What Are Atomic Swaps?

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  • March 05, 2021
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A revolutionary solution to centralized exchange woes

The introduction of Bitcoin as the first cryptocurrency in 2009 into the public consciousness generated a paradigm shift in the conduct of finance. The subsequent flooding of altcoins in the global financial market marked the need for cryptocurrency exchanges, both centralized and decentralized, in facilitating the conduct of trade between digital values.

 As being a nascent asset class, it is not without hitches and glitches with cryptocurrencies and exchanges encountering rough sailing along their maiden course:

  1. Centralized exchanges were vulnerable to malicious attacks as digital assets are pooled in a single place.
  2. Centralized exchanges are run by people who are liable to commit mistakes and bad intentions leaving user funds at their mercy.
  3. Centralized exchanges encounter scalability problems from time to time. Even top exchanges can experience crashes when there are spikes in trading volumes.
  4. Many exchanges are still unregulated, that is, not subject to rules provided by the government or financial authorities. Still, other users shy away from regulated ones.
  5. Exchanges have different rates in the trading and storing of crypto funds.

Given the problems stated above, a creative invention came into being – atomic swap – a method employed by decentralized exchanges that did away with centralized platforms, and instead, makes use of a wallet-to-wallet crypto swap using smart contracts.

Brief History

In July of 2012, Sergio Lerner first drafted a trustless exchange protocol. Later that same year, Daniel Larimer came up with P2PTradeX, another trustless protocol that was considered to be a prototype of an atomic swap. In May 2013, Tier Nolan released a full atomic swap procedure, thus earning the credit as the inventor of atomic swaps.

The first successful atomic swap happened between Decred and Litecoin (CDR/LTC) in September of 2017. By November, it was Bitcoin and Litecoin’s turn to engage in another successful swap (BTC/LTC) that led other developers to dabble in atomic swaps.

How It Works

Atomic swaps employ a specialized smart contract called HTLC, or hash timelock contract. It is a virtual lockbox that needs two keys: a HashLock Key that only allows the traded cryptocurrency to be distributed once contracting parties have signed off their respective atomic transactions. The other is called a TimeLock Key, where a traded cryptocurrency is safely returned to traders if ever the trade is not completed within a specified duration of time. These safety mechanisms prevent traders from cheating on each other.

To engage in an atomic swap, the first trader creates an HTCL address and then deposits a tradeable cryptocurrency. A secret passcode is then created for the said cryptocurrency called a preimage. The preimage is then locked by being hashed. The second trader receives the preimage who then verifies that the capital for the tradeable cryptocurrency has already been deposited, created with the same hash. The first trader then unlocks the capital of the second trader. The second trader also unlocks the tradeable currency deposited by the first trader. The atomic swap is successful.

Advantages

Its decentralized character renders as the biggest advantage of atomic swaps. A wallet-to-wallet cross-chain trading can happen even without the mediation of a centralized exchange. Privacy and security is guaranteed as one does not have to leave his wallet to cause a trade by entrusting funds to an exchange. Atomic swaps happen quickly owing to their interoperability and is charged free or at a very low fee as there is no mediating coin to facilitate a trade.

Conclusion

“Atomic” is the term for crypto exchange engagement that is not fragmented but must happen completely, or not at all. “Swap” is the process of a fast transaction and exchange of two different kinds of cryptocurrencies. Atomic swaps are peer-to-peer trading using a special smart contract called HTLC to make possible the trading between parties using their crypto wallets. It allows the trading between two different blockchains without needing a centralized exchange.

Atomic swaps are a revolutionary solution to the problems experienced by centralized exchanges. Digital value transfers using atomic swaps are predicted to influence the growth of the crypto industry as DEXs, or decentralized exchanges, are expected to maximize the use of atomic swaps to the hilt.

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