Peer-to-peer, or P2P for short, describes the sharing of data or assets between 2 or more parties without any central authority making the transaction happen. Peer-to-peer transacting has been used by computers and computer networks for 30+, with one of the most well-known examples of P2P being filing sharing.
In 1999, a peer-to-peer file-sharing application called Napster became famous for illegally sharing and distributing MP3-encoded audio songs. As the service was decentralized, when a user went to download a file, like a digital audio file, the file wasn’t downloaded from a single server operated by the company. You downloaded from another Napster user’s computer also running the Napster software.
With cryptocurrencies, peer-to-peer involves the exchange of digital assets themselves. These specific types of transactions, much like Napster file sharing, can be done without the need for anyone involved in the transaction to provide identification.
Bitcoin and many other cryptocurrencies that operate as P2P transaction systems had that initial goal of anonymous transactions without the need for a financial institution sitting in the middle.
The release of Bitcoin brought forward a system and network that used encryption and blockchain technology for all such a transaction to happen securely between two parties.
In regard to cryptocurrency exchanges, there are both centralized exchanges and peer-to-peer exchanges. Centralized exchanges, as we’ve discussed elsewhere, are heavily regulated in many parts of the world, and so require their users to provide personal information that helps identify them, and ultimately helps identify their transactions.
P2P exchanges, also called decentralized exchanges (DEX), on the other hand generally don’t ask the parties involved to confirm their identities.
Privacy is maintained and transactions happen between two parties directly, with no middleman processing any part of the transaction. There is no centralized exchange and no order book matching traders to orders.
Traders are matched with other traders.
This style of trading makes transactions censorship resistant, cheap, private, and secure.
However, it’s this lack of user transparency that could breed illegal behavior by users on P2P exchanges, which in turn could get regulators involved with more restrictions and rules.
P2P exchanges also tend to have lower liquidity and trading volumes, which affect trading times, resulting in longer trading times.
To combat fraud, P2P exchanges use different methods to try to reduce as compared to other types of exchanges.
For example, some require deposits to be made by both parties that are returned after a trade is completed without issue. Reputation systems and arbitrators are also used in the event that a dispute arises out of a trade.
LocalBitcoins exchange even lets its members meet in person to contact their business.