What Is a Peer-to-Peer Decentralized Crypto Exchange
A peer-to-peer decentralized crypto exchange is a type of cryptocurrency exchange that lets users trade funds directly instead of through software under centralized control.
It is important to note that peer-to-peer exchanges in the crypto space are often different from Decentralized Exchanges (DEXs) even though DEXs are also peer-to-peer.
The main difference is that most well-known peer-to-peer exchanges of the first kind are provided as additional services by companies running Centralized Exchanges (CEXs). While they connect traders directly with one another, the underlying software they use to do so is centralized and subject to company control and oversight.
This page concerns the second kind of peer-to-peer exchange — the DEX — most familiar to traders and investors in the decentralized finance (DeFi) and Web3 spaces.
In essence, a decentralized exchange is a peer-to-peer (P2P) marketplace that connects buyers and sellers. Decentralized exchanges are at the moment only used for cryptocurrency trading.
Joseph, R. (2022).
Key Attributes of Decentralized Peer-to-Peer Exchanges
P2P DEXs work just like traditional centralized exchanges that rely on order books; in this case, transactions happen directly between two users (i.e., peer-to-peer).
Their key features are as follows:
- Decentralized: Not owned or operated by any single entity.
- Open source: Developed and maintained by a community of independent developers.
- Trustless: P2P DEXs, like all DEXs, run on blockchains and use them to store and trustlessly verify transaction data.
And, of course, their main differentiating feature is that they are,
- Peer-to-peer: Connect traders directly with the use of smart contracts.
Other key features may or may not include community governance and enhanced privacy.
Benefits of Peer-to-Peer Decentralized Exchanges
Decentralization and accessibility are the two main benefits of P2P decentralized exchanges. They operate on free and open blockchains, making them completely free to use by anyone.
They are also free from censorship, and there is no third-party reviewer to decide the legitimacy or legality of transactions, only their validity, unlike banks, where every transaction goes through manual review for regulatory compliance.
Hurdles and Obstacles in Peer-to-Peer Decentralized Exchanges
P2P DEXs also have a few common downsides. The main drawbacks common among all P2P DEXs are often connected to transaction costs, security, and liquidity:
- High transaction fees: Because P2P DEXs operate directly on the blockchain, they rely on the blockchain’s native transaction processing capabilities. Many blockchains feature large transaction fees as a result of high usage and insufficient infrastructure (i.e., scalability issues).
- Security risks: P2P DEXs connect users directly with one another. Unlike on traditional centralized trading platforms where users are required to submit Know Your Customer (KYC) information, on a DEX there is no vetting process. Thus, every interaction on a DEX may potentially be with a malicious actor, so extra vigilance is recommended. Additionally, DEXs run on smart contracts, which, if not carefully developed, can be hacked or compromised in a number of ways.
- Liquidity issues: Because decentralized trading is relatively small compared to that on centralized exchanges, some DEXs may be illiquid (i.e., there are not enough counterparties to trade with effectively).
Exchange Operations
All P2P exchanges must seamlessly perform exchange operations like matching orders, executing trades, and managing secure settlements.
In a decentralized context, facilitating these operations reliably and consistently may prove more challenging than if they were all the work of a single centralized entity, like a company.
Additionally, decentralization doesn’t entail regulatory non-compliance, and P2P DEXs, like any other company providing financial services, need to adhere to established financial and securities trading laws.
Many governments around the world face the difficult question of how to implement this, although some (e.g., the EU) have made significant strides in passing favorable and comprehensive legislation to address the issue.
The Role of P2P DEXs in the Crypto Ecosystem
P2P DEXs are an essential element in the DeFi and broader crypto ecosystem. They are adopted by many communities around the world where centralized banking and currency are unreliable, as well as by everyday traders who wish to exchange their tokens with others.
Decentralized exchanges as a whole are becoming more robust and reliable by the day and are seeing rapid growth in users, liquidity, trading volumes, and features. For example, the average daily global DEX trading volume has grown from ~$25M in the second half of 2020 to the now firmly established ~$3B in late 2023, and into 2024.
As more people flock to the crypto ecosystem in search of financial independence and self-sovereignty, the use of DEXs, like those offering P2P order book trading, continues to grow.
Joseph, R. (2022). Decentralized exchanges: The future of exchanges? Square Intio.
https://www.square-management.com/wp-content/uploads/2022/01/square_white-paper-decentrated-exchange.pdf
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