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In its simplest sense, an Atomic Swap is a mechanism that uses smart contract technology to enable the exchange of one cryptocurrency for another without using centralized intermediaries, such as exchanges.
Atomic swaps are a technique that allows the quick exchange of two different cryptocurrencies running on distinct blockchain networks. Such a process (also known as atomic cross-chain trading) is based on smart contracts. It allows users to trade their coins directly from their crypto wallets.
Before discussing an Atomic Swap, let us first look at the need for the technology.
Why Do We Need Such a Mechanism?
The most significant advantage of Atomic Swaps is their decentralized nature. By removing the need for a centralized exchange, or any other kind of mediator, cross-chain swaps can be executed by two or more parties without requiring them to trust each other. There is also an increased security level because users don’t need to give their funds to a centralized exchange or third party. Instead, the trades can happen directly from users’ wallets.
Not all cryptocurrency exchanges support all coins. As such, a trader wishing to exchange his coin for another one not supported on the current exchange may need to migrate accounts or make several conversions between intermediate coins to accomplish their goal. Today, most centralized exchanges force traders to transfer cryptocurrencies via a wallet that is being controlled and hosted by a centralized exchange.
Atomic swaps can occur between blockchains of different cryptocurrencies or be conducted off-chain, away from the main blockchain. They first became prominent in September 2017, when an atomic swap between Decred and Litecoin was completed.
How Does an Atomic Swap Work?
Atomic swaps use a specific type of smart contract called a hash time-lock contract (HTLC). This can be thought of just like a “virtual lockbox,” which requires two special keys:
- A HashLock key: Only distributes traded cryptocurrency to traders when all parties have signed off on their respective transactions.
- A TimeLock key: A safety mechanism that returns traded cryptocurrency to traders if the trade is not completed within a specified period.
Atomic swaps require both parties to acknowledge receipt of funds within a specified time frame using a cryptographic hash function. If one of the involved parties fails to confirm the transaction within the time frame, the entire transaction is voided, and funds are not exchanged. The latter action helps remove counter-party risk.
Suppose Alice is a trader interested in converting 1 Bitcoin to an equivalent Litecoin with Bob. She submits her transaction to bitcoin’s blockchain. During this process, Alice generates a number for a cryptographic hash function to encrypt the transaction. Bob repeats the same process at his end by similarly submitting his transaction to Litecoin’s blockchain.
Both Alice and Bob unlock their respective funds using their numbers. They have to do this within a specified timeframe, or the transfer will not occur. Atomic swaps can also be used with a lightning network to conduct off-chain exchanges.
The Biggest Swap Platforms
Next, we will present some of the blockchain industry’s biggest names that have integrated some form of Atomic Swap mechanism into their platforms.
In December, Komodo, a blockchain network, shared with the world that it has successfully released the AtomicDEX platform. AtomicDEX is a decentralized exchange built on the Atomic Swap mechanism. The platform allows for non-custodial cryptocurrency trading through atomic swaps. The company has expanded its AtomicDEX mobile decentralized exchange (DEX) to work in web browsers on all major platforms. The official website said, “Atomic swap trading is magnitudes more secure than trading crypto on a centralized exchange, as users never need to give up control over their assets,” thus establishing their support for the technology.
Lightning Labs, the team behind Lightning Network, believes that “the closest solution in protecting privacy while acquiring and trading assets.” Since the first Atomic transaction in 2017, the Lightning team has followed the technology closely. Eventually, the network integrated the Atomic Swap mechanism into its platform, thus moving closer to making Bitcoin scalable and robust.
Atomic Swaps form a peer-to-peer exchange of cryptocurrencies from one party to another without a third-party service like a crypto exchange. During this process, the users have complete control and ownership of their private keys.
One of the most significant drawbacks of Atomic Swaps is their limited liquidity. A Swap can be conducted only if another person is willing to get into the contract. Without two or more parties, a swap cannot be initiated. Decentralized platforms built on Atomic Swap Technology, such as Komodo, dY/dX, etc., are just some platforms that have successfully solved the liquidity problem.
Although atomic swaps are still new and limitations certainly exist, this technology drives significant changes regarding blockchain interoperability and cross-chain trading capabilities. As such, the technique has great potential to influence the cryptocurrency industry’s growth, opening up new avenues in decentralization and peer-to-peer monetary transfers. However, atomic swap trades are limited by liquidity. It can be challenging for traders to communicate and exchange cryptocurrencies without an exchange platform.