What are P2P Exchanges?

Peer to peer exchanges are an integral part of the broader phenomenon of decentralized finance (DeFi). Peer to peer exchanges allow for two parties to trade with one another without the need of a third party. Typically, the function of an exchange is provided by a centralized entity called an exchange. Using an exchange to trade cryptocurrencies has inherent risk, as in order to use their services, you must send them your cryptocurrency. In other words, you need to trust the exchange with your money. A P2P exchange allows for you to keep control of your funds, AND trade with others.

Peer to Peer (P2P) Exchanges are Decentralized Exchanges (DEX)

If you are doing reading about decentralized exchanges and peer to peer exchanges, then it is helpful to know that they are the same thing. The different nomenclature has been used to refer to the same thing. An exchange that is built on a smart contract, rather than software owned by a centralized entity. On the Ethereum platform there are many P2P exchanges. UniSwap is one example of a P2P exchange. Users on either side of the exchange can initiate and complete exchanges without ever revoking access to their funds.

Cryptocurrency virtual transaction with P2P Exchange

Who Controls the P2P Exchange?

It matters who built, and deployed the P2P Exchange. Depending on how the exchange was designed, the core software developers could build various back doors into the code allowing them to take privileged action such as the withdrawing (stealing) of funds. So, before you decide to use a P2P exchange, you should ask yourself, who built this? With this in mind, you see that you still need to evaluate whether or not you can trust the underlying software. Sure, with P2P exchanges you can audit the code to make sure there is no funny business, but not everyone can do this. For people that are not software developers, knowing whether or not they can trust the underlying smart contract of a P2P exchange can be tricky. That is why it is important to only use P2P exchanges that have been tested and that are used by many other people.

How Does a P2P Exchange Work?

There are several ways to build a decentralized exchange, but they’re typically built with similar principles in mind. To understand the basic idea, we need to understand the difference between a transfer and a trade. Transfers are one way transactions. One transfer is a send, without a receive. A trade is a transfer from both sides. In other words, both parties end up with something, whereas in a transfer, the sender receives nothing in return. So how do you automate this function in a smart contract?

The smart contract acts like a trusted party in the interaction. It is programmed to not have any bias, and for the trade to go on uninterrupted. This is unlike centralized exchanges that can in theory, stop any trade they like, for whatever reason. Both parties “lock” the asset they’re trading on the smart contract. Only when the assets from both parties have been received by the smart contract, will it release the assets to each party. The only two humans involved in this trade are the buyer and seller. Thus a P2P exchange. In the event that either side never locks their funds, the trade may be cancelled and the funds returned to the user.

What are the Benefits of a P2P Exchange?

Peer to peer exchanges are beneficial to use if you’re worried about the ultimate ownership over your funds. When using P2P exchanges you always keep autonomy over your money. You initiate all of the trades, and at any time before the trade actually happens, you can cancel the trade. When you’re not trading, your funds are safe because they’re in your non-custodial wallet.

What are the Drawbacks of a P2P Exchange?

There are three main drawbacks to using a P2P exchange.

  1. Speed: P2P exchanges are limited by the speed of the underlying blockchain platform that it is built upon. For reference, most P2P Exchanges are built on Ethereum. The average transaction time on Etheruem is 30 seconds.
  2. Cost: Every interaction on a P2P is a transaction. Each transaction has a fee. Depending on how bloated the underlying blockchain is, the cost of your trade can be quite high.
  3. Liquidity: Decentralized exchanges tend to work great for smaller sized transactions upwards of $100. Low liquidity leads to price slippage, which ultimately means you’re getting less money / assets for your trade.

What Type of Exchange is Right for Me?

The best exchange for you depends on your crypto strategy. What are actually trying to accomplish with cryptocurrencies at the end of the day? How risk averse are you? For people that are worried that the exchange will run away with your money, P2P exchanges are a great option for you. As long as you are using audited P2P exchanges, the chances that you’ll lose your money are minimized. That being said, P2P exchanges are still considered new technology, and bugs are a reality that happen. Money has been lost and/or stolen due to improper programming of P2P exchanges.

If you are more concerned with getting the best bang for you buck in terms of speed, price, and liquidity, then centralized exchanges are your best bet. The process for selecting the best exchange is the same though. Pick one you can trust. Evaluate how well you can trust them on what their security protocols are, how long have they been around, and what is their reputation? Centralized exchanges tend to be much simpler to use as they are build with ease of use in mind. In order to trade on a P2P exchange, you need to be rather crypto savvy. That is, you need to be familiar with non-custodial wallets, and possibly even configuring your Ethereum gas fee.

In all likelihood, throughout your journey in cryptocurrency, you will end up using both P2P exchanges and centralized exchanges. When using a P2P exchange for the first time, make sure you follow some best practices. Make sure you understand the risks, and try out new things with as little money as you need to get confident with the process.

P2P Exchange Frequently Asked Questions

About the Author

Keegan Francis, CryptoVantage

Keegan Francis

Keegan Francis is a cryptocurrency knowledge expert and consultant. He recognized the opportunity in cryptocurrency early in his career and has been invested in it since 2014. His passion led him to start the Atlantic Blockchain Company which consults on blockchain technology and cryptocurrency know-how.