Atomic Swaps and Their Importance in Blockchain Space

Beginner’s Guide / 05.08.2020

The increase in the number of cryptocurrencies affords the consumer a more extensive choice of coins to use. However, exchanging them when the need arises proves a tedious affair due to the different blockchain technologies

Usually, the parties will have to find a third entity such as a cryptocurrency exchange, to act as the transaction’s trustee. Consequently, it could be both expensive and time-consuming as not all cryptocurrency exchanges support all coins. Migration of accounts or sourcing for intermediary currencies would be the only recourse.

Understanding Atomic Swaps

Atomic swaps are decentralized smart contracts allowing peer-to-peer exchange of different cryptocurrencies across different blockchains. They are atomic in that if either of the parties fails to meet their end of the deal, it gets canceled, and the funds automatically revert to the owner’s wallet.

To understand how this works, let us suppose Donna has Bitcoin that she wants to trade with Josh for his Ethereum coins of the same value. She creates a contract address and deposits her coins to secure the coins, like a temporary safe. At the same time, a key allowing access to the funds gets generated. Donna then shares a hash of the key with Josh. 

However, Josh can’t access the funds because all he has is a hash and not the real key. He then uses the hash to create his safe contract address and deposits his Ethereum. To claim Josh’s coins, Donna has to use the same key she has and, by doing so, reveals it to Josh. Immediately she claims Josh’s coins; Josh claims hers, and the swap finalizes.

History of Atomic Swaps

Atomic swaps are not an entirely new phenomenon. Sergio Demien Lerner, in 2012 developed a trustless peer to peer exchange; the P2PTradeX. His idea was further improved on by Tier Nolan in 2013, who described the process entirely. Other players, including Mike Hearn, expanded Nolan’s protocol allowing exchange on bitcoin-based blockchains. 

In 2014, a developer jl777 developed a procedure for testing Nolan’s description. He used it to test swapping Litecoin with Dogecoin. Decred then simplified the code enabling greater access to atomic swaps in September 2017. Subsequently, a successful exchange between Decred and Litecoin was achieved.

In the same year, Charlie Lee succeeded in swapping Bitcoin for Litecoin using the Lightning network. Following these steps, many startups and individuals are working on improving the protocol further.

Fundamentally, Atomic Swaps employ the Hash Time-Locked Contracts principle. This principle guarantees that funds can only be accessed upon the initiator revealing the private key to both parties. Additionally, the contract is timebound; it cannot carry on to completion after exceeding the set time. Ultimately, it allows for trustless exchange. 

Importance of Atomic Swaps in Blockchain

The following are some of the gains of using atomic swaps.

Increased decentralization

Atomic swaps eliminate the need for a centralized exchange or third parties. Cross-chain transactions occur with trust, a core tenet of blockchain, and crypto as a whole. 

Heightened security of transactions

The transactions don’t get subjected to a centralized exchange or a third party. This system removes vulnerabilities of centralized exchanges such as fraud and mismanagement of funds leading to losses. Furthermore, the use of HTLC contracts provides an additional layer of protection to all parties.

Lower transaction costs

The transactions are direct hence lowering or removing fees paid.

Speedy termination of trade

 As has been explained earlier on, trading is direct. Removal of obstacles to peer to peer transactions speeds up their completion.

Provides an opportunity for interoperability

Through atomic swaps, alternative coins are directly exchangeable, eliminating the need to resort to intermediary currencies. The coin holder, therefore, has greater choice and autonomy in their ownership and trade.

Increased privacy of the players

The elimination of go-between makes transactions highly confidential. Only the parties engaged know the details of the transaction.

Convenience in trade

In the absence of atomic swaps, it would be necessary for the parties to trade in their coins and acquire new ones from an exchange. Alternatively, they have no choice but to migrate to blockchains that host the offerings they seek. Atomic swaps remove the need to pursue either of these steps.

Eliminate uncertainty that could result from volume demands

Most cryptocurrency exchanges cannot deal with sharp changes in demand that cause downtime and loss of value. Atomic swaps remove the danger of sudden spikes in demand affecting the pace and value of transactions.

Limitations of Atomic Swaps

Atomic swaps are a useful tool in the attainment of cross-platform exchange. However, they do have their downsides. The following are their significant limitations:

  • Meeting the ideal conditions for a swap could be challenging because the two coins need to be on blockchains with identical hashing algorithms.
  • Privacy could be compromised. Using blockchain explorer, one can follow the transactions linking the contract addresses used.

What Does the Future Hold For Atomic Swaps?

Cryptocurrencies are somewhat disruptive as they are bringing about a significant change in the transactional space. However, they are not immune to change. The emergence of new ideas, atomic swaps, for instance, indicates that the crypto ecosystem is open to more significant developments. 

Atomic Swaps are an essential tool in coin trading today. They allow for the decentralization of transactions, lesser trading fees, and greater consumer choice. That notwithstanding, the limitations they have provided an opportunity for further innovation in the area. For crypto enthusiasts, the future has never been brighter.

After realizing the setbacks of centralization in the financial industry, Carol has dedicated her career to apprise everyone on the benefits of blockchain technology. When she is not writing, she’s probably somewhere in the park reading a book.