A Guide to Closing Illiquid Crypto Positions

Oliver Yates -

The cryptocurrency market has grown significantly over the years and more institutional investors are now considering investing in this digital asset class. However, one of the most common issues faced by these investors is how to close their illiquid crypto positions without incurring heavy losses or taking on excessive operational risks. In this guide, we will address all the important aspects of how to successfully close an illiquid crypto position, from understanding exit strategies to managing liquidity constraints. With a clear strategy in place and sound advice from experienced professionals, you can avoid potentially costly exit losses and complications associated with hedging operational risk when it comes time to liquidate your cryptocurrencies.

Institutional and high-net-worth investors often face unique challenges when it comes to selling their illiquid crypto positions. The lack of liquidity, the prevalence of wash trading, and the difficulty in trading on decentralized exchanges (DEXs) can make it difficult for these investors to offload large amounts of digital assets without incurring excessive costs or operational risks.

Furthermore, market makers will typically charge a wide spread when executing block trades, while running an algorithm requires software, FTEs, and constant monitoring. To minimize these costs and risks while still being able to liquidate their holdings efficiently, institutional and high-net-worth investors need access to specialized services that are uniquely tailored to their needs.

Why Institutional Investors Cannot Simply Go to Crypto Exchanges for Illiquid Positions

Institutional and high-net-worth investors cannot simply go to crypto exchanges for their need for liquidation because these exchanges are not designed for large-scale traders. While it can be tempting to focus on the exchange fees, real trading costs involve more than that. Because of the thin liquidity on the order books, the trade will suffer what is called Price Slippage. This means that the actual price paid or received during a trade will be different than the one initially expected.

Furthermore, the possibility of wash trading on these exchanges further reduces the trustworthiness of their pricing data. As a result, institutional and high-net-worth investors have to rely on alternative solutions that provide the necessary liquidity and security to facilitate large trades without any significant disruption to the markets or excessive costs. According to recent research, more than 60-80% of the volume in crypto exchanges is wash trading, which means that institutional investors would be unable to trade without moving the markets significantly. Furthermore, a lot of crypto-assets that are difficult to sell for cash will be available for trading on decentralized exchanges (DEXs), and sometimes, the majority of their liquidity will only be accessible through those platforms.

The Risks of Digital Assets Wash Trading

Cryptocurrency exchanges have revolutionized the way digital assets are traded, and they have become a crucial part of the global crypto market. However, these platforms can also be prone to wash trading which can lead to significant risks for institutional investors and high-net-worth individuals. Wash trading makes it hard for investors to sell their digital assets. It happens when traders buy and sell orders to make it look like there's more demand or supply than there is. This makes it so that investors can't find buyers who will pay the right price for their digital assets. So, investors have trouble selling large, illiquid digital asset positions safely on some crypto exchanges.

One real-life example of how wash trading on a crypto exchange prevented an institutional or high-net-worth investor from selling their large illiquid crypto position was seen during a recent cryptocurrency bull run. At the time, a large institutional investor was attempting to sell a significant amount of Bitcoin to cash out its profits. Unfortunately, due to rampant wash trading activity occurring on the exchange, there were very few buyers willing to purchase the Bitcoin at prices that would have allowed the investor to make a profit. As such, the investor was unable to successfully execute its sale and had to wait for market conditions to improve before it could offload its holdings.

This scenario highlights the operational risks and costs associated with attempting to sell large amounts of digital assets in a market that is often characterized by thin liquidity. To make matters worse, executing block trades on centralized exchanges can be time-consuming and costly due to the sizeable spreads demanded by market makers. Even if you can find a buyer, you may still have to deal with a multitude of other issues such as counterparty risk and custody solutions.

Understanding the Risks of Trading on DEXs for Institutional Investors

Trading on decentralized exchanges (DEXs) can be one of the more cost-effective methods to offload large amounts of illiquid digital assets. However, when trading on these platforms, investors must keep in mind that they are assuming smart contract risk (which arises from potential bugs or vulnerabilities in the smart contract code) and may not have the same protections as they would if they were trading on a regulated exchange.

A recent rally was driven by institutional investors who were attempting to offload their illiquid digital assets by trading on decentralized exchanges (DEXs). However, when trading on DEXs such as Uniswap and Curve, investors encountered issues due to thin liquidity and wide spreads between buy and sell orders. In addition, some traders had to wait up to 15 minutes for their orders to be filled, due to blockchain confirmation times – this is much higher than the times seen on centralized exchanges where trades are typically executed within seconds.

Furthermore, the costs associated with trading on DEXs can be substantial due to the spreads caused by market makers who price a higher risk of trading on such venues. Recent research published by Messari reported that Ethereum's spot price was over $200 more expensive than its futures price due to liquidity issues in DEX order books. This demonstrates just how difficult it can be to trade efficiently and cost-effectively when relying solely on DEXs.

The Pros and Cons of Block Trading with an OTC Desk Versus Running an Algo Across Multiple Exchanges

Executing a block trade with an OTC desk is often seen as the simplest way to trade illiquid crypto positions, as it typically involves only one counterparty and a single transaction. The liquidity provider will use their proprietary infrastructure to offload the extra risk into the markets over time. Using this approach may result in increased costs as the dealer may require wider spreads to execute a trade. The spreads are necessary as they must consider the risk involved in the trade, also known as Risk Facilitation in traditional finance.

On the other hand, running an algorithm across multiple exchanges has its benefits. By splitting up orders into smaller chunks and executing them over different venues and over time, traders can get better prices and avoid incurring large costs. To run an algorithm successfully, you will need expensive algorithmic trading platforms and full-time professional traders. That team will also require risk management tools to make sure the trade is being executed correctly. Additionally, you will need to continuously monitor the process and have access to competitive fees on specific exchanges. Finally, there is no guarantee on the final price you will be executed at, as the market could theoretically go in any direction. Please note that most software does not cover both centralized and decentralized exchanges.

Why are Crypto Prime Brokers Important in this Context?

Crypto Prime Brokers are important for financial institutions, hedge funds, or high-net-worth individuals who own digital assets. They help these investors to sell their illiquid positions while minimizing costs and risks. A Crypto Prime Broker can help with things like finding the best prices on different exchanges, providing risk management tools, and helping to monitor the trades. This can make it easier for institutional investors to get the most out of their investments.

The Prime Brokers will typically act as the main counterpart for all the trades, and protect their customers from the counterparty risk of global exchanges. They also provide a seamless settlement workflow by taking care of all flows with the trading venues. Finally, they protect customer funds through custodial services.

Aplo: The Prime Brokerage Solution to Maximize Value and Minimize Risk for Institutional Investors

Aplo provides institutional clients with a comprehensive suite of prime services to facilitate their trading needs. This includes executing trades, digital asset custody, credit, and technology services. Our knowledgeable team of professionals provides personalized service as needed to help maximize profits, while also offering detailed market intelligence to help clients make well-informed decisions.

First, our team will recommend a tailor-made trade profile based on your intent. This takes into account parameters like market impact, settlement constraints, or reporting requirements. Then we will execute trades for you across a wide range of centralized and decentralized venues, using sophisticated trade execution algorithms. Your counterparty risk with these venues is minimal as your assets are safe thanks to Aplo's custodial services. No need to open multiple accounts, plug software into multiple venues or monitor your trades. We take care of all of that. Our team even accounts for wash trading to adapt the trade execution in real-time. Finally, you will receive daily reports detailing all the relevant trade information for you, your accountants, and your auditors.

What sets Aplo apart from other digital asset prime brokers is our compliant and transparent model. Aplo is licensed with the French SEC (AMF) for custody services, digital asset brokerage, and trading platforms. This means that your assets are segregated from Aplo's balance sheet, and your counterparty risk to cryptocurrency markets is minimal. Also, please note that Aplo does not charge any hidden fees. This is because we operate under regulatory statuses that prevent us from trading against our customers. Essentially, we obtain the same prices that liquidity providers would have obtained over an extended period.

Unlocking Access to Institutional-Grade Crypto Prime Brokerage Services for High Net Worth and Institutional Investors

Managing illiquid crypto positions for institutional and high-net-worth investors presents several challenges, from understanding the associated risks to navigating the complexities of different trading platforms. Traditional methods such as Crypto Exchanges, DEXs, or Block Trading with a Market Maker all bring their own set of advantages and disadvantages that must be considered for optimal success. Fortunately, thanks to innovations like Aplo's Crypto Prime Broker Services and High Touch services, navigating these complex markets can now be done straightforwardly and safely tailored to individual needs.  Aplo's experienced team is here to assist on your journey of leveraging digital assets. Reach out today at contact@aplo.io if you'd like to learn more about Aplo and how we can help you reach your goals!