Atomic Swap Meaning
What Is Atomic Swap?
Also known as atomic cross-chain trading, the term atomic swap defines the transfer of digital assets between two parties without involving a third party, such as a centralized exchange (CEX) or market. This mechanism uses smart contract technology to execute transactions.
A major risk with peer-to-peer (P2P) transactions is that one of the parties in the trade does not fulfill their side of the trade. This is what is known as counterparty risk. Atomic swaps eliminate this risk, as the smart contract only releases funds when all the involved parties deposit the predefined amount of crypto to the smart contract. This facilitates P2P transactions without the need for intermediaries to process the transaction. What’s more, atomic swapping also reduces the transaction costs associated with withdrawals, deposits, or trading.
The swaps are atomic due to their indivisibility, implying that the transactions are either executed in full or not – there are no in-betweens. The atomicity ensures token holders retain the integrity of their tokens until the transaction is complete. Technically, the swap is fraud-proof as no individual user can steal the other’s cryptocurrency.
In addition, transferring tokens in CEXs has a lot of inefficiencies attached to it, such as uneconomical fees, unnecessary steps, and potential security threats. DeFi services remove the reliance on intermediaries through atomic cross-chain trading to streamline the process, speed up transaction time, and lower potential security risks.
Lastly, atomic swaps also enable different blockchains to communicate with each other, facilitating interoperability.
How Do Atomic Swaps Work?
Atomic cross-chain trading utilizes hash timelock contracts (HTLC) to automate the swaps. To clarify, HTLCs are time-bound smart contracts between the involved parties that generate a private key and hash functions. Each party must meet the predefined conditions within the specified timeframe for the transaction to be finalized.
An HTLC has two key components – a timelock and a hashlock.
- Timelock – A timelock defines the deadline or time limit for the exchange. It ensures that the transaction takes place within the specified timeframe. Otherwise, the contract aborts the transaction and returns the tokens to their respective owners.
- Hashlock – This is the cryptographic key generated by the individual initiating the transaction. It ensures that the transfer is only executed if both parties acknowledge receipt of the desired tokens. Otherwise, the contract aborts the transaction and returns the tokens to the original owners.