Crypto funds and market makers are acquiring tokens at significant discounts through private over-the-counter transactions and hedging with short positions, securing double-digit returns while retail traders absorb the risks.
Venture capitalists, funds, and market makers can usually obtain allocations at about a 30% discount with three- to four-month vesting periods, then hedge by shorting the same amount on perpetual futures markets, as noted by Jelle Buth, co-founder of market maker Enflux.
This arrangement essentially assures profits that can reach annualized rates of 60%-120%, irrespective of token price fluctuations.
Buth mentioned that Enflux also engages in these transactions, calling them a common strategy for projects to generate capital and for investors to secure returns. Retail traders, excluded from these deals, face selling pressure when hedges and unlocks are executed in the market.
“I would never want to be retail again,” Buth stated to Cointelegraph.
How OTC token deals function for funds and market makers
Over-the-counter (OTC) transactions inherently disadvantage retail traders, not only due to selling pressure affecting token prices but also because of the lack of transparency that prevents general investors from making informed choices, Buth explained.
Here’s an example of how a typical OTC deal might unfold.
An institutional investor engages in a $500,000 deal as part of a $10 million fundraising effort.
The investment involves purchasing tokens at a 30% discount with a four-month vesting term.
To mitigate price fluctuations, the investor opens an equal-sized short position on the futures markets.
Price movements are balanced out, while the embedded discount secures their profit once the tokens are unlocked.
As the 30% gain is realized over four months, the annualized return becomes 90% APY.
In traditional finance, companies are required to disclose fundraising activities through regulatory filings. If insiders or institutional investors receive discounted allocations, this generally appears in public records.
“Hedge funds have long acquired convertibles at reduced prices and protected their risk by shorting the underlying stock. This practice, though legal, is encased in a dense framework of disclosure mandates and trading regulations within equities,” Yuriy Brisov, a partner at law firm Digital & Analogue Partners, remarked to Cointelegraph.
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In the crypto sphere, terms of these arrangements are not always made public. Announcements frequently indicate that a project has secured $X million but fail to mention that it came with discounted tokens and brief vesting schedules.
“Discounted OTC allocations are one of crypto’s worst-kept secrets,” Douglas Colkitt, a founding contributor at layer-1 blockchain Fogo, pointed out to Cointelegraph.
“If you’re trading a token and are unaware that there’s a stack of paper that can be dumped at a discount, you’re essentially trading blind. Retail traders end up bearing the sell pressure while insiders secure risk-free trades. This disparity is severe.”
On paper, OTC discounts paired with hedging appear to be risk-free transactions. However, in reality, perpetual futures can also negatively affect investors.
Unlike traditional futures contracts, perpetual contracts do not have expiration dates. Traders must pay or receive a funding fee while holding them. When perp prices exceed spot prices, shorts compensate longs to maintain their positions. This cost can progressively diminish the profit margin of the discounted tokens.
“There is also an opportunity cost to consider,” stated Brian Huang, founder of the crypto management platform Glider. “That capital could have been allocated to other investments during the vesting duration.”
Why OTC continues to thrive despite retail drawbacks
Despite the challenges for retail investors, OTC token transactions have become entrenched as they benefit both parties involved.
For projects, private token sales offer a swift method to secure substantial funding without facing the volatility that comes from dumping tokens directly into the market. They provide resources for product development, marketing, or buybacks to stabilize the token’s price upon unlock.
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For funds and market makers, these transactions allow for capital deployment into tokens with forecastable returns instead of risking funds in uncertain pre-seed or equity rounds.
Hedging through perpetual futures diminishes exposure to market fluctuations, while the inherent discount guarantees a profit margin unless funding rates significantly erode it.
“Many VCs now opt out of pre-seed opportunities; they favor liquid deals or tokens from established ventures that they can trade immediately,” Buth noted. “When arrangements come with 12- or 24-month vesting, it becomes challenging to finalize those rounds because the lockups are too lengthy, and the returns don’t align with the 60%-80% APY expectations of investors.”
Ultimately, OTC transactions persist because they align the incentives of those who control the majority of capital in crypto. Projects gain immediate liquidity, funds achieve high-yield transactions, and retail investors are left to react to price movements without awareness of the terms that influenced them.
Making OTC deals accessible for retail participants
The overarching goal of any business is profit. Buth indicated he doesn’t hold projects accountable for conducting OTC deals or funds for participating in them. Enflux, like other market makers, is simply “playing the game.” Instead, he emphasized that retail traders should comprehend the landscape they are trading in, given the absence of transparency unlike in more mature industries.
Colkitt mentioned that the implications extend further. He argued that OTC hedging and discounted allocations distort token values, generating sell pressure that creates the illusion of weak demand.
“It isn’t the market concluding that the project is subpar. In reality, it’s the mechanics of these transactions themselves that cause the issues,” he stated.
Meanwhile, such arrangements are increasingly being featured on fundraising platforms that enable retail investors to engage in deals previously unavailable to them. Huang predicted further expansion of these platforms in the industry.
Huang offered a contrasting viewpoint, arguing that transparency is not the real issue. “The primary objective of these transactions is to facilitate the transfer of tokens without significant price impact,” he expressed. Instead, he suggested that startups should prevent VCs from selling their tokens in secondary markets.
Presently, the imbalance continues to favor retail investors. OTC token deals persist in providing projects and funds with predictable profits while leaving the retail sector consistently on the losing end of a game they never consented to participate in.
The best retail traders can do is to acknowledge the asymmetry, consider hidden sell pressure, and adjust their strategies with the understanding that they are trading against holders of discounted tokens.
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