryptocurrency field, has shown rapid growth in recent years, especially in bulk trades and high-net-worth investors. With the gradual acceptance of cryptocurrencies by mainstream financial institutions, institutional investors are increasingly participating in cryptocurrency asset trading. Due to the OTC market's ability to handle large trades without causing significant market price fluctuations, it has become a preferred channel for hedge funds, family offices, and wealth management companies. In the future, with more institutional investors entering the cryptocurrency market, OTC trading volume is expected to further increase, driving further market expansion.

The demand from high-net-worth individuals is increasing: High-net-worth individuals (HNWIs) also have a positive outlook on the OTC market, especially for investors with high-volume and privacy requirements. As the OTC market provides more flexible trading conditions and customized trading structures, the future demand for cryptocurrency allocation by high-net-worth individuals may continue to grow, further expanding the scale of the OTC market.

Rising demand for cross-border transactions: The digital transformation of the global economy has led to a continuous increase in demand for cross-border transactions, especially in regions where funds cannot be smoothly transferred through traditional banking systems. The OTC market, as a flexible and efficient trading method, can meet such demand. In the future, as global reliance on cross-border cryptocurrency transactions increases, the globalization trend of the OTC market will become more apparent, especially with significant expansion potential in emerging markets such as Asia, the Middle East, and Africa.

Growth of tokenized assets: In the future, as tokenization technology expands to more asset categories such as real estate, art, stocks, and bonds, the OTC market is expected to become the primary trading venue for these tokenized assets. The OTC market can provide customized trading solutions for these high-value and low-liquidity assets, attracting more investors to participate in tokenized asset trading, further increasing market trading volume and depth.

• Technological innovation and the application of blockchain technology

Smart contracts and automated trading: In the future, the application of smart contract technology in OTC trading will become more widespread. Through smart contracts, OTC trading parties can pre-set trading conditions to ensure automatic execution once the conditions are met. Smart contracts can not only improve trading efficiency but also enhance trust in transactions through the transparency and tamper resistance of blockchain, reducing default risks.

Transparency and security of blockchain technology: Blockchain technology brings higher transparency and security to the OTC market. Although the OTC market is essentially non-public, blockchain technology can provide auditable transaction records, making transactions more trustworthy. Additionally, distributed ledger technology helps reduce reliance on centralized institutions, lowering intermediary fees and improving transaction security and privacy protection. In the future, with further maturity of blockchain technology, the transparency and security of the OTC market will be significantly enhanced.

Application of multi-signature and zero-knowledge proof technology: Technologies such as multi-signature and zero-knowledge proof will provide new security measures for OTC trades. Multi-signature technology can ensure that trades cannot be executed without mutual authorization, increasing transaction security. Zero-knowledge proof technology can verify the validity of transactions without revealing sensitive information, further protecting user privacy. These technological innovations will inject new vitality into the OTC market, making the trading process more transparent, secure, and efficient.

Artificial intelligence and big data analysis: In the future, artificial intelligence and big data analysis will play an increasingly important role in the OTC market. Through AI algorithms analyzing market trends, trading history, and counterparty credit, investors can make wiser trading decisions. Additionally, data-driven analysis tools can help platforms optimize liquidity management and risk control. The intervention of artificial intelligence will help OTC trading platforms better match the needs of both buyers and sellers, improving the success rate of trades.

• Regulatory trends and compliance requirements

Improvement of global regulatory frameworks: Currently, there are significant differences in the regulation of OTC trades among different countries, with some countries having enacted regulations for cryptocurrencies while others have unclear regulations. In the future, as the cryptocurrency market matures, there is potential for the gradual unification of global regulatory frameworks, with countries possibly implementing stricter KYC (know your customer) and AML (anti-money laundering) policies, mandating OTC platforms to undergo compliance reviews. This unified regulation can help reduce compliance risks in cross-border OTC trades and enhance market confidence.

Regulation and impact of stablecoins: Stablecoins play an important role in the OTC market, especially in large fund transfers and cross-border transactions. In the future, global regulations on stablecoins may become more detailed, including reviewing the compliance and transparency of their reserve assets. If the regulatory environment for stablecoins becomes stricter, OTC markets may need to find new ways to address compliance pressures, such as turning to central bank digital currencies (CBDC) or other forms of compliant digital assets.

Integration with mainstream financial markets: As cryptocurrencies gradually integrate into the mainstream financial system, the integration of OTC markets with traditional financial markets may become a trend. For example, traditional financial institutions may conduct cryptocurrency asset trading through OTC platforms, and conversely, cryptocurrency trading platforms may gradually introduce OTC trading of traditional assets. This integration will bring new participants and capital flow to the OTC market, promoting a more standardized and transparent market.

• Market challenges and coping strategies

Liquidity issues: Although the OTC market is suitable for large trades, liquidity issues remain a significant challenge under specific market conditions. In the future, as more asset categories enter the OTC market, especially tokenized traditional assets, liquidity management will become more complex. Platforms need to address insufficient liquidity by collaborating with multiple liquidity providers and introducing innovative mechanisms such as automated market makers (AMM).

Market manipulation and price control: Due to the non-public and non-transparent nature of OTC trades, there is a risk of market manipulation and price control. For example, certain trades may affect price trends in the public market or mislead counterparties through false information. In the future, the market needs to combat market manipulation through tighter risk control and trade review mechanisms, while strengthening platform reputation management to ensure fair trades.

Technical security and cyber attacks: With the technological advancement of the OTC market, the risk of cyber attacks is increasing. In the future, platforms need to continuously enhance their network security capabilities to prevent data breaches and asset theft. The application of blockchain technology can improve security, but precautions against attacks targeting smart contract vulnerabilities are still necessary. Through regular security audits, vulnerability detection, and protocol upgrades, platforms can effectively reduce the risk of cyber attacks.

• Community governance and decentralization

Rise of decentralized OTC platforms: With the flourishing development of decentralized finance (DeFi), decentralized OTC trading platforms may occupy a certain market share in the future. These platforms achieve intermediary-free trading through smart contracts and decentralized liquidity pools, further reducing trust risks in traditional OTC trades. In the future, as decentralized finance matures, decentralized OTC trading may become one of the mainstream trading models.

Community governance and token economic models: Some decentralized OTC platforms may use community governance to determine platform operation modes, fee structures, and rules for listing new assets. By introducing token economic models, platforms can incentivize liquidity providers and users to participate in platform governance. This model helps improve platform transparency and credibility, while also empowering users with more autonomy.

Conclusion

The OTC market provides investors with a unique way to operate outside the public market, especially when it comes to high-volume and locked token trades. However, this market also comes with significant risks, including insufficient liquidity, credit risks, price fluctuations, and regulatory compliance issues. As the global cryptocurrency regulatory framework continues to evolve, OTC platforms and trading participants need to strengthen their understanding and implementation of international and local compliance requirements to ensure the long-term health and sustainable development of the market. Additionally, with technological advancements and changes in the regulatory environment, the OTC market is expected to become an indispensable part of the cryptocurrency ecosystem through higher transparency and security.

Chain Source Technology is a company focused on blockchain security. Our core work includes blockchain security research, on-chain data analysis, and asset and contract vulnerability rescue. We have successfully recovered multiple cases of stolen digital assets for individuals and institutions. Additionally, we are committed to providing project security analysis reports, on-chain tracing, and technical consulting/support services for industry institutions.

Thank you for reading, and we will continue to focus on and share blockchain security content.

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