Peer-to-Peer (Virtual Currency): Definition and How It Works

What Is Peer-to-Peer (Virtual Currency)?

Peer-to-peer refers to the exchange or sharing of information, data, or assets between parties without the involvement of a central authority. Peer-to-peer (P2P) involves decentralized interactions among individuals and groups. This approach has been used in computers and networking (peer-to-peer file sharing), as well as with trading virtual currencies.

Understanding Peer-to-Peer (Virtual Currency)

In a digital peer-to-peer network, each user is (in theory) an equivalent owner of and contributor to the network. This kind of network can be used for almost any kind of information or file-sharing. (One of the earliest mass uses of P2P networks was the now-defunct music-sharing service Napster).

With currencies, P2P refers to the exchange of cryptocurrencies, especially Bitcoin, which was created with the goal of enabling anonymous P2P transactions that don't require processing by a financial institution. This required the use of encryption and the creation of blockchain technology to enable two parties to safely conduct a transaction without the need for a trusted third party.

Blockchain can confer what P2P advocates consider to be a notable security advantage; with transactions recorded on every peer's network, it is extremely difficult—even "computationally impractical"—to overwrite or falsify ledgers in a cryptocurrency exchange.

Peer-to-Peer vs. Centralized Exchanges

Truly peer-to-peer cryptocurrency transactions generally do not require the involved parties to provide identification, thus protecting everyone's privacy. Most P2P exchanges allow the purchase of cryptocurrencies to be made with cash or other forms of exchange that support the protection of privacy.

However, not all cryptocurrency exchanges are truly peer-to-peer. Many of them are centralized exchanges subject to the regulations of the countries in which participants live. This means that governments sometimes require the exchanges to collect information about users' identities and transactions, resulting in an erosion of the privacy for which Bitcoin was aiming.

While privacy advocates may appreciate how peer-to-peer currency exchanges allow individuals to conduct business without government interference, the lack of transparency in virtual currencies may allow individuals and groups engaged in illegal activities to launder money without detection or oversight.

The Growth of P2P Cryptocurrency Transactions

As the acceptance and adoption of cryptocurrencies has grown, more people are turning away from the relative ease of centralized exchanges such as Coinbase and Binance and toward purely P2P exchanges, also known as decentralized exchanges (DEX).