By Larry Wright
Introduction – Both decentralization and blockchain technology has evolved into prospects that were unimaginable in the very beginning. It was believed that this technology was redundant and won’t have any real-life use cases, but here we are 10 years from the launch of the flagship cryptocurrency Bitcoin and tons of applications that are now being supported by blockchain technology and decentralization.
If you are a beginner and don’t have that much exposure to the crypto market, then the chances are that you only know the basics, such as what is crypto, how it works, and the overall aura of decentralization thrown into the mix.
Other than crypto, multiple offerings are present within the decentralized space you can invest in, such as the non-fungible tokens as you can sell them at a later date to earn some handsome profit, you can stake your crypto tokens into a dedicated mining pool and earn handsome rewards on your investment, or you can develop decentralized apps and make money by selling them off over a blockchain network.
Another great aspect of decentralization is swapping; suppose you have multiple Ether tokens on you, but due to some bad investment made earlier and the market not turning up in regards to Ether, you want to invest in some other cryptocurrency but are afraid of paying heavy transaction fees and conversion rates of a dedicated decentralized exchange for the conversion, but you can do that with the help of atomic swaps.
Today we will be talking about atomic swaps, which is merely a technique allowing for instant exchange of cryptocurrencies that run on different blockchain environments.
For the process to take place, there should be two different cryptocurrencies involved, one that you have in your hands and the other one in which you are presently interested.
Another name for atomic swaps is atomic cross-chain trading, and the whole concept is based on smart contracts; whenever a request to initiate a swap is received, it is instantly communicated to a smart contract which then executes it in real-time according to the terms and conditions agreed upon by the exchange in question and the user who wants to undergo the swapping process.
You don’t need to create a different crypto wallet for this specific use case, as you can trade these tokens directly from your personal crypto-wallet by linking it with the dedicated service. These atomic swaps act as a peer to peer trade functions that are present across multiple blockchains and are linked by smart contracts. You don’t need to worry about developing these smart contracts yourself because it can be done whenever you submit a request for a swap.
There is a lot of argument present within the crypto market about the idea of cross-chain swaps; some say that it is an innovative technology that has changed the game for a good, while others believe that it is hypocritical and unnecessary function that no one asked for. The idea has been under discussion for too long, and presently despite receiving some negative feedback from people and Internet bash outs, atomic swaps exist and are fully functional.
The idea of an atomic swap protocol was presented back in 2013, but a fully functional model was developed later on, which we witnessed today as an atomic swap protocol. Many developers have experimented with atomic swaps in their own way, and according to a survey, many elite cryptocurrencies such as Bitcoin, Ether, and many others did play a vital role in furthering the atomic swap protocol.
The very first atomic swap conducted by a random user was initiated in 2014, but the technique became much more popular in 2017 and was adopted extremely well by the general public because they were able to undergo many successful swaps between two distinct crypto protocols without having to pay for excessive transaction fees or horrendous conversion rates at all.
Working Mechanism of Atomic Swaps
As explained earlier, the whole prospect of atomic swaps is based on people’s interest in buying or exchanging their present cryptocurrency with a different one based on a change of heart, a new investment strategy that they want to explore, or some other reason. The whole technique is immutable once the conditions are agreed upon by the concerned parties and are autonomous as the whole deal is orchestrated by smart contracts.
These types of instruments are known for their extreme immutability, which means that once the conditions are agreed upon by the mutual parties, then nothing can be changed, and the contract will only work if all the parties involved behave according to their consent which was submitted when the smart contract initially went live.
The whole design is extraordinary, and it doesn’t allow any of the parties involved to cheat or get their way against the consent of other parties or back out from the play after signing up to see this deal close when the smart contract was initially developed.
Usually, there are two parties involved who or looking for swaps; for the sake of argument, let’s say there is user A who has Ether in their possession, and they would very much like to swap it out with some XRP. Now there is another user, B, who has XRP in their possession and would like to swap it out with Ether.
Both this personnel submit their request individually on the atomic swaps blockchain network, and once the system receives this request, the validators are going to validate their request that is indeed unique and legit; once it has been proved, the next step is to match these users and subject them into a dedicated smart contract.
Upon validation of the request, both of these parties would be notified by the network that their request has been authenticated, and now they should submit how many tokens they want to swap. User A would submit their own number for how many Ether tokens they want to swap or the total value in a dedicated Fiat alternative which they are looking to swap; now, user B would also submit their own value directly into the smart contract. Both parties are told of the circumstances and the initial draft of the smart contract, letting them know what other user has submitted in terms of swap options.
Once they reach consent on a dedicated value or number of tokens, the smart contract goes live. User A would now give away the agreed-upon sum of Ether tokens to receive XRP next, and user B would do the same. The exchange rate is calculated and adjusted by the smart contract itself so that there are no shortcomings and the deal goes smoothly.
None of the users submits their tokens directly into the crypto wallet of another user, but these are submitted into a contract address which is going to act like a safe. Once the safe has been created, a key is generated, and the crypto hash for that key is shared with the other user. There is something else that should be noted here because the user only has the hash of the key and not the key itself; therefore, they can’t access the safe yet.
The other user would also submit their tokens into a unique address which acts as a safe and develop a key for it, and then share the hash of the key with the other user. Once both users have received the hash, now, they are confident that because they have the hash in their hands; now, it would be safe to exchange the keys with each other.
This step takes place simultaneously so that there are no delays and both users receive the key, which they can then use to access the safe which was created in the first place. Once the safe has been accessed, the funds are now available for either withdrawal or shifting into a dedicated crypto wallet. Once access to the safe is warranted and the user can now interact with the funds, the swap is automatically set to complete.
The very notion of the word ‘atomic’ means that these interactions either take place right then and there or they don’t take place at all; this is being very analogy of this term which is often tied together with the word ‘swaps’ so the final issue is atomic swaps.
The contract is cancelled right then, and there should any of the parties back out and do not honour the terms of the contract and the funds which were initially subjected to a unique address that did act as a safe would then be transferred back to the users.
There are two different ways to get on with atomic swaps; you can either do this on-chain or off-chain. On-chain, swaps mean that these will take place on the blockchain network of either of the cryptocurrencies involved in this swapping option. It means that the swap would either take place on Ether or XRP’s blockchain environment.
The off-chain atomic swap, on the other hand, means that these can take place on a secondary layer; this means that a third party act as a mediator between the users for the swap to take place.
What are Hash Timelock Contracts?
Proceeding further, you have to understand hash timelock contracts because it is the very technology that ensures the safe transfer of crypto from one user to another during a swap. This is an incredibly relevant technology and is an important aspect of the lightning network for Bitcoin, and is among one of the key elements which allow for an atomic swap to occur. There are two specific functions that a hashed timelock contract has, and that is the hash lock and a time lock.
A hash lock, as the name suggests, is a potential lock that is subjected over the hash for a dedicated crypto key, and its sole function is to prevent the funds from being interacted with or withdrawn from the safety address until a relevant piece of data is revealed by the user obliged by the smart contract.
Time lock, on the other hand, is another function that makes sure that the contract could only be orchestrated within a dedicated time frame that was decided earlier when the smart contract came into being.
Due to the presence of hash timelock contracts, there is no need for the involved parties to trust each other or put their consent into their goodwill of swapping the tokens whenever the time to do so occurs.
These are the specific set of rules which both parties agree to when initiating a smart contract for atomic swaps to occur, should any party back out or don’t fulfil their end of the deal, the whole contract is nullified right then and there, and the crypto which was interlocked within the safety address is then transferred back to the owners.
Advantages of Atomic Swaps
One of the most elegant advantages that an atomic swap has on basically any other swapping technique or option out there on the market is its ability to execute the deal without the need for any intermediary or a third-party payment provider to execute the deal. There is absolutely no need for a centralized exchange or a body to provide their services when it comes to executing an atomic swap deal.
The whole thing is completely decentralized in nature which makes sure that the funds, the information, and moreover the security of the personnel, as well as the financial data of the user, completely remains anonymous, and the whole deal is also autonomous in nature which means that if both parties play by the rules and they continue to tread bit by bit according to the contract that is signed between them.
Then, the whole deal would go smoothly and efficiently; otherwise, the contract would be nullified, and, as told multiple times before, the funds would then be released and transferred back to the original owners.
The parties involved don’t have to trust each other, and that is another benefit of atomic swaps; because of the increased level of security, the users don’t have to directly convey their funds to the other user but interlock them into a security detail, a safe address which only generates a hash of the key transferred to the other user and the key is only provided when all the conditions of predefined smart contracts are met.
This peer-to-peer trading has an extremely low transaction fee which was the very purpose of going with atomic swaps because centralized exchanges ask for too much in terms of the transaction fee itself, and moreover, the conversion rates for converting crypto into another one are also abominable.
Last but not least, there is potentially no waiting time for the swaps to be validated; the whole process is overlooked by a smart contract that has very precise instructions, and should these instructions are not met, or there is a delay, or some kind of distrust has emerged the contract would nullify itself, and the funds would be transferred back to the original owners.
The level of interoperability that atomic swaps have is also phenomenal, which means that you could be working with Bitcoin or altcoins or some other token that has just launched, and you would still be able to make the swap without any additional worry or complications.
Limitations of Atomic Swaps
If something sounds too cheesy or too good to be true, then it usually is, same is the scene with atomic swaps. You get a fairly quantitative price that is pretty decent as compared to the market, but there are a few limitations when it comes to swapping your assets using atomic swaps.
Certain obstacles are placed in the way of you actually executing the swap using atomic swaps because certain technologies need to align before such a swap can take place.
To begin with, let’s take into account the earlier example for the swaps, the user wants to swap Ether, and the user who wants to swap XRP must use the same hashing algorithm; otherwise, it won’t work. Another crazy aspect of dealing with atomic swaps is the fact that both of these tokens need to be compatible with hash timelock contracts, or otherwise, swapping won’t take place.
There are added concerns about user privacy; according to some users, they don’t feel comfortable sharing their personal or financial data with atomic swaps because of the fact that on-chain swaps and transactions could be tracked in real-time using a blockchain explorer, which makes it convenient for others to find or link to the addresses that were used while making a swap or conducting another transaction over the blockchain network.
A vivid solution to this problem would be using privacy-oriented cryptocurrencies, but that too is a short term solution and, unfortunately, can’t be stretched into a long term regime where these kinds of errors and setbacks are completely rooted out of the system to provide users with an efficient and effortless blockchain environment to conduct swaps.
Digital signatures are being implemented by various developers, and they are concerned that these signatures could ultimately be embedded into the atomic swaps blockchain, making transactions and swaps much more accurate and efficient moving forward.