What Is an Atomic Swap? Definition, Meaning & How It Works

Atomic swaps are a new kind of blockchain technology that allow users to directly exchange cryptocurrencies across blockchains. While the systems that support these swaps can be difficult to build due to their immense complexity, they have significant potential to remove centralized intermediaries from the industry.

In this guide, we will explore the concept of atomic swaps, understand their essence, how they work using smart contracts, the story behind the first successful atomic swap, and the significance they hold in achieving a more decentralized and interoperable crypto ecosystem.

What Is An Atomic Swap?

Atomic swaps, also known as atomic cross-chain swaps, enable the direct exchange of cryptocurrencies between two parties with clear rules, ensuring that the trade is either completed fully or automatically canceled. If anything goes wrong with the swap, the coins are immediately returned to the parties.

The purpose of atomic swaps is to eliminate the reliance on centralized intermediaries such as centralized exchanges (CEX), giving complete control of tokens to owners through the secure and decentralized operation of smart contracts.

This could be an especially important innovation in the crypto market for two main interconnected reasons: decentralization and security. Crypto bridges, which often rely on centralized third parties to secure funds and transactions, are major targets for hacks and exploits, and billions of dollars have been stolen from them in the past. Atomic swaps could make the process of swapping tokens between blockchains both decentralized and secure.

The History of Atomic Swaps

Atomic swaps were first proposed around 2012, with multiple developers and cryptographers contributing to the technology over the years. However, the developer Sergio Demian Lerner is typically credited for laying the groundwork for the concept. Like many new ideas in the worlds of mathematics and cryptography, atomic swaps weren’t fully put into practice for many years.

On September 20, 2017, the Decred cryptocurrency development team reportedly executed the first successful live atomic swap between Decred (DCR) and Litecoin (LTC). This achievement became possible due to the prior efforts of Decred developers who implemented Hashed Timelock Contracts (HTLCs) functionality into their blockchain.

On September 22, 2017, Charlie Lee, the creator of Litecoin, tweeted about the successful completion of an atomic swap test between Litecoin and Bitcoin (BTC), and vice versa.

Did a cross-chain atomic swap with LTC/BTC! 😁
10 LTC for 0.1137 BTC with @JStefanop1. ⛓️⚛️💱https://t.co/vXwTNirk0Jhttps://t.co/3NTplBOoW9 pic.twitter.com/DRKaHg4Wc7

— Charlie Lee Ⓜ️🕸️ (@SatoshiLite) September 22, 2017

The success of these initial tests opened the door for more blockchains and decentralized exchanges to explore and implement atomic swaps, showcasing the viability of direct, intermediary-free exchanges between cryptocurrencies from different blockchains.

How Do Atomic Swaps Work?

Atomic swaps facilitate the direct exchange of cryptocurrencies between two parties using special smart contracts known as Hashed Timelock Contracts (HTLCs).

The process begins when both parties agree on the assets, amounts, and time limits for the swap across two different networks. One party generates a secret code and uses it to create a cryptographic hash, which can only be unlocked by someone who knows the secret code. This hash is subsequently embedded into HTLCs on both blockchains.

The same party then locks their funds into an HTLC using this hash.  Once the second party has verified that the funds are locked correctly,  they lock their own funds into their corresponding HTLC on the other blockchain. When either party redeems the locked funds, they have to reveal the secret code on-chain. This allows the other party to claim their corresponding funds. These contracts also have time limits built in, so this all must be done within the allotted time.

Assuming both parties complete the process within the time limit, both parties receive their new funds. If either party fails to do so, the HTLCs automatically refund the locked assets to their original owners. This is why atomic swaps are considered “all-or-nothing” settlement transactions.

Examples of Atomic Swap Platforms and Wallets

These are some of the most popular platforms that are implementing atomic swaps:

• AtomicDEX: This is a multi-currency wallet, bridge, and atomic swap platform that enables decentralized exchanges between more than 500 cryptocurrencies across different blockchains.
• Lightning Network: This Bitcoin Layer 2 payment network enables off-chain atomic swaps, outside of the main blockchain.
• LNSwap: This protocol, developed by Trust Machines, enables trustless atomic swaps between Bitcoin and the Stacks ecosystem.
• Liquality: This wallet supports atomic swaps between Bitcoin, Ethereum, and ERC-20 tokens. Allows swapping these cryptocurrencies without going through centralized exchanges.

Why Are Atomic Swaps Important in Crypto?

Even though atomic swap technology is still in its early stages, it could be an important innovation across the cryptocurrency market. The power of fully decentralized, peer-to-peer swaps that can exchange coins across totally separate blockchains is not lost on crypto enthusiasts.

Interoperability remains one of the crypto industry’s biggest problems for two main reasons. Firstly, there are a few solutions that effectively and seamlessly connect even the biggest blockchains. Secondly, many of the existing solutions we have today, including cross-chain bridges, are major points of failure. They often require a trusted third party to mediate between the decentralized protocols. If such an important piece of the market is still centralized, it can affect the entire ecosystem.

Atomic swaps enhance transaction security and decentralization by relying on self-executing, all-or-nothing settlement smart contracts that anyone can audit. This reduces the risks of swaps because if one party fails to complete the exchange within the stipulated time, the transaction is automatically canceled and the funds are returned to both parties.

However, we shouldn’t get too carried away about the potential for atomic swaps. As we will detail below, the tech has a variety of rather significant limitations that prevent it from becoming the answer to all of the market’s interoperability problems. For example, it suffers from inefficiency, poor liquidity compared to decentralized exchanges, and technical complexity.

Benefits and Limitations of Atomic Swaps

Now, let’s detail the main benefits and limitations of atomic swaps.

Benefits of Atomic Swaps

Here are the main benefits and advantages of atomic swaps in the crypto industry.

• Decentralization: Direct user-to-user transactions eliminate reliance on centralized intermediaries like exchanges and bridges, enhancing decentralization.
• Security: Atomic swaps use all-or-nothing settlement, which returns funds to both parties if the transaction fails or something goes wrong.
• Reduced fees: The peer-to-peer nature allows users to avoid high exchange fees, though regular network fees must still be paid.
• Self-custody: Users retain full control of their private keys throughout the process.
• Interoperability: Atomic swaps enable direct exchange between diverse blockchains, promoting ecosystem integration.

Limitations of Atomic Swaps

• Reduced speed: Atomic swaps are typically slower than DEX swaps as they require multiple transactions and confirmations with built-in delays required for all-or-nothing settlement.
• Complexity: These swaps are technically complex, requiring multiple steps, which could make it too confusing for less technical users.
• Limited support: Because of their complexity, many blockchains, wallets, and platforms don’t yet support the tech.
• Low liquidity: Most liquidity is concentrated in centralized and decentralized exchanges, and atomic swaps have to directly match individual users instead of using pooled liquidity.

What Is the Future of Atomic Swaps?

Atomic swaps represent a significant advancement in the realms of interoperability and decentralized exchange within the crypto ecosystem. As technology continues to evolve and mature, atomic swaps are likely to become more accessible and widely adopted.

However, they still face challenges related to technical complexity and the absence of user-friendly interfaces for the average user. These challenges must be addressed to achieve broader adoption and fulfill the decentralization vision that underpinned the creation of Bitcoin.