What is a Central Limit Order Book?

May 20, 2021 1 min read
What is a Central Limit Order Book?

A Central Limit Order Book (CLOB) is the basis for the earliest type of exchanges, specifically stock exchanges such as the NYSE. Today, this model is followed by a number of crypto exchanges such as Coinbase, Binance and Kraken. A CLOB is essentially a method for coordinating market activity. It helps liquidity providers and traders come together to discover and fulfil their orders. It functions as follows.

Market makers submit their intent to transact assets to the exchange, specifying basic information such as prices, quantities, and direction of their intent (buy or sell). The exchange collects all of these intents (orders) into a database (the order book). The exchange then organises and publishes the order book to all of its users. In order to complete a transaction, another party (a taker) must accept the prices and quantities available on the order book. The exchange operator matches the taker's acceptance (its market order) with the corresponding orders in the order book that fulfil the taker’s order at the currently available best prices.

A key element in this process is order matching. Most CLOB exchanges take an active approach and match orders whenever buyers' and sellers' orders overlap. When multiple orders are entered at the same price, CLOB exchanges implement algorithms to prioritise them, most commonly following a first in, first out (FIFO) policy.

While everything about a CLOB is characteristic of centralisation, there are also ways of running a decentralised CLOB, where the exchange operator has minimal influence. In this case, the exchange takes a hands-off approach from matching orders, and openly broadcasts submitted orders, leaving them open for any takers to fill.

Another way a CLOB can be decentralised is by foregoing asset custody. This means that the assets are always in control of the buyers and sellers, and never fall into any kind of holding by the exchanges. Transactions are then facilitated by smart contracts directly settling assets between market makers and takers.

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