Peer to peer or a decentralized exchange between two parties, P2P is the sharing of information, assets between parties without the involvement of a central authority or middlemen. The interactions between counter-parties on peer-to-peer network are directed exclusively by pre-programmed software, with no requirement for human middlemen.
In a P2P network, the user utilizes and provides the foundation of the network. Each peer (a “peer” being a computer system on the network) is considered equal and are commonly referred to as nodes. A peer makes a portion of computing resources such as disk storage, processing power or network bandwidth, directly available to other participants without the need for any central coordination by servers or stable hosts. P2p networks are completely different to traditional client-server network that are common today.
The P2P architecture was originally brought into mainstream use by the file sharing application Napster in 1999, where files such as music or film were stored across multiple computers.
In terms of finance, p2p usually refers to the exchange of cryptocurrency. There are numerous platforms that allow buyers and sellers to trade without an intermediary. Bitcoin represents a peer-to-peer (p2p) payment system, based on Blockchain technology: all transactions are verified by network nodes and recorded in Blockchain distributed ledger.
How are trade performed on P2P Exchanges?
The exchange software is used to automatically connect buyers and sellers with each other, based on the terms they prefer.
How traditional crypto exchange takes place?
A ‘regular’ cryptocurrency exchange works as people looking to sell Bitcoins specify the amount and the price they’d like to sell them at. All those requests, known as ‘orders’, are placed in a common ledger, called the ‘order book.’
When another person wants to buy Bitcoins, they either look for a satisfactory offer in the order book or, if none can be found, create their own ‘buy order’, specifying the terms of the deal as they like. Whenever possible, the exchange matches buy and sell orders by price and processes the trades.
Now, Bitcoin transactions can take a long time – from five to 10 minutes at the least, and up to several hours. Fiat money transfers usually take even longer; in some cases, international payments may take several days to complete. In order to speed up the process of trading, the exchange serves as a trusted intermediary: it settles all trades immediately, even though the actual transactions might have not yet been finished.
In order to remove the need for a third party, P2P exchanges operate in a different way.
Instead of matching orders in the order book, it matches the people behind those orders. That is, whenever a matching buy and sell orders are found, the exchange software does not immediately process the trade, but instead, it connects the buyer with the seller, allowing them to conduct the deal without any intermediaries.
Still, third parties may be involved as arbitrators in case of possible disputes, but no human involvement from the exchange is required by default.
Here, just like with Bitcoin itself, the software alone is perfectly capable of matching traders with each other in a decentralized manner.
So, there are no banks processing or recording transactions in the Bitcoin network. Instead, the blockchain acts as a digital ledger that publicly records all activity. Basically, each node holds a copy of the blockchain and compares it to other nodes to ensure the data is accurate. The network quickly rejects any malicious activity or inaccuracy.
In the context of cryptocurrency blockchains, nodes can take on a variety of different roles. Full nodes, for example, are the ones that provide security to the network by verifying transactions against the system’s consensus rules.
Each full node maintains a complete, updated copy of the blockchain – allowing them to participate in the collective work of verifying the true state of the distributed ledger. It’s worth noting, though, that not all full validating nodes are miners.
What are the advantages of P2P Network?
- Decentralized currency exchanges, no company is in charge of things.
- Transaction censorship resistance, regular cryptocurrency exchanges are run by people – they are vulnerable, and may be exploited by governments by imposing regulatory restrictions. Case in point: the recent intervention by the People’s Bank of China, which lead to two of the largest exchanges in China freezing all Bitcoin withdrawals for a month.
- However, p2p networks are resistant to government meddling because of lack of central authority. This advantage is exactly what has caused a sharp increase in the user base of LocalBitcoins, one of the top P2P exchanges, following the aforementioned PBoC’s actions.
- Cheap operations, regular exchanges are operated by people, who have to be paid for their work. P2P exchanges are run by software, so there’s little to no corporate overhead, and, by extension, very small fees for the users, if any.
- Security, P2P exchanges do not hold Bitcoins for their users – instead, they connect traders, allowing them to conduct deals directly. Not having to entrust your coins to a third party makes the process much safer.
What are its limitations?
- Since p2p crypto exchange are taking place on Blockchain, ledger must be updated with every transaction. It reduces the efficiency as every node has to be updated rather than a single central server.
- Since most blockchains are decentralized and open source, groups of nodes are free to copy and modify the code and split away from the main chain to form a new, parallel network. Hard forks are completely normal and not a threat on their own. But if certain security methods are not adopted properly, both chains may become vulnerable to replay attacks.
- Another disadvantage is longer trade time, it is caused by the manner in which the trades are conducted – with traders having to wait for actual Bitcoin and fiat transactions to complete before a trade is concluded.
- The distributed nature of P2P networks makes them relatively difficult to control and regulate, not only in the blockchain niche. Several P2P applications and companies got involved with illegal activities and copyright infringements.