An Atomic Swap (or atomic exchange) is a blockchain technology that allows access to direct cryptocurrency exchanges between two different wallets without using an intermediary like a centralized exchange. The deal? The operation is fully automated and secured through smart contracts.
Why “atomic”?
The term “atomic” comes from computer science and defines an indivisible operation. This means that an atomic exchange operates on an all-or-nothing principle. Either the transaction is completed successfully for both parties or it is automatically canceled, guaranteeing that neither party can lose the funds.
How does an Atomic Swap work?
Based on HTLC (Hash Time-Locked Contracts) technology, atomic swaps include a mechanism whereby both parties’ funds are cryptographically ‘locked’ and only released if the conditions of a secure transaction are met. Here’s how:
- Initiating the transaction
User A (with Bitcoin) decides to make an exchange with User B (with Litecoin). User A generates a unique hash based on a secret (a private cryptographic value) and locks his Bitcoin into a HTLC contract. The contract also includes a timelock – a deadline for the transaction.
- Creating a mirrored contract
User B receives the generated hash and locks their own Litecoins in an identical contract on the Litecoin blockchain.
- Reclaiming funds
User A claims the Litecoin blocked by User B revealing the initial “secret” in the process.
- Finalizing the transaction
Once the secret is revealed, User B uses it to claim the bitcoin from the bitcoin blockchain. If one party does not complete the transaction in a timely manner, the funds are automatically returned to the original owners.
This process ensures a 100% secure transaction without any risk of losing the funds.
Advantages of Atomic Swap
Implementing atomic swaps comes with a number of important benefits, especially for those looking to maximize security and decentralization.
1. Full decentralization
Atomic swaps completely eliminate the need for centralized intermediaries, giving users real control over their funds. This relieves you from the risks associated with centralized platforms, such as cyber-attacks or hidden fees.
2. Increased security
HTLCs ensure by design that funds are exchanged only if all transaction conditions are met. If not, they are automatically returned to the original owners.
3. Lower costs
Without the intermediation of a platform, fees are greatly reduced. You only pay the network fees specific to the blockchains involved.
4. Confidentiality
Centralized exchanges often require KYC (Know Your Customer) procedures to be completed. With an Atomic Swap, the transaction takes place between two wallets without requiring any personal paperwork.
5. Interoperability between blockchains
Works even with different blockchain networks, facilitating simple transfers between assets that traditionally would have been difficult or impossible to connect.
Disadvantages and challenges of Atomic Swap
Like any emerging technology, Atomic Swaps are not without their challenges:
- Technical complexity
If you’re new to the crypto world, setting up an atomic swap can seem intimidating. It requires a clear understanding of the blockchain technologies involved.
- Limited compatibility
Not all cryptocurrencies support atomic exchanges. They are usually only possible on blockchains that implement smart contracts and HTLCs.
- Low liquidity
In the absence of a centralized exchange, finding a willing counterparty to make an exchange can take time.
- Network fees
Although intermediary fees are eliminated, users should be prepared for the costs associated with network fees of the blockchains involved.
Examples of use
Atomic Swaps are already being tested and deployed in blockchain ecosystems such as Bitcoin, Litecoin and Decred. In addition, many open-source decentralized exchanges (DEXs) are integrating this technology to improve decentralization and remove classic liquidity barriers. As the ecosystem evolves, interfaces are becoming more user-friendly, and wide adoption of Atomic Swaps is only a matter of time.