Declining Spreads in Crypto Causing OTC Desks to Remain on Edge
The high volatility seen in 2017’s cryptocurrency market was a paradise for market makers and OTC desks,
as their profit margins continuously expanded along with spreads. Two years on, volatility is at a multi-year low and it has hit OTC desks right where it hurts. As the formerly largest OTC desk, Circle Trade, sells their business to Kraken, The Block reports that these entities are taking a second look at how they run their ships, December 24, 2019.
The Turbulence of Crypto Market Making
Depending on the state of the market, the firms providing liquidity to the order book stand to either make the most money or the least money. Volatility and ask-bid spread have a directly correlated relationship. So as volatility has come to a what can be considered a standstill, OTC desks have taken a hit relative to previous years. We often equate tight spreads to an efficient market, and this certainly holds on the customer’s side. But market makers have an incentive to provide more liquidity when spreads start to expand, giving the opportunity to earn a few basis points of extra profit per trade. Data from Skew shows that average realized volatility in Bitcoin has hit a periodical low, and spreads earned by OTC desks have contracted from nearly 200 basis points at the peak of the cycle to roughly 10 basis points now. Circle was forced to sell their once flourishing business to Kraken, in a deal that evidences Kraken’s desire to expand on the institutional side, and Circle’s pivot to focus on USDC.
Best Spread Wins the Game
From a trader’s perspective, the lowest spread is the best avenue to park capital, because it implies better entry-exit dynamics for customers. Crypto derivatives have historically had tight spreads. BitMEX built its empire on the back of having the most liquid order book in the industry. The reason they were able to attract so many traders, institutional and individual, is because they offer the best spreads in the market. So this is a fairly sensitive topic, or a dual-edged sword if you will. Lower spreads for customers attract more volume, but higher spreads help market makers net a larger profit from each trade.
Article Produced By
Ashwath is a financial market and technology junkie. He is a cryptocurrency investor, trader, and enthusiast. He has expertise in market psychology and explaining complex technology in a simple way. He aims to battle misinformation in the cryptocurrency space.