Atomic swaps are frequently regarded as one of the few truly peer-to-peer methods of trading cryptocurrency tokens. That information is true but that isn’t all that there is to atomic swaps.
This article will go over what atomic swaps are, their history, and how they work so grab your popcorn and let’s ride.
What Is Atomic Swap?
An atomic swap is the peer-to-peer (P2P) trading of cryptocurrencies from different blockchains enabled by a time-bound smart contract known as a hashed timelock contract.
The swap is carried out between two entities with no involvement from a third party. The goal is to eliminate centralized intermediaries such as regulated exchanges and give token owners complete control.
The term atomic comes from the term “atomic state,” which refers to a state that has no substates; it either happens or it doesn’t—there is no other option. This refers to the status of the cryptocurrency transaction; it either occurs or does not occur.
How Atomic Swaps work
“Atomic” is a term used to describe processes that either complete or do not begin at all. In other words, an atomic swap includes features that ensure both sides of the trade meet all predefined conditions before the trade can be completed. This is made possible by incorporating smart contracts, which are self-executing programs that enforce the conditions governing a transaction’s success.
An atomic swap, in particular, employs a Hashed Timelock Contract (HTLC), which serves as a two-way virtual safe. This contract, as the name implies, employs a sophisticated mathematical-based encryption mechanism known as a hash function. It also introduces a time constraint, so transactions are reversed when either of the parties fails to fulfill their sides of the bargain within a predefined time frame.
For example, the two parties may agree to a two-hour time limit for the atomic swap. When two hours have passed and not all of the trading conditions have been met, the contract will return the deposited coins to their original owners.
Another important aspect of the HTLC is that it requires two cryptography or encrypted keys. They are as follows:
Hashlock Key: This key ensures that trades are only finalized after both parties submit cryptographic proofs (more on this later) that they have fulfilled their sides of the transaction.
Timelock key: This is a safety mechanism that allows traders to set atomic swap deadlines. The mechanism ensures that deposited coins are returned to traders when the swap is not completed for one reason or the other before the deadline elapses.
Understanding Atomic Swap
For an atomic swap to occur, both parties must be involved in the transfer of cryptocurrencies in order for the trade to materialize. An HTLC enforces this by monitoring the fulfillment of these conditions within a specific time frame in order to automate the transaction process.
The hash function is an encryption mechanism used by HTLC technology. It includes a time limit for both parties to fulfill the transaction’s conditions within the time frame specified, or the transaction will be revoked.
For example, if both parties agree to a three-hour window for the atomic swap to take place, the contract will ensure that the tokens deposited for the exchange are returned to their respective owners if the trade conditions are not met within three hours.
With HTLC technology, the smart contract effectively secures the transaction for verification of transfer by both parties within a limited time frame before the transaction is completed. This necessitates the use of two critical security features: hashlock technology and a timelock mechanism.
The hashlock technology secures the contract with a special encrypted key that grants the depositor access to the deposited tokens of the other party — but only after both parties have deposited their respective tokens and submitted cryptographic proofs.
The timelock mechanism simply sets a deadline for the atomic swap to occur so that the deposited coins can be returned to their respective owners if the transaction is not completed by then, rather than being locked up indefinitely.
Atomic Swap Process
Two token owners agree to exchange their tokens for any amount they agree on in an atomic swap. When the smart contract program notices that they both agreed, it executes the trade for them. The transaction is recorded in the blockchain and validated by network nodes before a new block is created to accommodate another transaction.
The transaction is irreversible. If they want the tokens back, both parties must agree to another transaction to exchange them.
Atomic swaps automate the exchange of tokens by utilizing Hash Timelock Contracts (HTLC). HTLC, as the name implies, is a time-bound smart contract between two parties that entails generating one cryptographic hash on each end.
Both parties are required by HTLC to acknowledge receipt of funds within a certain timeframe. If one party fails to confirm the transaction within the timeframe specified, the entire transaction is null and void, and funds are returned. This eliminates counterparty risk or the possibility that one party will accept the offered coins while declining the transfer of their coins.
History Of Atomic Swap
Prior to the invention of the atomic swap technique, cryptocurrencies could only be traded anonymously through centralized platforms like Coinbase or Coinsquare. Sergio Demian Lerner’s brainchild, P2PTradeX, was the first to outline the concept of a P2P crypto trading protocol in 2012.
Tier Nolan coined the term “atomic” to describe the transfer of cryptocurrencies bound by a hashed contract a year later, laying the groundwork for atomic swaps.
The actual execution took place between Decred and Litecoin in 2017 and was later replicated for the exchange between Litecoin and Bitcoin.
P2P transactions at the time required both parties to download entire blockchains of the coins for trading, but Komodo quickly introduced a simplified version that only required specific payment channels, without having to download the entire blockchain to finalize the transaction.
This encouraged many decentralized exchange platforms and independent traders to use the technology to trade cryptocurrencies instead of relying on centralized trading platforms.
Benefits of an Atomic Swap
With an atomic swap, crypto users can exchange cryptocurrencies while maintaining direct control over their assets. The advantages of an atomic swap include the ability to conduct transactions in a faster, more cost-effective, and more flexible manner without having to go through a centralized custodial crypto trading platform and incur trading fees.
It also has enhanced security, relying on the aforementioned automated HTLC technology, which guarantees that users will receive their tokens within an agreed-upon time frame while avoiding counterparty risks.
Such a transaction grants crypto users autonomy, facilitating the transition to a more interoperable, interconnected crypto ecosystem in which transactions can occur across blockchains.
So that’s it for this article, but for context, Atomic Swap is a smart contract-based technology that allows the exchange of various cryptocurrencies without the use of a centralized market or other intermediaries. Atomic swaps, also known as atomic cross-chain trading, involve the exchange of one cryptocurrency for another, even if they are running on different blockchain networks.