Modernizing Traditional Exchanges through Blockchain:
Introduction
Traditionally exchanges have been a place where buyers and sellers of a commodity meet to decide on a specific price for the commodity based on demand and supply. Initially exchange was a common marketplace, later it evolved into an organized market place regulated by defined rules. The decentralized exchange which can facilitate the functions of exchange without relying on central point of authority embedding all the basic principles of exchange in an autonomous technical protocol by the extending the capabilities of blockchain.
Functions of exchanges
The exchange by very definition is an organized market place where various commodities, currencies, Financial Securities and derivatives are traded. The basic Components of any exchange are the entities (buyer and seller), A pair of Financial Instrument (Commodity, Security, Currency or derivatives), Quantity in trade and Price for the Financial Instrument against another Financial instrument.
Need for a completely decentralized exchange
Each financial instrument is subject to speed of transfer. Speed of transfer is time taken by each financial instrument to exchange hands from I-th owner to N-th owner. Speed of transfer is a limited of different Financial instrument is different. (i.e. Time taken by simple cash purchase transaction is not same time that has been taken for a transfer of real estate. ). The decentralized exchange standardizes the speed of transaction across all financial instrument there by reducing loss due to speed of transfer. One of the main function of exchanges is fair price determination between two financial instruments. In centralized exchange the price determination mechanism is a blackbox raising a ethical question over price. Keeping the entire exchange function over blockchain would ensure transparency in the entire system
Decentralizing with Blockchain
The decentralize exchange relies on the fundamentals of block chain for storing a transactions over a peer to peer network. Unlike crypto currencies the decentralized exchange have three type of entities (i.e. Issuer, Trader [User] and Miner). The network relies on issuing process (FI Definition, FI issue and FI withdrawal), orders (Open order and execution order) and blockchain . The miner would verify the transaction for validity as well as match the execution orders and upon successful conformation would generate a block using proof of work as followed by the Bitcoin protocol.
