How Did Crypto Exchanges Evolve?
14 years ago bitcoin emerged. This invention totally changed the financial industry and boosted technologies. No crypto exchange was developed when bitcoin came into being. Now a cryptocurrency exchange software development company can implement such a platform within 14 days. Let’s find out how crypto exchanges emerged.
What is Crypto Exchange?
It is a platform where users can operate with cryptocurrencies: buy, sell, trade, swap. An algorithm picks buyer’s and seller’s orders. When it finds a match, a transaction takes place. On big exchanges, like Binance or Kraken, this process takes a few seconds.
For each transaction, a crypto exchange collects a fee. Fees are not fixed and depend on many factors: type of exchange, type of transacted currency, volume of transaction, calling rate of an exchange.
Apart from cryptocurrencies, crypto exchanges accept fiat: USD, EUR, TRY, AED, etc. On crypto exchanges, fiat is used for deposits and withdrawals. Transactions with fiat are more expensive because they require conversion.
Crypto Trading Before Exchanges
The first cryptocurrency, bitcoin, appeared in 2009. At that time, there were no special websites to buy and sell crypto. Early crypto-enthusiasts could acquire bitcoin in 2 ways:
- Mining,
- P2P trading.
Early mining
Mining was less power-consuming back then. A basic central processing unit (CPU) was enough. The first person to mine bitcoin with a CPU power was Satoshi Nakamoto, the founder of bitcoin. He mined a genesis block and set up the blockchain.
Further, ArtForz and Laszlo Hanech started to use a graphics processing unit (GPU) to mine bitcoin. This new approach revolutionized the industry. The first mining farms emerged. Engineers invented graphics cards for mining.
Early P2P trading
P2P crypto trading is a predecessor of exchanges. The feature that is being installed into trading inventory of every exchange was once the only way to purchase bitcoin. Users would make connections on forums, like Bitcointalk, and trade. Transactions were risky. Yet, the stakes were low: 1 BTC was less than 1 cent USD in 2009.
The next step was #bitcoin-otc. It was a platform where users exchanged bitcoins and publicly rated traders. The problem remained. Users could exploit high ratings and run away. Or fraudsters could manipulate ratings to cheat.
First Centralized Crypto Exchanges
In 2010 the first crypto exchange Bitcoin Market was established. It differed from p2p trading. Bitcoin Market was an intermediary that held bitcoin until the seller received their payment. Once the payment was registered, bitcoin would flow to the buyer.
Another pioneering exchange was Mt.Gox, the first victim of crypto hackers. In 2011, the attack caused the bitcoin rate to collapse from 17 to 0 USD. In 2013, however, Mt.Gox performed 70% of global bitcoin transactions. Next year, the exchange underwent another hacker attack. The platform lost 850,000 BTC, 9.5 billion USD, and filed for bankruptcy. To learn about the means to secure crypto exchanges, read this article.
Among the groundbreakers also were VirWoX and Tradehill. VirWoX exchange allowed operations between bitcoin and Linden Dollars, the currency of a virtual reality game Second Life. Tradehill provided functionality for instant transactions with bitcoin: a trader didn’t need to place a limit order and wait for a counter offer from another user.
Ethereum and Smart Contracts
As crypto exchanges developed, they involved an intermediary that would store assets before they reach the final user. This scenario was safer than transacting crypto directly between unknown traders. Yet, such centralization did not solve the problem: what if the intermediary service is tampered with?
In 2015, Ethereum was launched. Along with it, the service brought smart contracts. A smart contract is a code that executes when predescribed conditions are fulfilled. With this feature, exchanges didn’t need a middleman anymore. Smart contracts can lock the funds sent and unbind them when the seller receives the payment.
If there is a payment dispute, an arbitrator can interfere. Nevertheless, arbitrators have no power to access the funds. The arbitrator can only allow reversing the transaction. This approach saves traders from hackers and fraudulent intermediaries.
Decentralized Crypto Exchanges
The first decentralized exchanges emerged in 2014. At that time these platforms were slow, illiquid and the interface left much to be desired.
In 2018 Uniswap was born. It is a decentralized exchange based on the Ethereum blockchain. Compatible tokens for Uniswap are ERC-20 tokens.
Uniswap solved the liquidity problem. Users send their money to a common fund, liquidity pool. If there is enough liquidity in the pool, a user willing to buy or sell their assets can instantly accomplish a transaction. Users who send money to liquidity pools become liquidity providers and make profit for that.
Also, Uniswap provides means for determining the price of an asset. This feature is called an automated market maker (AMM). Relying on supply and demand, AMM adjusts the price of a crypto: if there are too many coins in a certain liquidity pool, AMM will increase its price. And vice versa.
Future of Crypto Exchanges
A global adoption of cryptocurrencies means exchanges will further evolve. Centralized exchanges contradict the essence of blockchain: to provide independence and anonymity. Decentralized platforms have security flaws. Anyway, developers have always found alternative routes to trade cryptocurrencies and bring exchanges to a whole new level. A good example of this is over-the-counter trading (OTC). What is OTC in Crypto?
‘Among crypto exchanges, there is a trend to introduce over-the-counter trading (OTC). It is worth noticing that OTC is a way the first crypto was traded, p2p, without being registered in an order book. These days OTC is employed for large transactions, from hundreds of thousands USD. Over-the-counter helps to keep the price of an asset at the same level. As it is not publicly recorded, the market will not shake after the 200,000 USD deal,’ says Alexander Riedinger, CEO at Merkeleon.
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