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How Atomic Swaps Make Cross-Chain Trading Possible
March 27, 2024

How Atomic Swaps Make Cross-Chain Trading Possible

Atomic swaps were first introduced in 2017 by Charlie Lee, a famous founder of Litecoin, one of the most popular cryptocurrencies. However, back in 2012, it was Sergio Demián Lerner, who was the first to produce a trustless exchange protocol. Tier Nolan developed his ideas the following year. Nolan is acknowledged as the pioneer in atomic swap development due to his comprehensive study and detailed procedure description.

It was not until 2017 that Charlie Lee’s historic tweet informed the world about the first successful atomic swap. He implemented a cross-chain swap involving the LTC/BTC pair, which was the moment of a Litecoin to Bitcoin exchange. As of 2024, many more options are available, like Bitcoin to Monero atomic swaps, or vice versa.

Ever since that moment, plenty of DEXs and swaps have been fine-tuning this technology to create new crypto trading solutions. Among popular DEXs and networks supporting atomic swap trading are Uniswap, PancakeSwap, AtomicDEX, and Liquality.

Atomic swaps are a reliable P2P tool that enables greater interoperability across blockchains. Atomic swaps put in place crypto transactions without a third trusted peer-to-peer party. Such a solution simplifies crypto transactions greatly.

What are atomic swaps and how do they work?

Technically, atomic swaps enable P2P exchanges of cryptocurrencies across different blockchain networks. This works only if each party deposits a prearranged token amount to the exchange contract. In this case, two users can swap digital tokens without relying on a third party to implement the transaction. Taking a third party out of the equation reduces counterparty risks.

‘Atomic Swaps’ comes from the ‘Atomicity’ software term. It refers to database transactions that can only be executed in full or not at all, so it is a YES/NO approach based on formal logic. Accordingly, atomic swaps either receive the necessary token deposits from each user and perform the swap or return all deposited tokens to their initial owner. The YES/NO approach is proof of safety. Any fraud or third-party involvement during the transaction leads to its complete cancellation.

Atomic swaps use a hash timelock contract (HTLC), a specific smart contract that acts as a ‘virtual vault’. It keeps users’ assets safe at all times. The HTLC only executes when the correct amount of tokens has been deposited into the contract. To unlock them, each individual must verify receipt of tokens within a specified interval.

Hashed Timelock Contract (HTLC)

An HTLC is a time-bound smart contract. It uses a private key and cryptographic hash to control access to assets. Each party must meet all of the swap agreements for it to be executed. Otherwise, tokens return to their owner.

An HTLC has two main security features:

  1. Hashlock key. Both parties must provide cryptographic proof verifying that they have met their side of the swap contract.
  2. Timelock key. The deposited assets are returned to their original owner if the proofs are not submitted within a pre-agreed time limit.

Understanding Atomic Swaps as a Reliable P2P Solution

Let’s now learn how it works in practice, using an example of an atomic swap transaction.

Step 1: Jane agrees to swap X tokens with Bill for Y tokens. Then, they create an HTLC that expires in one hour.

Step 2: Jane creates a contract address and deposits her X tokens. This action generates a private key, which only Jane has access to. Then, Jane creates a cryptographic hash of her private key and sends it to Bill.

Step 3: Bill uses the hash to confirm that Jane has deposited her X tokens to the contract address. At the moment, Bill cannot access the assets because he only has the hash, not the actual private key.

Step 4: Bill uses the hash to generate a new contract address where he deposits his Y tokens. Now, Jane and Bill have deposited their crypto assets into the contract.

Step 5: As Bill has created the address using the hash of Jane’s private key, she can claim his Y tokens. She does this and, in the meantime, reveals the private key to him. If Bill does not complete the transaction before the timelock expires, the tokens claimed by Jane will return to Bill.

Step 6: Now, Bill uses the private key to withdraw Jane’s X tokens and complete the transaction.

The swap was finalized within one hour, so the contract cannot be reversed, and Jane has successfully swapped her X tokens with Bill for his Y tokens.

Benefits of Atomic Swaps

Atomic swaps offer traders various advantages that are unavailable from other solutions.

  • Enhanced security. The atomic swaps crypto option removes the need to entrust assets to a CEX third party to implement the transaction. The hashlock and timelock keys in the self-executing smart contracts provide users with higher security. Traders maintain complete control over their funds at every stage of an atomic swap.
  • Deeper liquidity. Making funds tradeable across different blockchains makes those assets more liquid.
  • Direct asset-to-asset swaps. Individuals can buy crypto assets directly from each other. Users don’t need to swap to a highly liquid stablecoin to make multiple transactions. They can buy or sell any token in a fully decentralized environment. Plus, many CEXs do not allow traders to swap all altcoins. Atomic swaps eliminate this problem by allowing practically all altcoins to be traded.
  • 100% guaranteed outcome. Users enjoy guarantees that their transaction will be executed as intended or that they will receive their funds back in case of a delay or fraud.
  • Lower costs. P2P swaps usually incur lower fees compared to relying on a third-party actor.

Limitations of Atomic Swaps

Yet, atomic swaps, a progressive crypto exchange tool across different blockchains, still have disadvantages.

  • Complexities with trade swap. Atomic swaps require the exchange of data, information, and cryptographic hash. All these details and the know-how can be challenging for beginner crypto traders. Such technological complexity may lead to higher blockchain wait times, resulting in slower adoption rates.
  • Absence of fiat-crypto exchange option. This can be challenging for traders who wish to trade cryptocurrency for fiat currency or vice versa. Fiat-to-crypto and crypto-to-fiat exchanges are not possible within the atomic swap DEX model.
  • Compatibility. Currently, executing atomic swaps across all existing blockchain networks is not possible. For atomic swaps to work, each blockchain must use the same hashing algorithm.

Future of Atomic Swaps

Atomic swaps, as a P2P crypto exchange instrument, definitely have a bright future. They offer a seamless and safe cryptocurrency exchange option across different blockchains without the need for a third party and with lower fees compared to other solutions.

Moreover, one of the primary purposes of atomic swaps is to remove the necessity for fiat currencies in cryptocurrency exchange. Thanks to atomic swaps, converting Bitcoin to Ethereum doesn’t require an intermediary conversion to a fiat currency; such a solution lowers exchange fees and saves time.

There are some obstacles, too, in this field. Currently, only a few trading platforms support such types of P2P swaps. It also requires specific programming skills and hash knowledge to utilize atomic swaps.

Nevertheless, as time goes by, crypto wallets will likely integrate the atomic swap technology into their software in the future. In this case, most barriers to atomic swaps’ faster development across crypto traders can be removed.

Conclusion

Atomic swaps have become a vital part of a cross-chain cryptocurrency exchange. They have dramatically improved blockchain interoperability and reduced risks while providing buyers and sellers greater flexibility at a lower cost.

Such a P2P option looks very promising for the crypto community worldwide. It would rapidly change the previously challenging cross-chain landscape.

FAQ

  • What are atomic swaps?

    Atomic swaps are automated, self-enforcing cross-chain cryptocurrency exchanges based on specific contracts. They allow cryptocurrencies to be traded P2P without needing a third party.

  • Are atomic swaps safe?

    Yes, they are safe; and based on the YES/NO approach. The engagement of specific smart contracts based on hashlock and timelock keys provides a secure and smooth procedure. It guarantees the safety of funds for both sides. Atomic swaps can be fully performed or cancelled in case of any fraud or time delay.

  • Do I need to use fiat currency when exchanging Bitcoin for Ethereum, enabling an atomic swap option?

    Not at all. Atomic swaps remove the need for fiat currencies in cryptocurrency exchange. Converting Bitcoin to Ethereum, for instance, doesn’t require using a fiat currency as a bridging instrument.

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