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What are Atomic Swaps?

Atomic swaps, an innovation considered competent enough to transform modern-day trading systems, take cryptocurrency or token trading to a new level by eliminating the need for trade fees while conducting a transaction that is safe and secure. A smart contract technology powered by cryptography, atomic swap helps in conducting trade while ensuring that no party involved in the trade cheats or defaults.

Atomic swaps eliminate the need for a third-party firm or escrow mediating the trade, hence saving the fees that are usually charged per trade. Atomic swaps are highly noted for the blow they have brought about for centralized exchanges. They are also known as cross-chain atomic swaps for facilitating trading between different cryptocurrencies.

In more precise terms, atomic swaps allow one cryptocurrency to be traded for another, for example, some bitcoins in exchange for lite coins. This can be carried out in a safe and secure manner without the mediation of any third parties. Atomic swaps make use of Hash Time Lock Contracts (HTLC) to protect the transactions occurring through it.

Hash Time Lock Contracts

Hash time lock contract, the prime attribute of atomic swap is the one that imparts authenticity and integrity to the application. The well-constructed algorithm ensures that both the parties involved in the transaction hold their end of the bargain with integrity. The contract works on the basis of a multi-signature transaction system where both the parties involved in the transaction are accountable for the successful closure of the swap process.

HTLC makes use of a cryptographic algorithm to ensure that the transfer or swap of cryptocurrency actually occurs only after both the parties involved have signed off. The time lock feature acts as an insurance policy, ensuring that the funds are returned to the respective parties in the event that the transaction is not completed within the specified timeframe.

The working of Atomic Swaps

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Take in the scenario where A has 1 BTC but is in need of 50 LTC, while another person B has 50 LTC but is in need of 1 BTC. They arrange for a trade using atomic swaps. To initiate the transaction they open up payment channels for the transfer of funds to each other. Now, one of them should act as the instigator of the transaction and create a contract address.

Let’s say, A is in urgent need of the LTC and hence acts as the instigator and opens a contract address. Now, this contract address functions like a safe for the tokens to be transacted. While making the address, A also deposits his BTC in them, along with a value or secret string that basically acts like a key. Now the cryptographic hash acts like the lock to the safe (contract address) and the secret value acts as the key.

The facilitation of the transaction begins when A sends the hash to B. After B receives the hash, he creates a contract address with it which is similar to the one created by A. While doing this, B deposits his part of the transaction, which is the LTC, in the safe. The key of both the contract addresses created by A and B are the same. So, for A to retrieve the LTC A has to sign the transaction towards B’s contract address and vice versa. 

The signing of the transaction takes place when A signs B’s contract address with the key that was used to produce. When this is done, A can retrieve his funds and the key gets revealed to B, who can also do the same. This completes the transaction. The insurance policy included Atomic Swap’s HTLC, holds the transaction for some time to ensure integrity. Also, if the procedures of the transaction are not completed within a stipulated timeframe, the transaction gets automatically aborted and the funds are released back to the owner.

Types of Atomic Swaps

Atomic Swaps can be classified into two types depending on where the procedure takes place. They are as follows: –

On-chain atomic swaps – Here the swapping process and transaction are executed on the blockchains of the respective crypto currency used. As of now, this type of atomic swap is only possible if both of the currencies makes use of the same hashing algorithm. They should also support and be compatible with HTLC.

Off-chain atomic swaps – Off-chain atomic swaps occur off the blockchain, at secondary layers or nodes. At present these swaps are considered as an extension of Bitcoin Lightning Network.

The significance of Atomic Swaps

It is indisputable that the arrival of cryptocurrency, blockchain technology, and so on have created quite a ripple in our financial market. However, they have not been able to percolate the market to the best of their capability. Centralized exchanges and trading are predominant than their decentralized counterparts, despite the security and other prime features they offer. Why?

One of the main reasons is the fear of getting cheated. Decentralized exchanges and cryptocurrency trading are notorious for their lack of regulatory norms and laws that govern them, unlike centralized ones. Naturally, people feel reluctant to initiate the transaction in such a risky environment.

Atomic swaps aim to eliminate this concern of the traders. It creates a better environment for trading that is free of risks, hacking attacks or fund misallocation. They also help in streamlining transactions according to the convenience of the parties involved in the transaction. Atomic swaps are also built with the capability of wallet integration which enables trading directly from web wallets, software, mobiles, and so on.

If the recent responses are anything to go by, atomic swaps are expected to change the way an average trader goes about his business! It could bring about a high dose of efficiency, security and speed to decentralized exchanges. Off-chain atomic swaps with proper tweaks towards the right direction could help make trading exchanges automatic and not dependent on the blockchain processing times.

Further reading

Want to know more about atomic swaps? Here’s a list of some extra reading material that might interest you.

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Last modified on August 3rd, 2023 at 3:46 pm