Atomic swaps eliminate middlemen and centralized authority, further decentralizing bitcoin exchanges.
Atomic swaps remove the need for a middleman (like a centralized exchange) and allow peer-to-peer (P2P) transactions between users of different cryptocurrencies on two different blockchains. Users can exchange digital assets through atomic swaps in accordance with self-executing smart contracts.
Centralized exchanges (CEXs) offer a trading experience similar to that of traditional stocks and fiat trading by managing trading pairs and order books, supplying asset liquidity, ensuring fair market pricing, and bringing buyers and sellers together on a platform. Because they have access to user private keys, they exercise centralized control and are custodial.
High trade volumes make CEXs popular, but they go against the decentralized nature of cryptocurrencies and blockchain. Decentralized exchanges (DEXs) aim to represent a noncustodial infrastructure in this context. Greater interoperability across different blockchain networks is made possible by atomic swaps. They allow for the trading of many decentralized blockchain cryptocurrencies, promoting the real decentralized finance (DeFi) ethos.
The significance of atomic swaps
Atomic swaps enable decentralized finance (DeFi) and eliminate the inefficiencies related to cryptocurrency exchange within centralized finance (CeFi).
By using a CEX like Coinbase or Binance and the processes below, one may swap Ether (ETH) on the Ethereum network and Bitcoin (BTC) on the Bitcoin network:
- Opening a user account on a centralized exchange that accepts the ETH/BTC trading pair. According to the CEX’s regulation, this can call for an application procedure and a KYC requirement.
- ETH transfer to the central exchange.
- Converting ETH to BTC may require paying transaction fees and occasionally waiting a lengthy time.
- Transferring the purchased Bitcoin to a Bitcoin wallet, which can come with extra costs.
- The final step is to wait patiently for the exchange to be processed for the money to finally arrive.
This typical CEX trade offers a number of processes, prohibitive prices, and several potential issues. Furthermore, CEXs may provide unforeseen security vulnerabilities relating to asset custody. The exchange keeps custody of the private keys and stores user monies in custodial wallets at CEXs. The user’s cryptocurrency may be vulnerable to risks in the event of a security breach, hack, or regulatory withdrawal freeze.
DeFi and DEXs enable atomic swaps, which eliminate the need for middlemen in trading, expedite the procedure, and drastically lower several possible security risk points for cryptocurrency users, in order to address these issues.
How are atomic swaps used?
Atomic swaps safeguard the exchange of digital assets using hashlock cryptographic methods and smart contracts.
There is just one possible outcome for processes that are described as “atomic”: they either end successfully or don’t start at all. For cryptocurrency trading, there are just two possible outcomes: either the deal is done successfully or nothing happens.
Simply said, an atomic swap establishes a process where both parties to a bitcoin transfer must meet all prerequisites before the deal can be closed. Smart contracts, which are self-executing programs created to enforce the criteria necessary for a transaction to be successful, are used to do this.
Atomic swaps enable safe and trustless cryptocurrency transfers by using hashed time lock contracts (HTLCs), a type of smart contract. HTCLs essentially “lock” a transaction and require both parties to confirm the data before the exchange can take place.
Atomic swap smart contracts need to include these two things:
Hashlock
With the help of the hashlock method, the contract may be secured using a special cryptographic key that can only be created by the person who deposited the bitcoin. This key, which is a special piece of data, makes sure that the exchange only goes through when both sides agree to it.
Timelock
The timelock technique functions as a swap deadline. It guarantees that the transaction will be finished in a specific length of time, and if it is not, it will reimburse the depositor’s money. with essence, Timelock aids with transaction security. The transaction cannot be completed unless both parties agree to the exchange within the allotted time frame, in which case the cryptocurrency will be returned to its respective owners.
The advantages and disadvantage of atomic swap
Atomic swaps increase the interoperability of blockchains, lessen risks, and provide traders more freedom for less money.
Benefits of atomic swaps include:
Fully decentralized nature
- Trades have the benefit of decentralization with atomic swaps. Peer-to-peer trading offers financial independence from CEX platforms or a centralized liquidity pool as well as control over one’s own money.
Enhanced security
- A higher degree of security is offered to traders by the hashlock and timelock methods in the self-executing smart contracts utilized by atomic swaps. In the case of delays or disputes, traders may be sure that their bitcoin will be refunded.
Interoperability and altcoin trade flexibility
- Atomic swaps allow users on various blockchains to exchange data. Many CEXs restrict traders from trading a wide variety of altcoins. This issue is resolved by atomic swaps, which enable the exchange of almost all types of alternative currencies.
Technology-wise, atomic swaps can be challenging, and slower adoption rates are a direct effect of longer blockchain wait times.
The following are some downsides of atomic swap:
Complexities with trade swap
- Atomic swaps need the exchange of hashed cryptographs, data, and information. For traders who are new, this may be intimidating.
Lack of fiat-crypto on-ramp
- It might be difficult for traders to liquidate to fiat because atomic swap DEXs do not provide fiat-to-crypto and crypto-to-fiat trades.
- Few platforms now enable atomic swaps. To use atomic swaps, one might also need to have a certain level of programming expertise and haveh understanding. But in the future, it’s conceivable that bitcoin wallets will include this technology into their programs.
Is it possible to trace atomic swaps?
User anonymity is protected through atomic swaps so that identities are not revealed.
Atomic swaps do not need KYC, unlike CEXs. Since atomic swaps are intended to be trustless and private, neither the transaction details nor the identity of the participants should be made publicly known.
The underlying blockchains for atomic swaps, like Bitcoin and Litecoin, are public ledgers where transactions are recorded and available to all, therefore it is crucial to keep that in mind. The individual transactions involved in the swap may still be traced on their separate blockchains even if the atomic swap transaction itself may be difficult to distinguish from other transactions on the blockchain.
Participants can employ other strategies like currency mixing or privacy-focused cryptocurrencies to further increase privacy. In order to make it more difficult to track down the cash, coin mixing involves merging many transactions to obfuscate the transaction history. Cryptocurrencies with a privacy focus, such as Monero (XMR) or Zcash (ZEC), provide built-in privacy features that may be combined with atomic swaps to increase anonymity.
Atomic swap vs. bridge
Atomic swaps make P2P trading possible, and cross-chain bridges connect blockchains so that assets may be transferred via tokenized representations.
Cross-chain bridges and atomic swaps both improve the interoperability of blockchains and are used to transfer cryptocurrency between multiple blockchains, although they operate in distinct ways. Bridges that span different blockchain networks are known as cross-chain bridges. They serve as brokers who make it easier for assets to move between various networks.
Cross-chain bridges demand that a token be burned or locked before it is made available on another blockchain. An equivalent quantity in a liquidity pool on the target chain is made accessible together with the creation of a wrapped token. Then, these wrapped tokens may be traded, transferred, or exchanged for the original assets on the source network.
Cross-chain bridges are seen as a cutting-edge, approachable solution to exchange coins on different blockchains and are growing in popularity due to their simplicity of use and appealing user interface.
Atomic swaps, often referred to as cross-chain atomic swaps, were first postulated in 2013 but just recently become a reality.
A developer named Sergio Demián Lerner created the first iteration of a trustless exchange protocol in July 2012. However, Tier Nolan, who is commonly regarded as the inventor of atomic swaps because to his in-depth explanation of the atomic swap process, presented a complete working paper in 2013.
When Charlie Lee, the creator of Litecoin, announced the momentous event of the completion of the first successful atomic exchange, the idea became real for the first time in 2017. He successfully carried out an LTC/BTC cross-chain atomic swap, trading Litecoin (LTC) for Bitcoin (BTC).
Since this significant day, many DEXs and swaps have been utilizing this technology to develop fresh approaches to trade cryptocurrencies. The Lightning Network, Liquality, AtomicDEX, and other well-known DEXs and networks facilitate trading atomic swaps.
