Atomic Swaps: Revolutionizing Cross-Chain Crypto Trading
Decentralized exchanges and trustless cross-chain trading are innovative technologies representing the future of cryptocurrency. They’ve solved many problems that early crypto users faced when using centralized exchanges, such as their susceptibility to hacks and the risk of funds being stolen.
Many users consider decentralized exchanges as the future of cryptocurrency trading. However, they can be difficult and slow to use. As such, it’s hardly surprising that there are multiple articles online comparing “atomic swap Vs decentralized exchanges (DEXs)”.
Atomic swaps facilitate trustless trades between two blockchains. Simply put, these transactions don’t rely on any third party to proceed. They have the potential to change the way cryptocurrency is traded, and we could see the transition from decentralized exchanges happening soon. In this article, we will explore the definition of atomic swaps, how they function, their benefits, limitations, and their future potential.
What Are Atomic Swaps and How Do They Work?
Atomic swaps are slowly becoming the rave in the DeFi world. But how did they come about, and how do they work in real time? This section will provide comprehensive answers.
Early Developments in Atomic Swaps
So, what are atomic swaps? They are a new technology that changes how we interact with digital assets across different blockchains. They impact the gaming industry, hardware wallets, and decentralized exchanges. How? By promising a new level of financial privacy in the restrictive cryptocurrency world.
An atomic swap allows the trustless trading of digital assets with different privacies under distinct governing models and diverse rules. Before the development of atomic swaps, trusted intermediaries were necessary for the exchange of assets between differing chains. Trades that didn’t occur on the same chain introduced the risk of fraud along with transfer and exchange fees. However, involving third-party intermediaries add a layer of complexity and cost to the process. This scenario creates a burden that blockchain technology should naturally address.
With atomic swaps, transactions are instant and do not rely on a trusted intermediary. Typically, they also don’t feature fees. If they do, these charges are minimal. As such, atomic swaps between blockchain assets are the cheapest and fastest way to trade digital assets worldwide.
The Mechanics of Atomic Swaps
We’ve answered the “How do atomic swaps work?” question. Now, let’s take a peek at its mechanics. At the most basic level, the method enables peer-to-peer trading for cryptocurrencies through the creation of a smart contract. This smart contract provides the framework for the currency exchange to occur. Swaps happen automatically without the need for an exchange or escrow service.
In an atomic swap, two parties agree to buy and sell a specific cryptocurrency and get it done. That’s what makes it atomic since it happens simultaneously. On a blockchain, such a transaction goes through completely or not at all. This type of trade can’t be partially or entirely blocked, like the norm in traditional exchanges. Once the atomic swap is activated, there’s no backing out.
Hashed Timelock Contract (HTLC)
A hashed timelock contract (HTLC) is an agreement that locks funds, so a payment can only be made if the recipient acknowledges receipt before a deadline. It involves a hashlock and a timelock, forming a cryptocurrency smart contract. The hashlock requires a cryptographic key to verify the document’s hash, while the timelock sets a deadline for the transaction.
Anyone can use the key to verify the document’s hash. However, to unlock the document, both parties must know and share a secret within a defined period. This secret is stored on the blockchain and must be shared between the involved application software.
Here’s an example of how to do an atomic swap:
You (Party A) create and share a secret (S) and its cryptographic hash (H) with Party B.
Then, Party B creates a simple contract that locks funds to Party A via H over a defined time period.
Both parties wait until Party B’s contract becomes final. In this timeline, they can size the value of each other’s funds to remove any counterparty risk.
Afterwards, you send the secret to Party B, unlocking the contract.
Finally, Party B then sends the secret to you.
You can actualize the above example on wallets with atomic swap functionality. However, you must get a hold of the best practices for atomic swaps before executing related transactions.
Understanding Atomic Swaps as a Reliable P2P Solution
Cryptocurrency developers have been working to free the movement of value spread across various digital wallets. Atomic swaps are the latest development to solve this issue. This is the third major cross-chain exchange method.
Nowadays, most cross trades, swaps, and transfers of coins for different values require the use of middlemen. These intermediaries, however, come with additional costs such as fees, time, risks, and regulation challenges. Also, traders must trust the other party to release the assets as agreed.
Some decentralized exchanges have established market smart contracts requiring holders to deposit assets into the exchange to be part of the market. However, not all arbitrary traders undergo comprehensive security reviews. There have been several instances of smart contract flaws causing significant issues for exchanges. In decentralized trades, the counterparty risk is carried by the transaction participants themselves.
Benefits of Atomic Swaps
Here are some of the major benefits of atomic swaps:
- Direct spending: With atomic swaps, there’s no need for multiple exchange interactions. The person owning two types of coins can potentially spend the one they possess the most. The best part? They’ll be able to do so without worrying about conversion.
- Security: Once on-chain transactions are confirmed, It’s difficult for an attacker to track and modify an atomic swap. This lowers the risk of phishing and potential loss of coins.
- Lower transaction fees: So, how will atomic swaps affect cryptocurrency exchange fees? Atomic swaps shield users from high transaction fees. Unlike centralized exchanges, where you’ll encounter deposit and withdrawal charges, atomic swaps don’t need intermediaries. Therefore, fees are low or non-existent.
Limitations of Atomic Swaps
Each variant of the atomic swap protocol has unique conditions that must be met for the swap to successfully execute. Many cryptocurrency developers and blockchain engineers are identifying drawbacks to these conditions. Let’s quickly go through the major limitations of atomic swaps.
One of the main issues is compatibility as both cryptocurrencies involved must support the same scripting language and hash functions to be compatible with HTLCs. Additionally, the process itself can be complex, requiring a good understanding of smart contracts. This new technology is still developing so it’s not widely adopted. That means that there is not a great variety of tools and platforms yet that support atomic swaps.
Apart from their complexity, there’s also the risk that one of the parties involved in the swap may not fulfil the necessary requirements. Remember, atomic swaps are sensitive to time so if the transaction is not complete within the defined period, it’s automatically cancelled.
These fundamental weaknesses extend to payment channels, as multiple parties share OmniWallet transaction methods. Payers in this situation must reveal their private signing key of the channel that initiated the atomic swap. They also need to disclose this channel to the payee if they’d like to close it.
Future of Atomic Swaps
What’s the future of atomic swaps in DeFi (Decentralized Finance)? We expect them to be integrated into crypto wallets and have impacts on cross-chain transactions. Let’s examine how:
Integration with Crypto Wallets
One way for atomic swaps to integrate with crypto wallets is to make them accessible and easy to use. But how? One possibility is relying on decentralized exchanges to provide solutions by accumulating liquidity and solving the liquidity challenge with their own accounts. This route would see them performing the swap behind the scenes for an end user within their exchange.
Alternatively, atomic swaps might require a wallet with built-in support for trading pairs with multiple supported blockchains. These wallets would require funds in a specific script to execute the swaps. This way, the wallet provider can preallocate accounts.
Impact on Cross-Chain Transactions
One of the most significant impacts of atomic swaps is the potential to revolutionize cross-chain transactions. In traditional financial systems, an intermediary like a bank or government ensures a transaction is valid and prevents double-spend attacks. Without this assurance, a user could spend money twice by broadcasting a transaction to both the sender’s and receiver’s blockchain.
By using the HTLCs feature in both blockchains, atomic swaps allow two parties to reach an agreement and execute the trade atomically. As such, both participants must follow through with the trade; otherwise, the trade is cancelled.
Conclusion
Cross-chain atomic swaps use a combination of time-locked transactions and hash-time-locked contracts. As such, involved parties adhere to the original terms. If a party violates the terms, the transaction will fail, and both parties will reclaim their assets. Atomic swap technology is growing in popularity, and you’ll find several platforms that support atomic swaps now. It’s only a matter of time before they become the most-used route to exchangeing cryptos without an intermediary.
FAQs
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