The Benefits and Limitations of Peer-to-Peer Transactions

The global financial marketplace was once dominated by rigid centralized exchange forums, but the emergence of cryptocurrency has created a need for greater flexibility in a new era of digital trading. Peer-to-peer, or P2P, exchange takes that need for market freedom to its logical conclusion — trades made between two parties with no central platform or agent.

Peer-to-peer is the term for a a decentralized exchange that enables trading without third party governance by using software to match buyers and sellers. Peer-to-peer transaction is a form of over-the-counter, or OTC, exchange, as trades are negotiated and executed outside a centralized exchange. However P2P describes the counter parties and method of transaction, which does not include an intermediary, while OTC describes the venue where a transaction takes place.   

Designed to circumvent the limitations imposed on crypto trade by traditional exchange, P2P can allow faster, cheaper transactions for traders. However, the decentralized exchange poses its own set of risks that come with an unregulated market.

Here’s what you need to know about peer-to-peer trading.

Format

Before the internet enabled worldwide connections, peer-to-peer transactions could only take place among a network of people with existing relationships. With the advent and optimization of web based communication, traders now have a much larger pool to engage in for more efficient counterpart discovery.

In a digital peer-to-peer network, assets traded are not created or maintained by a central financial institution. P2P buyers and sellers are automatically connected through an exchange software based on preferences around price, trade amount, and the types of currency accepted.

Once matched, traders connect independently to arbitrate terms and conduct the exchange without management from an intermediary. Where centralized exchanges list prices in a public order book, final P2P trades are kept private and are often anonymous. If an intermediary is involved in the brokerage of a transaction the format of trade cannot be considered P2P, even if it was not traded over an exchange.

The self-supporting nature of P2P better serves the needs of a cryptocurrency community than a strict financial marketplace that lacks agile digital infrastructure and crypto liquidity. Because peer-to-peer networks don’t broker or collect fees on transactions, P2P traders can also save on the costs of trade management that are standard in traditional exchange. However unlike even managed OTC exchanges, P2P does not provide recourse for irreversible cryptocurrency transactions that may not be fulfilled.

Since cryptocurrency trade is based on the fundamental mechanics of peer-to-peer transactions, P2P exchange is a natural fit for digital currency lending. In addition to its cost efficiencies, Bitcoin was developed to prevent any central agency from having the power to manipulate the payment transfer process — a problem that P2P circumvents through direct exchange.

Regulation

The primary benefit of peer-to-peer exchange is its lack of rules dictating trade activity. Unlike traditional exchange, there are no barriers to entry, trade caps, or extraneous operating fees that limit buyers and sellers in the network. Peers manage their own transactions, and are personally accountable for completing trades as well as dealing with the potential risk of unreliable buyers or sellers.

Some P2P lending platforms provide light managing infrastructure that includes arbitration, and escrow systems to ensure funds are not released until the buyer has made payment. The rapid growth in popularity of P2P exchange among institutional investors has also prompted some platforms to expand offerings and include asset back securities, or ABS, lending, and mortgage back securities loans, or MBS. These regulations and securitization offerings come with a brokerage fee, and are not inherent in all forms of decentralized trade.

Risks

The lack of regulation that enables agile crypto trade can also create some challenges for peer-to-peer traders. Unfortunately the network’s freedoms attract borrowers with poor credit histories who no longer qualify for traditional loans or trade, and may present a greater risk of defaulting in their P2P exchanges.

Buyers and sellers may be attracted to the benefits of trade privacy and fast, direct exchange, but these perks can come at the risk of scam sellers who can’t be held accountable if they refuse to deliver on their end of the agreement, or engage in illegal activity such as money laundering.

With the rise of the gig economy creating more opportunity for direct transaction, peer-to-peer consumer platforms like Airbnb, eBay, and Uber have been developed to facilitate the discovery of buyers and sellers through a central network. These platforms do the work of recording user profiles and transaction histories to secure transactions, and provide recourse for parties on either side of the trade.

Platforms like these work to prevent against a lack of credibility and default risk in P2P exchange. The peer-to-peer method of transaction can be extremely useful for traders seeking a flexible and cost efficient exchange option, provided there is a credibility system in place to hold counter parties accountable in the event of bad behaviors.    

Building with NUTS

To ensure security for all traders in the open OTC market, NUTS provides an accessible, distributed ledger that secures non-standardized trading and provides the transparency needed to safeguard every transaction.

We integrate essential financial capabilities into smart contracts to create diversified technology modules, and enable open, inclusive financial processes that serve the changing needs of a digital asset class.

Ready to build something incredible? Drop us a note.