What is Atomic Swap?

Explanation

  • It is when the research in this area took a step forward. Sergio Demian Lerner, a developer, created the first draft of a trustless exchange protocol in July 2012. But Nolan is widely regarded as the developer of atomic swaps because, in May 2013, he provided a full account of a procedure for atomic swaps.The term atomic is a word derived from the field of computer science that here means either that the operation is conducted as programmed or the operation is not conducted.The term swapSwapSwaps in finance involve a contract between two or more parties that involves exchanging cash flows based on a predetermined notional principal amount, including interest rate swaps, the exchange of floating rate interest with a fixed rate of interest.read more means an act of exchanging one thing for another.With the help of atomic swaps, there would be no chance for manipulation, theft, or human error. It is important to note that they do not work with formal currencies. They work only with cryptocurrenciesCryptocurrenciesCryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service.read more.

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How Do Atomic Swaps Work?

  • It enables the parties included to trade directly from one wallet to another without a body acting as an agent or intermediary such as an exchange.In this process of swapping cryptocurrencies from peer to peer, the parties involved would have full control over their private keys.It uses the technology by the name hash timeLock Contracts, which generates the cryptographic hash function that ensures hash locks and timelocks are verified and acknowledged by both parties.

Example of Atomic Swap

  • Let us suppose there are two parties, namely Tim and joy. Tim has bitcoins while joy has litecoins. While Tim wants litecoins, Joy wants bitcoins. Both of them decide to trade with the help of an atomic swap. Tim opens a contract, and a hash is produced when Tim deposits the bitcoinsBitcoinsBitcoin is a digital currency that came into existence in January 2009, speculated to be created by Satoshi Nakamato, whose true identity is yet to be authenticated. It provides lower transaction fees than the traditional online payment systems, is controlled by the decentralized authority, and is not like government-issued currencies.read more to that contract.This hash works like a lock on a safe. Tim also generates value in a data string that acts as a key to retrieve those funds from this so-called safe. He then sends it to Joy so that he can fulfill his side of the transaction of this contract.Joy follows the same steps by depositing his litecoins in the contract address using the same hash that Tim has used. In this way, both funds are locked to the same key. When Tim receives Joy’s litecoins from his address, the key being used is revealed while allowing Joy to retrieve bitcoins from Tim’s address.

Importance

  • Atomic swaps are very important as they open up a horizon of possibilities allowing faster and simpler trading and removing third parties like crypto exchanges between them, which increase the possibility of hacks and transaction costs or might increase the risks of mismanaging funds.Suppose any of the parties to the contract, as mentioned above in the example, fail to confirm the transaction or complete any action within the specified time frame. In that case, the transaction stands void, and there would be no exchange between the parties, which would eliminate theCounterparty risk refers to the risk of potential expected losses for one counterparty as a result of another counterparty defaulting on or before the maturity of the derivative contract.read more counterparty riskCounterparty RiskCounterparty risk refers to the risk of potential expected losses for one counterparty as a result of another counterparty defaulting on or before the maturity of the derivative contract.read more.

Advantages

  • It helps attain more liquidity in the crypto market because the peer-to-peer transactions directly from one’s wallet to another can be processed easily.There are no third parties involved, which reduces the transaction costs and tediousness in settlement transactions.Privacy is protected because of the existence of private keys, encryption, and has functions.It ensures both the parties to the contract fulfill their requirements of the trade so that either the parties honor the contract or the contract itself is voided in its entirety.

Limitations

  • The world of atomic swaps is not fully developed yet. That means not all cryptocurrencies are made available for atomic swapping. Only bitcoins or litecoins are the names being heard predominantly, making it inevitable to peg every transaction to be there in both cryptocurrencies again.Another major complaint would be that this technology requires knowledge and experience in blockchain and programming.The user interface is not user-friendly, making it harder for lay people to adopt it easily.Though it seems secure, there is still a possibility that attacks may compromise the address.

Conclusion

  • Atomic swaps are hence a revolution in the world of cryptocurrency transfer. Sergio Demian Lerner and Tier Nolan are responsible for the same.  As discussed, there would be no third-party involvement, and hence only the parties involved in the swap are responsible for honoring the trade or otherwise.This smart chain technology uses cryptography, hash functions, and timelocks which ensure the swapping is secure and is done in a time frame, but novices may not adopt the user interface.However advantageous it may seem, there is a long way to go, for the mainstream adoption of atomic swaps requires more cryptocurrencies to be involved, rigorously tested software, and much more research. The disadvantages may seem like small barricades over the advantages attached to them.

This has been a guide to What is Atomic Swaps and its Definition. Here we discuss the importance of atomic swaps and how it works, along with their advantages & disadvantages. You can learn more about it from the following articles –

  • What is Share Swap?Equity SwapsSwap RateAsset Swap