Considering the novelty of cryptocurrencies, exchanges for cryptocurrencies are still in their early beginnings. After Bitcoin took the world by storm in the late 2000s, entrepreneurs started founding centralized exchanges through which Bitcoin could be more easily traded. These centralized exchanges, however, repeated the same problems with centralized financial institutions that led to the development of cryptocurrencies. In the last few years, two of the largest cryptocurrency exchanges, Mt.Gox (2014) and Bitfinex (2016), have lost millions of dollars worth of Bitcoin, with the money yet to be returned to investors.
Traditionally, when investors want to sell their Bitcoins, for example, they give the money to intermediaries such as Bitfinex and Mt.Gox who take care of the exchanges for them, which means that the company holding massive stores of Bitcoins. The centralized nature of these exchanges meant that hackers could get into the system and drain the currency. If the exchanges had been decentralized with Bitcoins dispersed across individual accounts, hackers would not have been able to steal all of that currency.
Though the technology required to protect investors from losing money in massive heists might not have been available then, the advancements in blockchain technology have opened the door for the development of new protocols. Loopring offers a solution to avoid these issues through a decentralized peer-to-peer open-source protocol that will not only create a safer platform for exchanges, but will also add more flexibility when trading cryptocurrencies.
How is the Loopring Protocol Different?
Loopring has improved many aspects of traditional exchanges, so let’s have a look at the benefits of their protocol over those of traditional online cryptocurrency exchanges.
But, before we start, let’s clarify one of the common misconceptions about Loopring. Loopring is a protocol, not an exchange platform. Simply put, this means that trades will be conducted on exchanges that are running Loopring’s software in the background. You might be using it without even knowing that you are, much like the back-end code of most websites.
More Secure & Lower Counterparty Risk
On traditional exchanges investors are required to hand over the amount they want to trade to the intermediary company that creates matches for exchanges. But, as has happened in the past, there is always a chance that the money will never make it to its destination, illustrated by the disappearance of millions of dollars with Mt.Gox. Loopring created a system in which the owners of cryptocurrency keep their assets until the match has been made and the trade is ready to be completed.
The protocol will achieve this through the use of self-executing smart contracts. When a crypto investor wants to buy or sell a currency, they will put out an order for a certain coin detailing what they are buying and what they are selling. The wallet will then authorize Loopring smart contracts to handle the designated amount of money that the person wants to sell. But, the money will not leave their wallet and the investor will continue to have access to and control over that currency including the amount they want to trade.
Allowing users to maintain control over their assets provides a few significant advantages. Firstly, it means that exchanges will no longer keep large amounts of capital in a centralized location. This means that investor’s assets will be more secure because the exchanges’ funds will be decentralized and dispersed across all of the user’s wallets. Secondly, it will ensure that if an exchange becomes insolvent or is hacked, investors’ assets will not be lost since they will still be in their personal wallets. Thirdly, it manages counterparty risk through the binding, self-executing nature of smart contracts whereby it is impossible to pull out of these contracts unless specific terms of the contract have been broken.
Order Sharing Leads to Greater Liquidity
One of Loopring’s most exciting features is that they allow order sharing. Order sharing implies that orders can be split into multiple smaller orders to ensure the best prices from all of the participating exchanges. The best way to picture this is by thinking of sites like Expedia, Kayak, and Skyscanner, which browse for deals and find the best prices across the internet for your search. Loopring will do a similar thing, except that it will match parts of orders to be bought or sold at the best prices.
Traditional exchanges do not support order sharing. This means that when large orders are inputted it can take a long time to find a trade for the whole amount, however, if the order was made up of a few coins it would be sold/bought in a few seconds. But, with this technology small and large orders will not only be pushed through much faster but at better rates. Investors will be able to buy at lower rates and sell at higher rates than on traditional exchanges.
Order sharing will also work to solve the problems of low liquidity on centralized exchanges. Generally, on existing exchanges, there are certain platforms that hold the bulk of a type of coin whereas other platforms hold only a small percentage of that same currency. Therefore, if an investor were to place a large order on a platform that only has a small percentage, it might not have enough volume of that coin to match the order. Loopring’s order sharing increases liquidity because the protocol allows coins to be traded across exchanges platforms.
Though Loopring currently only supports ERC-20 tokens, it will eventually allow for trades to be conducted across blockchains.
Faster, More Efficient Trading
Trade times will be greatly reduced by Loopring as a result of order sharing and ring matching technologies working hand in hand. In order to better understand ring matching, have a look at the example below:
‘Investor A puts an order out to sell ETH tokens for USD. Investor B wants to buy ETH and is selling MIOTA. Investor C is buying MIOTA, and selling XRP, and so on and so forth until it gets back to Investor A in the desired currency.
By creating the code behind this circular trade, Loopring has been able to greatly boost efficiency and consequently have reduced trading times. They have done so by eliminating the need for one-to-one matchmaking, which plagues other exchanges.
A New Era for Crypto Exchanges
So, there you have it! A new, all-in-one protocol that will have a profound effect on the way in which cryptocurrencies are traded. Loopring has managed to create the backbone for tokens to be truly interchangeable both across exchanges and blockchains. The startup is about to launch their first smart contract in January, so join their Slack channel and their Reddit to stay tuned for further developments!