What is an Atomic Swap?
Although cryptocurrencies revolutionize traditional finance, multiple concerns hinder their widespread adoption. For example, they use a complex addressing system. Also, the trading of virtual currencies is mainly reliant on centralized exchanges (CEX). Assets held on CEXs are worth billions of dollars, providing an incentive for hackers to compromise their security and steal funds. Check out this article to improve the security of your accounts.
Decentralized Exchanges (DEXs) eliminated the need for users to delegate the security of their virtual wealth to a central authority, but lack enough liquidity. Atomic Swaps were the next secret card in winning the liquidity and security war.
What is an Atomic Swap exactly?
An atomic swap is a method that allows peer-to-peer (P2P) trading of two separate virtual currencies without the help of a third party. The process uses a smart contract and connects directly to the cryptocurrency wallets of the involved parties.
The first clear explanation of atomic swaps was done in 2013 by Tier Nolan, although Daniel Larimer built an atomic swap-like platform a year before. But, how do atomic swaps mitigate risks such as dishonesty without an intermediary? It’s simple.
An Atomic Swap in Use
Let’s consider a situation where Janet wants to atomically exchange her Litecoin (LTC) with Evan, who owns Bitcoins (BTC).
Janet needs to send her share of LTC to a smart contract. Janet gets the key to the contract. To connect with Evan, she shares a cryptographic representation of the key with him. Here’s where security comes in; Evan can’t open the safe to withdraw Janet’s LTC without the actual key.
Using the cryptographic representation, Evan creates a smart contract and deposits his share of BTC. Using her key, Janet can open Evans BTC safe and take the coins. What about Evan? Janet’s key has a hash lock functionality that enables the contents of the two safes to be claimed simultaneously. This ensures there’s no cheating.
Once Janet and Evans claim their individual shares, the swap is complete. Note that funds involved in an atomic swap are claimed in full. So, it’s either the swap is complete or canceled. There can never be a half-settled swap.
An atomic swap can happen either on or off-chain on a layer two platform. Notably, layer-two based atomic swaps use payment channels similar to those employed by the Bitcoin Lightning Network.
2 Critical Features of an Atomic Swap
To enhance fairness, swaps use a hash lock and a time lock.
- Hash lock – The hash lock feature deals with the keys involved and ensures that the funds locked within a smart contract are claimable only when enough key centric data has been provided.
- Time lock – This binds the swap with a timeframe. When this period elapses, the swap is canceled, and funds are returned to their respective owners.
Advantages and Disadvantages of an Atomic Swap
An atomic swap is advantageous because it facilitates trading across blockchains without the need for a third party. Also, it doesn’t rely on liquidity from an exchange, it is secure and trustless.
Unfortunately, it can only be conducted between decentralized networks using the same hashing method. In addition, the blockchains must support smart contracts with time and hash lock functionalities.
An atomic swap falls short of securing users’ privacy since a swap on one blockchain can easily be connected to its corresponding swap on another decentralized system.
An atomic swap saves participants the transaction costs charged by cryptocurrency exchanges and improves the security of funds. Additionally, it’s not affected by a lack of liquidity or overstretching of trading platforms due to high trading activities.