One of the most important aspects of the cryptocurrency ecosystem is the use of digital currency exchanges — platforms that enable users to buy, sell and trade digital currencies — whether through traditional fiat currencies or through cryptocurrencies. Today, there are more than 200 exchanges in the world, each of which falls into one of two categories: centralized or peer-to-peer (P2P) exchanges.
These two categories of exchanges currently dominate the cryptocurrency ecosystem, but the Lightning Network (LN) is poised to be an interesting newcomer to the space by offering instant transactions between network participants.
Centralized exchanges, such as Coinbase, Coinsquare, and Binance, are trusted middlemen who handle user funds and facilitate cryptocurrency trades. Rather than directly trading with other cryptocurrency holders, users first need to deposit their funds into the exchange, which then aggregates orders from buyers and sellers. These platforms work by matching you with a trade partner and executing the trade on their own end with an order book.
Centralized platforms tend to be popular due to their ease of use and convenience, but they come with certain requirements, including:
- Traders need to trust the exchange. However, some exchanges may end up being fraudulent, while others may fail to properly secure traders’ funds. A few notable exchange hacks include Mt Gox and Bitfinex; and
- Centralized exchanges come with fees, such as miners’ fees, as well as an exchange’s own fees for deposits and withdrawals.
There is limited depth to the market. At present, arbitraging between different exchanges has its limitations due to bitcoin transaction confirmation times.
Some centralized exchanges, however, have adopted Lightning Network technology to bring faster, lower-cost payments to their users. Bitfury’s Lightning Peach team helped the BTCBIT exchange (at BTCBIT.NET), a fully regulated cryptocurrency exchange, enable Lightning Network payments.
P2P exchanges allow people to share data, information, or digital assets in a trustless manner. More specifically, P2P exchanges permit traders to buy and sell cryptocurrencies directly between one another without requiring a central intermediary. Unlike centralized exchanges, P2P exchanges do not require users to deposit their funds into an exchange. They also do not require documentation regarding a person’s identity, instead of providing a reputation system to track users’ trading histories.
Transactions are undertaken when buyers or sellers post a bid searching for trading partners. If the terms are agreeable between the parties involved, the offer is selected whereupon the buyer and seller enter into the agreement. Once a bid has been selected, the digital assets are locked in cold storage inaccessible to both parties, and once the buyer sends their payment, the crypto is released to the buyer.
Unlike centralized exchanges, P2P exchanges are completely run by software. In this design, not only is there is no overhead to worry about, but also low transaction fees. In most cases, transaction fees are anywhere from zero percent to 0.7 percent.
A P2P Exchange on the Lightning Network
While current crypto trading is mainly limited to these two types of exchanges, the Lightning Network is quickly becoming a promising option as an add-on to decentralized exchanges.
The Lightning Network is a decentralized second-layer protocol built on top of the Bitcoin Blockchain that seeks to solve Bitcoin’s scalability issues by enabling instant transactions between network participants. By having transactions take place off-chain, the Lightning Network minimizes congestion on the blockchain. Only when a channel has been closed is the payment broadcast on the blockchain.
The Lightning Network was primarily built for bitcoin, but it can also be extended to other cryptocurrencies and blockchains. Adoption of the Lightning Network across blockchains could solve the arbitrage issue that centralized exchanges suffer from by using “atomic swaps.” Atomic swaps are a feature that enables the exchange of one cryptocurrency for another without using central intermediaries by connecting two blockchains directly, allowing users to trade with one another without a centralized exchange.
Just as atomic swaps connect blockchains, the Lightning Network connects payment channels. Combining the Lightning Network with atomic swap technology could allow LN users to essentially act as cryptocurrency exchanges or payment processors by opening payment channels on multiple blockchains.
Back in July, Charlie Lee, creator of Litecoin, endorsed this idea, tweeting that the “Lightning Network will be the ultimate decentralized currency. Users who are running LN on both BTC and LTC can advertise an exchange price and act as a maker earning a spread. Other users can act as a taker and automatically swap LTC/BTC with the maker node via lightning.”
The technology of the Lightning Network is highly useful for building a P2P settlement layer for decentralized exchanges. With the right implementation, the trading process will be faster than existing exchanges, more secure, trustless, and, importantly, affordable. Some of the main advantages include:
- The absence of a single point of failure. For example, if an exchange platform goes offline, a trader can switch to another platform, as he/she won’t be storing their funds on a specific platform; and
- Traders control their funds and don’t have to give up control of their funds to third parties, unlike centralized exchanges. This eliminates the risk of a hacker targeting an exchange and stealing a person’s money.
While the Lightning Network is still in the beta stage of development, you can start using it now by installing the PeachTM Wallet. It’s an open-source, non-custodial and user-friendly bitcoin wallet built for the Lightning Network, designed by Bitfury’s leading Lightning Network engineering team, Lightning Peach.
LightningPeach is Bitfury’s team of engineers dedicated to advancing the Lightning Network.