Understanding Atomic Swaps: The 2024 Guide To Cross-Blockchain Transactions
In modern finance, trading assets requires the involvement of intermediaries to mitigate risk and ensure the completion of trades. However, in the burgeoning world of cryptocurrencies, technology allows us to rethink how assets are exchanged. Enter atomic swaps, a concept first described in 2012 and seen in 2017. Atomic swaps are suitable for exchanging assets across various blockchain networks. For cryptocurrency enthusiasts, tech investors, and governments alike, atomic swaps offer an alternative to custody and exchange counterparties used in traditional finance. Transfers of value can be secure, trustless, and without a centralized intermediary.
What Are Atomic Swaps?
At their core, atomic swaps enable the exchange of one cryptocurrency for another between different blockchains without the need for third parties. The term “atomic” refers to the concept that the swap happens entirely or not at all, ensuring neither party in the exchange is left shortchanged.
Ten Seconds of History: The First Atomic Swap
The first atomic swap occurred in 2017 when Decred and Litecoin were exchanged without using a third party or a government-issued currency as part of the conversion. A few days later, Litecoin and Bitcoin were exchanged.
The Magic of Hash Timelock Contracts (HTLCs)
The underlying technology that makes atomic swaps possible is what’s known as a Hash Timelock Contract (HTLC). It is a type of smart contract that uses cryptographic hash functions and time-lock constraints to secure transactions on the blockchain. The HTLC requires the receiver to acknowledge receiving the payment before a deadline by generating a cryptographic proof of payment. If they fail to do so, the transaction does not take place, and any locked-in funds are returned to the sender.
The Distinction Between Traditional Transactions and Atomic Swaps
On a blockchain, a transaction shifts asset ownership on that chain from one wallet to another. The transaction is unidirectional — there is a sender and a recipient. It is trustless in that no intermediary or counterparty is required.
As an aside, the participants must trust the blockchain. Thus, the blockchain itself is the intermediary.
A blockchain transaction does not require an exchange. It is purposefully built NOT to require an exchange. Moving value between two different blockchains, however, adds a complication. One way to solve that complication is through an exchange, which serves as a third party involved in the transaction.
While this works, it undermines the intent of the blockchain. Instead of removing third parties, a cross-blockchain transaction with an exchange requires one.
Atomic swaps permit a cross-chain trade without third-party involvement. Rather than a conventional ‘transaction,’ it’s a ‘swap’ because separate standalone transactions are formulaically tied together and predicated on each other’s successful completion. This aligns more cogently with the trustless nature of blockchain.
Contrasting a Bridge with Atomic Swaps
One of the significant challenges in implementing atomic swaps is ensuring compatibility between different blockchains. This is where bridges come into play. Bridges serve as a connection, allowing the transfer of assets and information between two separate blockchains that otherwise would not be directly exchangeable. They support the communication necessary to initiate and complete atomic swaps.
A bridge is usually a pair of contracts: one resident on each blockchain being bridged. Typically, a bridge will escrow (or “lock”) assets on one blockchain and issue (or “release”) assets on the other blockchain. Hence, the contracts serve as a bridge between the blockchains.
The challenges with bridges are clear in the definition. Third parties don’t just write the contracts but must fund sufficient assets on both contracts to allow for bridging. This creates an involvement like an exchange, though the number of counterparties in the transaction is likely reduced.
This consolidation increases the risk of attack. At the time of writing, just over $2.8 billion has been lost in hacks on bridges.
(Another aside: the Cosmos ecosystem solves the bridge problem differently. Cosmos uses its Inter-Blockchain Communication Protocol to facilitate swapping between compliant blockchains. The author’s work on a Cosmos-based Web3 currency Dyme uses the IBC Protocol.)
The Advantages of Atomic Swaps
For cryptocurrency traders, atomic swaps have several distinct advantages over using traditional exchanges:
- Decentralization: Atomic swaps are carried out directly between user wallets, eliminating the need for centralized exchanges that can be hacked or become insolvent and charge fees.
- Reduced Counterparty Risk: Since both parts of the swap transaction are bound together, there is hardly any risk that one party won’t fulfill its obligations.
- Cross-Chain Capability: They enable direct trades across different blockchains, which would otherwise be incompatible or require an intermediary.
- Privacy and Security: Atomic swaps can offer enhanced privacy since they don’t require passing through an exchange where personal information is typically needed.
The Challenges and Limitations
Despite their promise, atomic swaps are not without their limitations:
- Complexity: Setting up an atomic swap can be technically complicated, potentially limiting its adoption to those with technical know-how.
- Adoption: For atomic swaps to become mainstream, supportive technology must be widely adopted across various blockchains.
- Liquidity: Compared to centralized exchanges, there may be less liquidity for certain assets currently, making it harder to find a swap match.
- Compatibility: Not all blockchains are currently compatible with the protocols needed for atomic swapping.
- Conversion: Atomic swaps don’t allow conversion from a blockchain asset to a government-issued asset (e.g., you can’t swap BTC for Euros with an atomic swap.)
The Future of Atomic Swaps
Those within the cryptocurrency space closely watch the evolution of atomic swaps as it could lead to much larger implications for how we think about money and value exchange. Atomic swaps could potentially eliminate or reduce reliance on current financial systems and centralized entities, putting power back into the hands of individuals.
Innovation in this area is ongoing, with more projects aiming to make atomic swaps more user-friendly and widely supported across various cryptocurrencies. Layer-2 solutions, like the Lightning Network, seek to boost atomic swap efficiency, making them near-instantaneous while also solving the blockchain scalability problem.
The cryptocurrency industry is developing quickly, and it is still young. Use cases for crypto and blockchain technology are still being implemented at a limited scale, though that scale is growing significantly.
Key Takeaways
Atomic swaps are important to understand as they attempt to create a more frictionless economy. Atomic swaps are limited in what they can do, but they are an attractive option for quick, low-cost transactions where they are suited.
Thus, they represent an important stride towards a decentralized financial environment where users have full control over their assets and personal information. While still emerging and facing technical and adoption hurdles, atomic swaps pave the way for a more interconnected and open blockchain landscape, offering intriguing possibilities for everyone, from casual cryptocurrency users to serious tech investors.
About Dana:
Dr. Dana Love is currently the CTO of Lifetoken Software. He guides the economic engine and blockchain development for Dyme. Love is a 32-year technology veteran active in Bitcoin and blockchain since 2011. From 2018–22, Dr. Love founded and led the blockchain payment platform Radpay, where 500 Startups and the Arizona Commerce Authority recognized him as a fintech innovator. From 2012–18, Dana spearheaded four blockchain ICOs and led different enterprise leadership roles. From 2007–12, as CEO of military contractor Bright Dawn, Dana led the development of complex real-time data systems, big data and data fusion projects, and various digital and kinetic work for the IC, Defense, and civilian agencies. From 1995–2007, Love founded or served in leadership for various firms, including Cisco Investments-backed Metacloud and Warburg Pincus-backed Radnet, and led divisions of public companies, including GTE (now Verizon), Prosodie (now Cap Gemini), and ADC. Dana’s career began in civilian service to the U.S. government. Dana Love holds a doctorate in public policy economics from the University of Glasgow, is a Harvard Business School Baker Scholar, and graduated from the University of Richmond.
