Tips & Tricks Part 4: A Simple Guide to Understanding How a Trade Matching Engine Works | From Beginner to Expert

In this article, I am going to talk about a certain software component that isn’t typically mentioned in the crypto space — a trade matching engine. I’d want to cover this topic in my tips & tricks blogs since I think anyone who wants to be involved in this field needs to realize how crucial trade matching engines are to modern financial markets.

Simply put, a trade matching engine is a computer program that matches buy and sell orders for financial instruments on a trading exchange. The engine uses complex algorithms to match orders based on price and time priority, ensuring that the best price is obtained for each trade. When a buyer and seller agree on a price, the engine executes the trade, updating the exchange’s order book and the traders’ account balances.

I could go through and list all the advantages of trade matching engines, including increased scalability, fair pricing, decreased risk of fraud, improved transparency, efficient trade execution, and so on. However, as part of this series of blogs on tips and tricks, I’ll emphasize general guidance for using trade matching engines.

Understand the matching algorithm

Each trade matching engine uses a specific algorithm to match orders, so it’s important to understand how the algorithm works and how it affects the execution of trades.

An example of a matching algorithm used in a crypto trade matching engine is called First In First Out (FIFO). The oldest counterorder that matches the best price will receive priority. Of course, the order’s position is lost if any changes occur to it. Another example is the pro-rata algorithm. This algorithm is commonly used in decentralized exchanges. In a pro-rata algorithm, when a new buy or sell order is placed, the algorithm first checks for any existing orders that can be fully or partially matched with the new order.

Be aware of latency

Latency is the time it takes for a trade matching engine to process an order. What does it mean then? It only implies that high latency can cause delays in the execution of trades and can affect the outcome of trades. It’s important to use a trade matching engine with low latency to minimize delays.

For example, consider a scenario where a large number of buy and sell orders are placed simultaneously on a trade matching engine. If the engine has high latency, it may take longer to match and execute these orders, which could result in some traders missing out on profitable opportunities. Additionally, if the latency is too high, it could lead to a backlog of orders, causing delays and potential errors in the trade execution process.

Furthermore, latency can also lead to market inefficiencies if some traders are able to access the market faster than others. This can create an unfair advantage for certain traders who are able to take advantage of market conditions before others, which can lead to market manipulation and harm the integrity of the market.

Monitor the order book

The order book contains a list of all outstanding buy and sells orders and their prices. Monitoring the order book can help you understand the supply and demand for security and make more informed trading decisions

For example, if there is a large imbalance between buy and sell orders, it could indicate that there is a problem with the trade matching algorithm or that there is a problem with the communication between the trading platform and the exchange. Additionally, monitoring the order book can also help detect and prevent potential fraud or manipulation of the market.

Therefore, monitoring the order book is important for maintaining the integrity and stability of the trade matching engine and the market as a whole.

Hardly a Conclusion…

This isn’t much of a conclusion because I think the information presented on this blog is not yet strong enough to arrive at a definite conclusion. I still have a lot to share with you guys, and I just think that what I have already shared is not yet conclusive. Well, if you’ve been reading the series of blogs on tips and tricks, you could have already expected it lol. Anyway, If you feel you’ve found something useful here, do share it with your peers, and feel free to support me 🙂