Decentralization in crypto involves eliminating intermediaries to facilitate transactions. Atomic swaps utilize self-executing smart contracts to enable peer-to-peer (P2P) cryptocurrency transactions across blockchains.
Read on to learn how atomic swaps work, how they differ from cross-chain bridges, and what their benefits and drawbacks are.
What Are Atomic Swaps?
An atomic swap protocol enables P2P transactions between parties wishing to exchange cryptocurrencies on different blockchain networks.
Smart contracts eliminate the need for a third party, such as a centralized exchange, enabling decentralized, cross-chain crypto asset trading.
The trustless and private nature of atomic swaps ensures that the parties involved remain confidential. However, the individual transactions involved in a cross-chain swap are still trackable on the public ledger of their respective blockchains.
How Do Atomic Swaps Work?
Atomic swaps enable cross-chain crypto asset swapping powered by cryptography and smart contracts. Let’s look at the process step by step.
- The smart contract creates a virtual vault for the crypto swap.
- The first party sends their cryptocurrency to a locked contract address within the vault.
- The second party confirms the deposit and sends their cryptocurrency to another locked contract address within the vault.
- The smart contract confirms that both parties have locked their respective amounts per the contract terms.
- Upon confirmation, the funds are released to the parties.
If either party fails to execute their part as specified in the contract, the swap becomes invalid. If one party has sent their crypto, they receive a refund.
How Do Atomic Swaps Differ From Bridges?
Cross-chain swaps differ from cross-chain bridges even though they both offer blockchain interoperability.
Blockchain bridges involve creating a wrapped token and then availing an equivalent amount on the target blockchain. You can then transfer or trade the wrapped token on the target blockchain or redeem it for the original assets on the source blockchain.
Alternatively, atomic swaps enable P2P exchanges between two parties across two separate blockchains. There are no intermediaries involved. Additionally, swaps require the same hashing algorithm, while bridges don’t.
Benefits of Atomic Swaps
Cross-chain swaps provide a suite of benefits to crypto traders.
- Lower fees: The absence of a third party generally reduces transaction costs.
- Cross-chain interoperability: Users can exchange assets from different blockchains without losing assets or private keys’ custody.
- No fiat currency involved: Crypto users can exchange assets without utilizing fiat currency as a baseline value.
- Faster speeds: Transactions are executed swiftly since the smart contract automatically executes once each party does its part.
- Enhanced security: The smart contracts involved offer higher security since users can regain their assets if the other party fails to perform as agreed.
Drawbacks of Atomic Swaps
In their current form, cross-chain swaps present several challenges to users.
- Technical complexities: Atomic swaps require exchanging hashed cryptographic information. This closes the door to traders who lack the technical knowledge to understand such details and those with privacy concerns.
- Cryptographic hashing algorithm: Atomic swaps are only possible for cryptocurrencies belonging to networks with similar cryptographic hashing algorithms limiting the options for traders.
- Process complexity: In its current form, the atomic swapping process comprises more steps than trading on a centralized exchange.
- No crypto-fiat on-ramp: Cross-chain swaps don’t allow crypto to fiat exchanges. If you wish to liquidate to fiat, you must look for an alternative.
One of the key aspects of decentralized trading is that users can maintain custody of their crypto assets. Conversely, centralized exchanges take custody of your assets and maintain access to your private keys. Consequently, the security of your crypto holdings relies on the exchange remaining solvent and invulnerable to any malicious attacks.
Cross-chain swaps offer greater interoperability across various blockchain networks, ensuring truly decentralized trading. However, support for atomic swaps is only available on a few platforms, making access challenging. Additionally, you need some programming and cryptographic knowledge to understand the technical aspects of atomic swaps, which may be daunting to non-tech-savvy traders.