Introduction to transaction matching engine

Summary

• A matching engine is a complex software system designed to match buyers and sellers in financial markets.

• Modern matching engine matches and executes trades fairly and quickly, creating a better, more responsive trading environment.

• The matching engine can use different types of algorithms, which define the order sorting and execution methods of the matching engine. Common algorithms used by matching engines include first-in-first-out (FIFO), Pro-Rata and time-weighted average price (TWAP) algorithms.

Are you curious how magically a buy or sell order is filled on a stock exchange or cryptocurrency trading platform? The secret behind this is what is called a matching engine.

What is a matching engine?

At its core, a matching engine is a complex software system designed to match buyers and sellers in financial markets. We can think of it as a matchmaker in the trading world, matching people who want to buy or sell. The main task of the matching engine is to execute transactions quickly and efficiently to create a level playing field for market participants.

Comparison between matching engine and traditional methods

In the past, trading and order matching mainly relied on phone calls and manual operations. Such systems are significantly more time-consuming and more prone to human error than the complex matching engine systems we use today. In contrast, modern matching engines match and execute trades fairly and quickly.

How does the matching engine work?

Imagine traders shouting bid and ask prices in a busy market. In the digital realm, this chaos has been replaced by calm order books. Traders enter their buying or selling intentions and record them in the order book. At this time, the matching engine will step in, first analyze the situation, and then match compatible orders.

The matching algorithm is the brain that supports the operation of the matching engine. They follow predefined rules and determine the priority of orders. One of the most common rules is the so-called "first in, first out" (FIFO) rule. The rule is similar to waiting in line at the grocery store, where first-come orders are given priority. Another type of rule is "Pro-Rata", which tends to prioritize large orders, ensuring that large orders enjoy a proportionately greater share of the available liquidity.

Order Matching Algorithm

The order matching algorithm defines the functionality of the matching engine. Several examples of order matching algorithms are as follows:

1. First-in, first-out (FIFO) algorithm

FIFO, also known as "first come, first served" (FCFS), is a classic algorithm that prioritizes orders based on their price and creation time. When multiple orders have the same price, the system will give priority to matching orders that arrive first to ensure fairness in order execution.

2.Pro-Rata Algorithm

The Pro-Rata algorithm is different from the FIFO algorithm in that it prioritizes large orders. This means that if two pending orders are created at the same time and at the same price, the system will prioritize the execution of the order with the larger trade size.

3. Time Weighted Average Price (TWAP) Algorithm

The TWAP-based algorithm calculates the average price of all orders within a period of time and gradually executes multiple transactions to reach the average price. The TWAP algorithm can split large orders into smaller orders with the same average price as the initial order, thereby reducing the impact of large orders.

Matching engine type

1. Centralized matching engine

The centralized matching engine can achieve real-time matching with extremely fast speed and efficiency. They run on a single centralized server and process orders quickly, making them ideal for high-traffic trading platforms that focus on fast matching.

2. Decentralized matching engine

The decentralized matching engine operates based on a peer-to-peer network and has the resilience to resist various attacks. While such engines provide a more secure trading environment, they may sacrifice some speed and efficiency compared to centralized matching engines. Since decentralized matching engines do not use centralized servers, they minimize the risk of leaks and are a safer alternative.

Choose the right matching engine

Speed ​​

For platforms with larger trading volumes, centralized engines excel at matching orders quickly. In comparison, decentralized engines that rely on peer-to-peer networks can be relatively slow to match.

Securities

Centralized engines rely on centralized servers and are therefore vulnerable to attacks, while decentralized engines run on distributed networks and are more resilient to various potential attacks.

Fees

Centralized engines typically charge more due to higher infrastructure and resource requirements. In contrast, decentralized engines run on peer-to-peer networks and typically have lower fees.

Why matching engine is important

In the busy trading field, success or failure can be determined in milliseconds, so matching engine plays a decisive role. The functions of the matching engine are as follows:

1. Efficient execution of orders

An excellent matching engine can quickly execute orders. The ability to process orders quickly is critical, especially in a trading environment where every second counts.

2. Maintain fairness and transparency

The matching engine determines the order of order processing through a predefined algorithm to maintain transaction fairness and improve the transparency of transaction execution. Traders can rest assured that their orders will be processed fairly and in accordance with established rules.

3. Provide market liquidity

The matching engine can smoothly match buyers and sellers, thereby improving market liquidity. With efficient order matching, this liquidity helps create a more responsive market environment.

Epilogue

Although matching engines are often overlooked, they are a testament to the precision and sophistication of modern trading platforms. The matching engine is the invisible force that ensures markets run smoothly, allowing traders to execute trades quickly, fairly and efficiently.

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