While having been on the cryptocurrency scene for some years, there is a great deal of misunderstand as to the mechanics and utility of Atomic Swaps.
What Is an Atomic Swap?
Atomic swaps involve the direct exchange of cryptocurrencies between distinct blockchain networks in a peer-to-peer (P2P) manner, without the need for an intermediary such as a cryptocurrency exchange. The term “atomic” refers to the indivisible nature of the swap – either the entire transaction takes place, or nothing happens at all. Atomic swaps are a significant advancement in the world of blockchain and cryptocurrencies as they enable decentralized peer-to-peer trading without the need for intermediaries like exchanges.
Atomic Swaps are defined by three (3) key characteristics:
- Smart Contracts: Atomic swaps utilize smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. Smart contracts facilitate and automate the exchange process.
- Hash Time-Locked Contracts (HTLCs): HTLCs are a type of smart contract used in atomic swaps. They involve time locks and cryptographic hash functions to ensure that the swap occurs correctly and without the risk of one party not fulfilling their part of the deal.
- Cross-Chain Compatibility: Atomic swaps are typically used to exchange cryptocurrencies that are based on different blockchain networks. The participating blockchains must support similar cryptographic hash functions and scripting capabilities to enable atomic swaps.
Atomic Swap Mechanics
At first glance, the process of arranging for an Atomic Swap seems long and complicated – I point I will address below, but the general process involves:
- Two parties agree to exchange cryptocurrencies using an atomic swap.
- A smart contract is created that outlines the terms of the swap, including the amount of cryptocurrencies being exchanged and the time window for the swap to occur.
- Each party then creates a transaction on their respective blockchain network, locking up the funds they intend to exchange in a way that the other party can only access once the conditions of the swap are met.
- The smart contract also includes a cryptographic hash of a secret that only one of the parties knows.
- Once both transactions are locked, the party who knows the secret reveals it, allowing the other party to claim their funds. If the secret is not revealed within the specified time, the swap is canceled, and the locked funds are returned to their original owners.
Atomic swaps enable peer-to-peer (P2P) transactions in a fully trustless fashion, eliminating the necessity for any form of third-party involvement or centralized infrastructure to facilitate these exchanges.
The current challenge within the cryptocurrency space lies in achieving interoperability among various assets. Atomic swaps offer a solution by uniting users from diverse coin communities, enabling seamless interaction. This technology introduces a “currency agnostic” aspect to the crypto ecosystem . As individuals with different cryptocurrency holdings can now engage with one another, the likelihood of embracing diversified portfolios instead of relying solely on a handful of coins is notably increased.
Other advantages of Atomic Swaps include:
- Trustless Transactions: Atomic swaps eliminate the need for a trusted third party, such as a centralized exchange, to facilitate the exchange of assets. This reduces counterparty risk and enhances the security of transactions.
- Decentralization: Atomic swaps align with the principles of decentralization, enabling peer-to-peer trading without relying on intermediaries. This empowers users to maintain control over their assets and transactions.
- Security and Privacy: Atomic swaps use cryptographic techniques to ensure that transactions are executed as intended or not at all. This eliminates the risk of one party not fulfilling their side of the bargain. Moreover, atomic swaps can be designed to occur without revealing sensitive transaction details to the public, enhancing privacy.
- Reduced Fees: By bypassing the fees associated with centralized exchanges, atomic swaps can potentially lead to lower transaction costs for users.
- Cross-Chain Compatibility: Atomic swaps allow for the exchange of assets across different blockchain networks, enabling interoperability and facilitating transactions between cryptocurrencies that may not have direct trading pairs on exchanges.
- Currency Conversion: Atomic swaps can be used to perform currency conversion between different cryptocurrencies. This could be especially useful for users looking to diversify their cryptocurrency holdings or for cross-border transactions.
At present, the primary limitation of Atomic Swaps is of a technical nature. For cryptocurrencies to engage in atomic swaps, a prerequisite is the shared utilization of a hash algorithm. Additionally, both cryptocurrencies need to support the initiation of hashed timelock contracts (HTLCs) featuring specialized programming capabilities. At present, these specific criteria serve as significant constraints, effectively narrowing down the range of cryptocurrencies eligible to participate in such swaps.
In addition, the current speed of Atomic Swaps calls into question its ability to be used as a long term solution. The current form of atomic swap requires substantial refinement and enhancement before it attains the speed necessary to manage significant data volumes effectively. In fact,
Atomic swaps require confirmations on both blockchains involved in the exchange, which can lead to slower transaction times compared to some centralized exchanges that offer near-instant trades.
Atomic Swaps & Cross-Border Payments
Atomic Swaps have not gained significant traction for use in money transfers or remittances. While Atomic Swaps offer a trustless and decentralized method for exchanging cryptocurrencies across different blockchains, their adoption for practical financial use cases like remittance has been limited for several reasons:
- Currency Conversion: Atomic swaps are primarily designed for exchanging cryptocurrencies, not traditional fiat currencies. Money transfer and remittance often involve the conversion of fiat currencies, which would require additional steps and complexities to integrate with atomic swaps.
- Liquidity and Accessibility: Successful atomic swaps require matching counterparties on both sides of the trade. Achieving the necessary liquidity and accessibility for different currency pairs, especially for less popular cryptocurrencies, can be challenging.
- Alternative Solutions: The cryptocurrency and blockchain space has seen the emergence of various solutions tailored for cross-border money transfers and remittances, such as stablecoins, blockchain-based payment networks, and remittance-focused cryptocurrencies. These alternatives might offer more straightforward and user-friendly options for these use cases.
Thus, at present, Atomic Swaps exist more as one-off, peer-to-peer transaction rails. If a platform such as Circle – which relies heavily on intermediary dealers for cross-border transactions, were to emerge and technological barriers overcome, one could envision Atomic Swaps being a viable, cost effective mode of cross-border payments.
Regulation of Atomic Swaps
To date, there has been no significant attempt to regulate Atomic Swaps – nor has any regulatory enforcement actions been taken against promoters or participants in Atomic Swaps.
However, as Atomic Swaps typically involve the exchange of cryptocurrencies across different blockchains, the regulatory treatment of Atomic Swaps may vary globally. Some countries consider cryptocurrencies as commodities, some as securities, and others as a form of digital or virtual currency. The legal classification of the assets being exchanged through atomic swaps could have regulatory implications. For example, if the tokens being exchanged through atomic swaps are considered securities, they could be subject to securities regulations as the Atomic Swap would appear to be a regulated security-based swap.
While not new on the crypto scene, Atomic Swaps nevertheless show long term promise and can currently provide immediate benefits to those seeking trustless, private cross-chain transactions.
My company offers services related to payment systems architecture, crypto product development and crypto licensing , including Atomic Swaps. Be sure to reach out should you have any questions.
Otherwise, you can book a meeting here.
About Adam Tracy
Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.
Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor – both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.
In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.
Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, Hollywood Reporters, CNBC, Reuters, CoinDesk, and Bitcoin.com.
Find Adam: https://linktr.ee/adamtracy
Blockrunner, LLC., is a financial services match-making marketplace and consulting company. We are not a bank, FI/NBFI, Payment Service Provider, deposit taking institution, trust, or money services business of any kind. We are not regulated by any financial regulator. Banking, Payment, Processing, and Licensing services are provided by our participating members. This website is for informational purposes only and does not constitute legal advice. If you need legal advice, please consult a licensed attorney in your jurisdiction.