Peer-to-Peer exchanges (P2P) has been in existence since almost the beginning of cryptocurrencies. The most familiar form of exchange for most of us is the Centralized Exchange. Here, the system uses an order book to effectively pair buy and sell orders made by the users. The exchange acts as a clearinghouse ensuring that both sides of the trade get their assets and preventing any from cheating during the transaction. In this model the two parties have no contact with each other, meaning that they remain anonymous among themselves, but not to the system running the exchange.
Finally, and perhaps most crucial, a Centralized Exchange has custodial power over the assets deposited in their system. This means that the people running the exchange have control over those assets the users have deposited and trade with. Most of the exchanges out there are honest businesses, so the chances of the exchange stealing funds are minimal. But if its security ever becomes compromised, then stealing the funds is a trivial matter.
Also, Centralized Exchanges are under the regulatory power of their host country. Even if they are global businesses receiving clients from different countries, they are bound to the laws of a single place. The country could outlaw people from certain regions, prevent deposits to outside territories, or demand the identity of those using the exchange. A person using this service is at the mercy of the country in question.
This system was easy to implement because it was copied from the old financial world. Exchanges have existed for commodities, money markets, equities, etc. So, when crypt started the most natural thing was to migrate what was already working into this new market. But it does not have to be this way.
More information in How to Begin Cryptocurrency Trading in 2020.
The peer-to-peer (P2P) model
As early as the Bitcoin white paper, peer-to-peer transactions are mentioned. In fact, the Bitcoin network was specifically designed to be a P2P system for transactions, without a central authority. This almost unprecedented ability power charges the P2P model that had already existed for a while.
In the very early days of Bitcoin, people would use the Blockchain to exchange BTC directly with their trusted friends. They would meet somewhere, exchange crypto for something else like money, and go their separate ways. At the start, this was an awkward market difficult to scale since it needed that both parties would meet physically and have a prior trust in each other to allow them to make the trade.
In order to scale and expand P2P trading a new type of exchange was created, the P2P Exchange. Here the system provides escrow services that lock both parts of the trade while the transaction is being conducted. Once the price is settled, then the assets are delivered to the two sides.
The is no order book, and the offers to buy and sell are publicly visible in the form of a list. People can transact directly from their crypto wallets without having to relinquish control of their money. But an important innovation by P2P exchanges is to provide an integrated web wallet that can also be used to exchange crypt for FIAT money quickly and securely.
The P2P model leverages the benefits of the Blockchain and combines them with the security provided by an escrow system. They have become one of the most rapidly growing business models in the crypto economy, and are serving to expand crypto adoption.
Benefits and drawbacks of the P2P system
Here are some of the great positives of this model:
Censorship resistance: as we said before, Central Exchanges are subject to regulation by their host country. This is not so much the case for peer-to-peer trading. There are no central systems to match the trades, instead, people freely offer and take offers by the pool of participants.
These users don't even have to be in the same country. So, a person from a country with a small crypto market can purchase BTC from another living in a place with a bigger market, at a better price.
Cheap to use: the costs of running a P2P exchange are lower than those of a traditional one. This means that these lower operational costs result in savings that are passed to the users of the platform.
Global reach: these types of exchanges operate in a decentralized way virtually in any country with an internet connection. So, a user immediately has access to offers from all over the globe, without having to access different markets on different platforms.
Some downsides are:
Slow response time: In a centralized system, traders actually buy and sell to the clearinghouse, and not between each other. This means if a buyer finds a suitable price, he is able to execute the trade immediately.
In a peer-to-peer exchange, two persons have to coincide in rice at the same time and be willing to trade simultaneously. If attractive offers don't appear, the only choice is to wait.
Not friendly to assets with low market capitalization: a Centralized Exchange can risk adding coins and tokens with small market caps because again traders are buying and selling to the clearinghouse. This means some risks are more acceptable in this type of system.
In a P2P exchange, if an asset doesn't already have a large demand then it is difficult to include. People won't trade in it often, and this will result in long waiting times and frustration. Generally, P2P exchanges only work with cryptocurrencies that are already very popular.
P2P Exchanges and altcoins
A crude definition of an altcoin is any cryptocurrency that is not Bitcoin. This is because BTC was the first and remains the biggest crypto asset in the world. The P2P model is ready to expand to these markets since more and more people are using these coins than ever before.
The global reach, censorship-resistant, and cheap operation of a P2P exchange can broaden the altcoin market. This is because these advantages make viable small purchases that would not make economic sense when using large Centralized Exchanges.
Furthermore, the P2P model is very important in emerging economies where peer-to-peer local markets have existed for decades or even longer. In these places, a P2P network can increase the pace of adoption and allow for transactions in an economic model well understood by these communities.
Read this article about the top cryptocurrencies in 2020 for the most promising altcoins in the market.
The blockchain through P2P Exchanges is already reaching this market. Here crypto is being used to protect oneself against inflation, send cheap remittances, purchase supplies from neighboring countries, and many more uses. As the market for altcoins grows, P2P will be at the forefront of adoption in traditional markets and emerging economies.
