What is Peer-to-Peer exchange?
Commerce is synonymous with human existence. Humanity has bartered goods, invented fiat currency and now the age of cryptocurrency is here. There has always been give and take in society, person to person transactions preceded what is now known as conventional banking and financial centralisation. Nearly twenty years after the launch of the earliest financial peer-to-peer platforms, we see tremendous growth and adoption as blockchain technology lays the groundwork for the re-emergence of peer-to-peer economies.
To better grasp the mechanisms behind peer-to-peer crypto changes let’s first clarify what blockchain and cryptocurrencies entail.
Blockchain
is a modern technology that runs on a communal database. The database is spread across computers around the world owned by individuals and is publicly accessible. Each item of data or an individual transaction is recorded as a “block” and the next transaction is another block. These transactions are organised chronologically and form a chain, hence the name.
Immutability
The information in a block cannot be changed by anyone once it exists. This feature is referred to as immutability and is one of the unique features of the blockchain.
Cryptocurrency
Whenever you hear blockchain technology close behind is often cryptocurrency. These blockchains allow for asset transfer, meaning your fiat money can buy assets on the blockchain. That asset can then be transferred to someone else and they can convert it to fiat currency as well. These assets on the blockchain are referred to as cryptocurrency. Cryptocurrency is regarded as secured by cryptography to prevent counterfeit and double spending.
Peer-to-peer
Cryptocurrency is transacted through the peer-to-peer (P2P) method. In its simplest form, P2P transactions refer to an individual or entity selling directly to or buying directly from another individual or entity. The key word being directly. Peer to peer transactions typically bypass third party institutions, often banks, allowing individuals do business without an intermediary. Assets of different kinds such as coins and NFTs (Non-fungible tokens) can be traded.
The purchase of cryptocurrency mainly employs peer to peer transacting technology as it upholds the aims of blockchain technology- decentralisation.
What is decentralisation?
Centralisation promotes the governance of financial activities by a single institution. Whereas, blockchain technology upholds decentralisation by the use of a distributed digital ledger that records transactions across computer networks. These records are publicly accessible and promote community governance. By this, no one person has control over financial interactions, transparency is maintained and fraud is nearly eliminated.
Therefore, in peer-to-peer transactions, a trade is not limited by governmental or financial policies and proceeds at the behest of the principal participants of the transaction. Centralised finance is also characterised by the pooling of customer assets into a single storage location e.g banks. These large collections of assets pose security risks as they are prime targets for hackers.
How transaction works
Peer-to-peer (P2P) transactions operate on the foundation of blockchain technology. Certain features of blockchain technology are crucial in enabling the swift, smooth and secure trade of assets. Smart contracts are one of such features. They are self-executing contracts. The terms and conditions as specified by users are incorporated into the code of the contract, causing it to carry out the trade without need for input or clearance from a third-party institution. Speed and accuracy are therefore achieved with little transaction cost, unlike in centralised transactions which are slower and more expensive due to the involvement of more parties and fees per transaction. Smart contracts are the technology behind the automation of many areas of the trading process, such as order matching, settlement etc.
Security is one of the major selling points of blockchain technology. This is achieved by decentralisation and immutability amongst other things. The decentralisation of the blockchain makes it more difficult for hackers to target user assets as they are not pooled into a single location. Each user is furnished with a private key which could be a unique set of words or numbers or combination of both. This key is the only access to the user’s assets and so, neither the platform nor any other party can access a user’s assets.
Financial fraud is another major security concern in the world of finance, but less so when trading on the blockchain. Transactions on the blockchain are listed on the public ledger and cannot be retrospectively altered. This guards against falsifications and fraudulent attempts.
Cryptocurrency trading is increasingly finding favour in the eyes of people due to these benefits. However, it is not all roses, as decentralisation creates an unregulated space, allowing bad actors when they surface to go unchecked or making it difficult to curtail them as they are nearly untraceable and autonomous. Third-party institutions bear the brunt of work done to curb and create consequence for bad actors. Decentralisation leaves this in the hands of individuals who may not be effectively equipped to do so. The major cryptocurrency exchange platforms of today attempt to strike a balance between risk and benefit by utilising aspects of the blockchain technology alongside certain regulatory features.
Key players in Crypto exchange
There are many players in the cryptocurrency exchange field, and the choice of which to use is up to each individual. Although P2P exchange is the basic template of operation, individual platforms available today function with varying degrees of decentralisation. Popular crypto exchange platforms like Binance, Kucoin, Paxful etc are well known for their P2P crypto trade services but do not operate as completely decentralised autonomous organisations (DOAs). This is because, they employ certain features to mitigate some of the risks that these DOAs and ungoverned systems face. They do this in the following ways:
Reputation system: It is a peer rating system which allows a user to rate their transaction with another user once the transaction is done. This creates a system of communal vetting. Members of the community are incentivised by this to continuously act in good faith to get better ratings as members with higher ratings are more likely to be patronised.
Third-party services: Escrow services are often employed as third-party services to enforce good faith in transactions. Escrow companies operate by receiving the terms of an agreement from both parties then, payment is made into a temporary holding account in such a company. When both parties have confirmed that the terms of agreement have been met, the payment is transferred to the recipient. This differs from traditional third-party holding as the user’s assets are not primarily stored with the third-party company and users retain autonomy of access to their funds.
Nevertheless, the ability to transact is not fully in the control of the user as it is in decentralised autonomous organisations. In this method of operation, transactions can be affected or stopped by the platform’s policies. e.g. Binance commenced a cessation of peer-to-peer transactions for Nigerian users from the 8th of March 2024.
Take for instance one person decides to sell her car on an online platform. She posts the details of the car and a picture. Another lady has indicated interest in buying. The seller faces the risk of providing the car and being given counterfeit money or being sent a fake receipt. The buyer faces the risk of a “what I ordered vs what I got” situation after payment. To mitigate this risk, P2P platforms utilise an escrow service where the buyer will pay into a temporary account. The money will be held in the escrow service until the buyer and seller both agree that the terms of agreement have been met. Once agreed, the funds are sent to the seller and the buyer receives the car.
Order matching: This employs the use of algorithms to match demand and supply. Buyers indicate the amount they are willing to purchase and sellers indicate how much they have for sale. The algorithm does a swift job of matching orders. This means transactions can occur swiftly and seamlessly. It also means that users seeking out a coin that is in short supply face difficulty in their purchases and this can cause delays.
As decentralised finance gains traction, peer-to-peer(P2P) crypto exchanges are poised for significant growth. While still an evolving technology, these platforms leverage blockchain to enable secure, direct trading between individuals. However, addressing risks around lack of oversight and bad actors remain a challenge. Leading P2P exchanges strive to strike a balance through reputation systems and escrow services. Going forward, continuous innovation in areas like cross-chain operability, scaling solutions and decentralised identity could further revolutionise P2P trading. As adoption rises, and with collaboration across platforms, such exchanges have the potential to drive greater financial inclusivity worldwide.