Beginner’s Guide to Atomic Swaps – Solving the Centralization Problem

Beginner’s Guide / 20.01.2020

What are Atomic Swaps?

In its simplest sense, an Atomic Swap is a mechanism that uses smart contract technology to enable the exchange of one cryptocurrency for another, without using centralized intermediaries, such as exchanges.

Atomic swaps consist of a technique that allows the quick exchange of two different cryptocurrencies, running on distinct blockchain networks. Such a process (also known as atomic cross-chain trading) is based on smart contracts. It allows users to trade their coins directly from their personal crypto wallets.

Before discussing in detail what an Atomic Swap is, let us first look at the need for the technology.

Why Do We Need Such a Mechanism?

The biggest advantage of Atomic Swaps is its decentralized nature. By removing the need for a centralized exchange, or any other kind of mediator, cross-chain swaps can be executed by two or more parties without requiring them to trust each other. There is also an increased level of security because users don’t need to give their funds to a centralized exchange or third party. Instead, the trades can happen directly from users’ personal wallets.

Not all cryptocurrency exchanges support all coins. As such, a trader wishing to exchange his coin for another one that is not supported on the current exchange may need to migrate accounts or make several conversions between intermediate coins to accomplish their goal. Today, most centralized exchanges force traders to transfer cryptocurrencies via a wallet that is being controlled and hosted by a centralized exchange.

Atomic swaps can take place directly between blockchains of different cryptocurrencies, or they can be conducted off-chain, away from the main blockchain. They first came into prominence in September 2017, when an atomic swap between Decred and Litecoin was conducted.

How Does an Atomic Swap Work?

Atomic swaps use a specific type of smart contract called a hash time-lock contract (HTLC). This can be thought of just like a “virtual lockbox” which is requiring two special keys:

  1. A HashLock key: That only distributes traded cryptocurrency to traders when all parties have signed off on their respective transactions.
  2. A TimeLock key: A safety mechanism that returns traded cryptocurrency to traders if the trade is not completed within a specified time period.

Atomic swaps require both parties to acknowledge receipt of funds within a specified time frame using a cryptographic hash function. If one of the involved parties fails to confirm the transaction within the time frame, then the entire transaction is voided, and funds are not exchanged. The latter action helps remove counter-party risk.

Suppose Alice is a trader interested in converting 1 Bitcoin to an equivalent Litecoin with Bob. She submits her transaction to bitcoin’s blockchain. During this process, Alice generates a number for a cryptographic hash function to encrypt the transaction. Bob repeats the same process at his end by similarly submitting his transaction to Litecoin’s blockchain.

Both Alice and Bob unlock their respective funds using their respective numbers. They have to do this within a specified timeframe or else the transfer will not take place. Atomic swaps can also be used in conjunction with a lightning network to conduct off-chain exchanges.

The Biggest Swap Platforms

Next, we will present some of the biggest names in the blockchain industry that have integrated some form of Atomic Swap mechanism into their platforms.

Komodo’s AtomicDEX

Komodo, a blockchain network, shared to the world in December that it has successfully released the AtomicDEX platform. AtomicDEX is a decentralized exchange built on the Atomic Swap mechanism. The platform allows for non-custodial cryptocurrency trading through atomic swaps. The company has expanded its AtomicDEX mobile decentralized exchange (DEX) to work in web browsers on all major platforms. The official website said “Atomic swap trading is magnitudes more secure than trading crypto on a centralized exchange, as users never need to give up control over their assets”, thus establishing their support for the technology.

Lightning Network

Lightning Labs, the team behind Lightning Network, believes that “the closest solution in protecting privacy while acquiring and trading assets”. Since the first Atomic transaction in 2017, the Lightning team has been following the technology closely. Eventually, the network integrated the Atomic Swap mechanism into their own platform, thus moving closer to making Bitcoin scalable and robust.

Closing Thoughts

Atomic Swaps form a peer-to-peer exchange of cryptocurrencies from one party to another, without going through a third-party service like a crypto exchange. During this entire process, the users have full control and ownership of their private keys.

One of the biggest drawbacks of Atomic Swaps is its limited liquidity. A Swap can be conducted only as long as another person is willing to get into the contract. Without two or more parties, a swap cannot be initiated. Decentralized platforms built on Atomic Swap Technology such as Komodo, dY/dX, etc are just some of the platforms that have successfully solved the liquidity problem.

Although atomic swaps are still new and limitations certainly exist, this technology is driving significant changes in regards to blockchain interoperability and cross-chain trading capabilities. As such, the technique has great potential to influence the growth of the cryptocurrency industry, opening up new avenues in terms of decentralization and peer-to-peer monetary transfers. Atomic swap trades are limited by liquidity. This means that without an exchange platform, it can be difficult for traders to communicate and exchange cryptocurrencies.

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.