Atomic Swaps

Updated on April 23, 2024
Article byWallstreetmojo Team
Edited byPallabi Banerjee
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Atomic Swap?

Atomic swaps, also known as atomic cross-chain trading, is a technology that allows the trader to trade two cryptocurrencies directly without involving any intermediary or trust, fulfilling the idea of having programmable and decentralized currencies and exchanging the assets digitally over blockchain technology.

What Is Atomic Swap

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The process allows the two parties to exchange the cryptos without trusting or involving outsiders. It consists of the exchange of cryptographic hashes that has proof of the ownership of the cryptos. However, the method is relatively new, and thus there still needs to be more adoption of the technology.

Key Takeaways

  • Atomic swaps enable the direct exchange of different cryptocurrencies without intermediaries using blockchain technology. This revolutionary concept allows traders to transact programmable and decentralized digital assets securely.
  • Developed in May 2013 by Nolan, atomic swaps build upon a trustless exchange protocol initially drafted by Sergio Demian Lerner in July 2012.
  • Atomic swaps in computer science ensure operations are executed fully or not at all, preventing manipulation, theft, and errors. However, it’s important to note that atomic swaps are limited to cryptocurrencies and not applicable to traditional currencies.

Atomic Swap Explained

Atomic swap is the process which uses the peer to peer technology to interchange the cryptocurrencies between two traders. There is no intermediary involved and is executed through smart contracts that are self-executing and the conditions of the atomic swap smart contract is directly written in the code.

This smart chain technology uses cryptography, hash functions, and timelocks which ensure the swapping is secure and is done in a time frame, but novices may not adopt the user interface.

It is when the research in this area of atomic swap exchange took a step forward. Sergio Demian Lerner, a developer, created the first draft of a trustless exchange protocol in July 2012. But Nolan is widely regarded as the developer of atomic swaps because, in May 2013, he provided a full account of a procedure for atomic swaps.

The term atomic is a word derived from the field of computer science that here means either that the operation is conducted as programmed or the operation is not conducted.

The term swap means an act of exchanging one thing for another.

With the help of atomic swap exchange, there would be no chance for manipulation, theft, or human error. However, it is essential to note that they do not work with traditional currencies. They work only with cryptocurrencies.

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Features

Let us note some important features of this type of technology.

  • It enables the parties included to trade directly from one wallet to another without a body acting as an agent or intermediary such as an exchange.
  • In this process of swapping cryptocurrencies from peer to peer, the parties involved would have full control over their private keys.
  • It uses the technology by the name hash timeLock Contracts, which generates the cryptographic hash function that ensures hash locks and timelocks are verified and acknowledged by both parties.
  • Atomic swap crypto is significant as they open up a horizon of possibilities allowing faster and simpler trading and removing third parties like crypto exchanges between them, which increase the likelihood of hacks and transaction costs or might increase the risks of mismanaging funds.
  • Suppose any of the parties to the contract, as mentioned above in the example, fail to confirm the transaction or complete any action within the specified time frame. In that case, the transaction stands void, and there would be no exchange between the parties, which would eliminate the counterparty risk.

Example

Atomic Swap Example

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  • Let us suppose there are two parties, namely Tim and joy. Tim has bitcoins while joy has litecoins. While Tim wants litecoins, Joy wants bitcoins. Both of them decide to trade with the help of an atomic swap crypto. Tim opens a contract, and a hash is produced when Tim deposits the bitcoins to that contract.
  • This hash works like a lock on a safe. Tim also generates value in a data string that acts as a key to retrieve those funds from this so-called safe. He then sends it to Joy so that he can fulfill his side of the transaction of this atomic swap smart contract.
  • Joy follows the same steps by depositing his litecoins in the contract address using the same hash that Tim has used. In this way, both funds are locked to the same key. When Tim receives Joy’s litecoins from his address, the key being used is revealed while allowing Joy to retrieve bitcoins from Tim’s address.

Benefits

The process of the atomic swap blockchain has a lot of advantages over the traditional exchanges of cryptocurrencies, as given below:

  • It helps attain more liquidity in the crypto market because the peer-to-peer transactions directly from one’s wallet to another can be processed easily.
  • There are no third parties involved, which reduces the transaction costs and tediousness in settlement transactions.
  • Privacy is protected because of the existence of private keys, encryption, and has functions. It uses cryptographic hashes that is used to verify the ownership, reducing the risk of fraud.
  • It ensures both the parties to the contract fulfill their requirements of the trade so that either the parties honor the contract or the contract itself is voided in its entirety.
  • The times involved in the process is very less. It is done almost instantly, unlike the traditional method where several confirmations are needed.
  • Since it is done on a peer to peer basis, it makes them decentralized.

Limitations

However advantageous it may seem, there is a long way to go, for the mainstream adoption of atomic swaps requires more cryptocurrencies to be involved, rigorously tested software, and much more research. The disadvantages may seem like small barricades over the advantages attached to them.

  • The world of atomic swap blockchain is not fully developed yet. That means not all cryptocurrencies are made available for atomic swapping. Only bitcoins or litecoins are the names being heard predominantly, making it inevitable to peg every transaction to be there in both cryptocurrencies again.
  • Another major complaint would be that this technology requires knowledge and experience in blockchain and programming.
  • The user interface is not user-friendly, making it harder for lay people to adopt it easily.
  • Though it seems secure, there is still a possibility that attacks may compromise the address.

Atomic swaps are hence a revolution in the world of cryptocurrency transfer. Sergio Demian Lerner and Tier Nolan are responsible for the same.  As discussed, there would be no third-party involvement, and hence only the parties involved in the swap are responsible for honoring the trade or otherwise.

Atomic Swap Vs Cross-Chain Bridges

Both the above technologies are used in exchanging cryptocurrencies between various blockchains. But let us understand the basic differences between them.

  • The former allows the exchange of crypto between two parties without any intermediary of exchange but the latter involves intermediary like an exchange of a multi-signature wallet.
  • For the former, smart contracts are executed once the agreement conditions are met, but for the latter transfer of assets take place between blockchains by creation of a connection between them.
  • Atomic swaps use same hashing algorithms or similar type of scripting languages but cross chain bridges use different hashing algorithms or different scripting languages.
  • The former is decentralized unlike the latter, which is centralised.
  • The former exchanges only crypto but the latter exchanges any type of digital asset.

Thus, both the technologies have their own features and is used for various purposes depending on the user’s need.

Frequently Asked Questions (FAQs)

1. Is Atomic Swap safe?

Yes, Atomic swaps are generally considered safe. They are designed to enable peer-to-peer cryptocurrency exchanges directly between parties without the need for intermediaries. Smart contracts facilitate these swaps, ensuring that the exchange occurs simultaneously or not at all, reducing the risk of one party not fulfilling their end of the trade.

2. Why is it called atomic swap?

The term “atomic” in atomic swap refers to the indivisible and irrevocable nature of the exchange. In an atomic swap, either the asset exchange between two parties occurs, or nothing happens. It is similar to the concept of an atom, which cannot be divided further, making atomic swaps instant and secure.

3. What is the relevance of atomic swap?

Atomic swaps offer several advantages in the world of cryptocurrencies and blockchain technology. They enable trustless peer-to-peer trading between different blockchain networks, fostering interoperability. By eliminating the need for centralized exchanges, atomic swaps enhance privacy and security and reduce trading fees. Moreover, they open up new possibilities for decentralized finance (DeFi) and cross-chain asset transfers, making them relevant and promising in the crypto ecosystem.

Recommended Articles

This has been a guide to what is Atomic Swaps. We explain its features along with examples, its benefits, limitations & differences with cross-chain bridges. You can learn more about it from the following articles –

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