Square quietly changed its bitcoin service to trade through private brokers instead of public exchanges

Key Points
  • Square disclosed in its latest quarterly report that it's moved off of public exchanges and is now trading through private brokers for its bitcoin app.
  • Cryptocurrency experts say the move will make Square's bitcoin trading app a more sophisticated service.
  • Square still isn't making much money off its bitcoin service, reporting $400,000 in profit on $37 million of revenue in the second quarter.
Jack Dorsey, CEO and co-founder of Twitter and founder and CEO of Square, speaks at the Consensus 2018 blockchain technology conference in New York City, May 16, 2018.
Mike Segar | Reuters

Square's bitcoin service may not be a huge money-maker yet, but a little-known change from last quarter could turn it into a more sophisticated trading platform going forward.

Square disclosed in its latest quarterly report that it's now trading bitcoin through "private broker dealers" instead of "public cryptocurrency exchanges" for its Cash app, which facilitates all of its bitcoin transactions.

That means most of Square's bitcoin trading comes from private, over-the-counter (OTC) desks as opposed to the open, public exchanges.

The change, which was first disclosed this week, is a step towards offering a more professional bitcoin trading service, cryptocurrency experts say. By moving off of public exchanges, and trading through OTC channels, Square is able to build a faster and more secure platform that would create less price volatility when trading large amounts of bitcoin, experts say.

Square declined to comment on this story.

"Working with a broker likely gets Square better pricing and better execution services than floating orders on the open market, as well as more confidentiality," said Meltem Demirors, chief strategy officer at CoinShares, a cryptocurrency investment firm.

Public exchanges are prone to hacks, as seen in a series of attacks in recent years that cost users tens of millions of dollars. Their transactions also take a long time — often hours, or even days — as they can't trade instantly. Also, most exchanges have open order books, giving competitors room to track transactions and exploit them.

Moving to OTC platforms can solve many of these problems, according to Hunter Horsley, CEO of Bitwise Asset Management, a company that runs a cryptocurrency index fund. Trades can run faster as they don't require cash or bitcoin to be deposited in the platform before placing an order, while transactions are more secure, he said. Orders also remain private, providing more secrecy around Square's market activity.

"There are many merits to trading OTC, which might be motivating Square's switch," Hunter said.

Price "slippage"

But perhaps the biggest advantage of moving to an OTC is protection from what's called price "slippage."

Slippage happens when an investor sells a large chunk of bitcoin at once on a public exchange, causing the bitcoin price on the exchange to fall as the order is placed. By the time the order is filled, the investor could end up selling at a lower price than intended.

Horsley said a bitcoin order worth a few million dollars could often cause a 5 to 10 percent price slippage on a public exchange. But that number improves to a 0.5 to 2 percent slippage rate on an OTC desk, he said, allowing Square to move blocks of bitcoin in one big transaction.

"Prices, net of fees, are often better, especially for large orders," he said.

The move off exchanges was also likely motivated by a desire to be more compliant, said Demirors of CoinShare. The nature of Square's business draws a lot of scrutiny from regulators and banks, and partnering with OTC desks and private brokers, who are generally perceived as "far lower risk," can work in its favor, she said.

It's unclear which OTCs have partnered with Square so far. In June, Genesis Trading, a bitcoin brokerage firm owned by Barry Silbert's Digital Currency Group, announced its partnership with Square, shortly after Square secured a virtual currency license from the New York State Department of Financial Services.

Square first launched its bitcoin trading service to limited people in the fourth quarter of 2017, and made it publicly available in the first quarter of this year. Both Bitcoin's price and Square's share price jumped after the launch of its bitcoin service.

Despite these moves, Square isn't making much money from its bitcoin service. In the second quarter, Square made about $400,000 in profit on $37 million of revenue from bitcoin transactions. That's a slight improvement from the quarter before, when it made a profit of $200,000 off $34 million in bitcoin revenue.

During an earnings call with reporters on Wednesday, Square CFO Sarah Friar said that the bitcoin service isn't expected to be a huge growth driver anytime soon.

"It's not a major monetization engine," Friar said. "The goal is to continue to drive utility in the Cash app."

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