What is atomic swap?
Atomic swap is a technique that enables the rapid conversion of two different cryptocurrencies running on different blockchain networks. Such a process (also known as cross-chain atomic trading) is based on smart contracts and allows users to buy and sell their coins directly from their personal crypto wallet. So, in essence, an atomic swap is a peer-to-peer trade carried out between different blockchains.
Although the idea of cross-chain trading is an innovative technique, it has been discussed for many years. Tier Nolan was probably the first to describe a full atomic swap protocol in 2013. However, a trustless exchange protocol, P2PTradeX, was proposed by Daniel Larimer in 2012, and some consider it the prototype of atomic swaps.
In the years that followed, many developers experimented with atomic swap protocols. Evidence shows that the Bitcoin, Litecoin, Komodo, and Decred communities all play an important role in the process.
Apparently, the first peer-to-peer atomic swaps started being made in 2014. But the technique only became generally known in 2017. The main reason for this is the successful swaps between LTC/BTC and DCR/LTC.
How do atomic swaps work?
Atomic swap protocols are designed to prevent participating parties from cheating. To understand how the protocols work, let's assume that Alice wants to exchange her Litecoins (LTC) for Bob's Bitcoins (BTC).
First, Alice deposits her LTCs to a contract address that acts as a vault. When this safe is created, Alice also creates a key to access it. Alice then shares a cryptographic hash of this key with Bob. Bob cannot yet access the LTCs because he only has the key hash, not the key itself.
Then, Bob creates another vault contract address using the hash given by Alice and deposits his BTCs to this address. To receive the BTCs, Alice must use the same key, and by doing so she makes the key visible to Bob (thanks to a special function called hashlock). This means that as soon as Alice accesses BTCs, Bob can also access LTCs, thus completing the swap.
The term 'atomic' means that these transactions either occur completely or do not occur at all. If one party backs out or does not do what they are supposed to do, the contract is canceled and the funds automatically return to their owners.
Atomic swaps can be made in two different ways: on-chain or off-chain. On-chain atomic swaps occur on the network of one of the two currencies (in this case, on the Bitcoin or Litecoin blockchain). Off-chain atomic swaps, on the other hand, occur at the second layer. Typically, these types of atomic swaps rely on two-way payment channels similar to those used on the Lightning Network.
From a technical perspective, most of these trustless trading systems are based on Hash Timelock Contracts (HTLC) and smart contracts that use multi-signatures.
Hash Time Locked Contracts (HTLC)
While Hash Time-Locked Contracts (HTLC) are important parts of the Bitcoin Lightning Network, they are also the key elements that enable atomic swaps. As the name suggests, they are based on two basic functions: a hash lock and a time lock.
The hash lock prevents funds from being spent unless a piece of data (Alice's key in the previous example) is shared. Time lock is the function that guarantees that the contract can only be implemented within a predetermined time interval. As a result, the use of HTLCs eliminates the need for trust because the set of rules they create prevents partial execution of atomic swaps.
Advantages
The most important advantages of atomic swaps are related to their decentralized nature. By eliminating the need for a central exchange or any other intermediary, cross-chain swaps can be made between two (or more) parties without the need for mutual trust. Since users do not entrust their funds to a central exchange or a third party, the level of security also increases. Instead of using a broker, trades are made directly from users' personal wallets.
Additionally, the operational expense of this form of peer-to-peer trading is much less because trading costs are either very low or non-existent. Finally, atomic swaps enable trades to occur very quickly, with a high level of interoperability. In other words, altcoins can be swapped directly without using Bitcoin or Ethereum as an intermediary coin.
Limitations
There are several conditions that must be met before atomic swaps can be implemented, and these conditions may hinder wider use of the technique. For example, to make an atomic swap, two cryptocurrencies must share the same hashing algorithm (e.g. SHA-256 for Bitcoin). They also need to be compatible with HTLC and other programmable features.
Apart from this, atomic swaps also raise concerns about user privacy. This is because on-chain swaps and transactions can be quickly tracked through the blockchain browser, making it easier to link addresses. The short-term solution to this problem is to use privacy-focused cryptocurrencies to be less visible. Still, many developers are exploring the use of digital signatures in atomic swaps to create a more reliable solution.
Why are Atomic Swaps important?
Atomic swaps have huge potential to improve the cryptocurrency world, but they still need to be tested on a larger scale. Cross-chain trading can solve many problems that exist in most centralized exchanges. Although these exchanges keep their cryptocurrency systems running to this day, some concerns still remain. Some of the current problems include:
Vulnerability to attacks: Keeping many valuable resources in one place makes them more vulnerable to hacking, and centralized exchanges are a prime target for digital attacks.
Mismanagement of funds and human error: centralized exchanges are run by humans. If key officials make mistakes or executives make poor choices regarding exchange operations, user funds can be seized.
Higher operational costs: withdrawal and trading costs are higher on centralized exchanges
Inefficiency for high volumes of demand: When market movements are very intense, centralized exchanges are often incapable of responding to increased trading demand, causing the system to slow down or go offline.
Regulatory regulation: in most countries, cryptocurrency regulations are far from ideal. There are still many concerns regarding approval and administration by governments.
latest ideas
Although atomic swaps are relatively new and have limitations, this technology is driving significant changes in blockchain interoperability and cross-chain trading capabilities. The technique holds enormous potential for the growth of the cryptocurrency industry, opening up new possibilities in terms of decentralization and peer-to-peer money transfer. It is very likely that atomic swaps will be used more and more in the near future, especially in decentralized exchanges.
