The Exchange Ecosystem: Understanding the Complexities Behind a Simple Transaction

In today’s global economy, exchanges play a crucial role in facilitating economic transactions between individuals, businesses, and governments. But the exchange ecosystem is far more complex than you might realize.

While the exchange is responsible for order matching, reporting data, and facilitating the trade, it’s just one part of the larger exchange ecosystem. There are many other moving parts — including systems, entities, and people — working behind the scenes to ensure a seamless transaction at every step.

Three Core Components of the Exchange Ecosystem

The exchange ecosystem is made up of three primary components: the exchange, distribution, and clearing.

The exchange is the heart of the ecosystem. It has several essential functions, including the order matching engine, which matches buyers and sellers based on the price and time of their transactions. The exchange must also manage the trading schedule and generate reports for both internal and regulatory purposes. Maintaining a fair and orderly market for all participants is the mandate of any exchange. To fulfill this mandate, the exchange must reliably stay open, surveil for bad actors, and monitor the health of the platform.

As part of the exchange ecosystem, distribution is a critical function that allows investors access to the market. This network often involves brokers or other intermediaries who connect their systems to the exchange to ensure that the investor’s transactions are securely routed to the exchange. They perform pre-trade and post-trade risk management on customer accounts to manage financial risk.

In addition to the exchange and distribution, trade clearing and settlement is another critical component of an exchange’s infrastructure. Clearing houses assume the counter-party risk by becoming the buyer to every seller and the seller to every buyer on the exchange.  They play a crucial role in settling transactions, ensuring that buyers receive their assets and sellers receive their payments. They also act as a safety net in case of any clearing member defaults, using the clearing member clearing fund to backstop any losses.

The Exchange Ecosystem in Action

To understand the exchange ecosystem, let’s take a stock exchange as an example. For instance, Customer A wants to buy 100 shares of Apple at a price of $150 per share and Customer B wants to sell 100 shares of Apple at the same price. They would log on to their account at their broker, or instruct their broker, to enter their respective orders to buy and sell. These orders would then be sent electronically to the exchange where the orders would be placed into a Central Limit Order Book (CLOB) for the shares of Apple.

Once both orders are in the CLOB, the buy and sell orders are matched using order-matching technology. A report of the trade is then sent to the broker systems, which are then relayed to the customers and to a clearinghouse for settlement.

From the market participants’ perspective, this is a simple process automated by the exchange’s infrastructure technologies that allow these different parts of the ecosystem to seamlessly integrate.

Ensuring the Security of User Assets and Transactions

Security is a top priority in the exchange ecosystem. Regulated exchanges and platforms, like EP3TM, have put strong measures in place to protect customer assets and transactions. Regulatory agencies are the first line of defense and provide a framework that all participants must follow. These agencies audit the activities of those involved to ensure they comply with regulations.

Additionally, brokerage firms must insure customer accounts to protect them in case of losses. Clearinghouses also require clearing members to contribute to a clearing fund to provide a backup in case any brokerage firms fail. All these precautions work together to create a secure environment for everyone involved in the exchange ecosystem.

While regulators are certainly a component of exchanges in regulated markets, they can vary greatly by jurisdiction and asset type. In unregulated markets, there are fewer of these regulatory controls, which allows for innovation in exchange technology, yet can also open up the exchange operator and customers to increased risk if not managed properly with the right technology.

Exchanges are complicated. EP3™ makes it easy.

Connamara’s future-ready exchange platform​, EP3, brings order to the chaos of the exchange ecosystem, providing a streamlined and efficient way for businesses and organizations to host their own exchange. From order matching technology, pre-trade risk checks, alternative market mechanisms, market surveillance, operational monitoring, and an easy-to-use exchange administration interface, we’ve combined all the necessary functionality into a configurable deployment tailored to your organization’s needs.

The use case described in this post is for a traditional exchange ecosystem. We are seeing exchanges being started in non-regulated spaces that combine all three functions in the exchange ecosystem. EP3 is equally suited for the non-traditional, non-regulated use case, and allows those exchanges to scale as their market evolves.

Looking to launch a new exchange or upgrade your existing exchange? Contact us to see how you can leverage EP3.

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