An atomic swap is a method that allows people to exchange cryptocurrency across different blockchain networks without any intermediaries. Instead of relying on a third-party platform like an exchange, users can trade coins or tokens directly from wallet to wallet through a time-locked smart contract that acts as a “virtual vault.” This contract ensures that the trade only occurs once both parties deposit the previously agreed-upon amount into the vault — if not, the transaction cancels.
Atomic Swap Definition
An atomic swap is a peer-to-peer trading method that uses smart contracts to enable direct cryptocurrency exchanges between different blockchains, without involving third-party intermediaries or centralized exchanges.
Crypto traders use atomic swaps to avoid transaction fees and tedious know your customer (KYC) processes often required by exchange platforms. As a decentralized alternative, atomic swaps allow traders to maintain full control over their coins and private keys, while reducing the risk of fraud, theft or human error.
What Is an Atomic Swap?
An atomic swap is a smart contract-based mechanism that enables two users to directly exchange different types of cryptocurrencies from separate blockchain networks. This trust-free trading method ensures that transactions between two strangers are carried out as planned. In other words: Atomic swaps are either fully completed or not executed at all, eliminating the risk of one party defaulting — hence the name “atomic.”
Atomic swaps are one of the only mechanisms that allow cross-chain interoperability without the need to wrap tokens, use a specialized wallet with built-in swap functions or rely on centralized exchanges, liquidity pools or over-the-counter brokers. By removing third parties from the process, and instead relying on automated protocols that self-execute once conditions are met, atomic swaps take intermediary fees and human error out of the equation. With full control of their private keys and funds, users enjoy more privacy with minimal exposure to third-party oversight, data tracking and bad actors.
How Do Atomic Swaps Work?
The main component of an atomic swap is a hashed timelock contract (HTLC), a type of smart contract functioning as a virtual vault, locking the funds of both parties until they can provide proof that all conditions have been met within a specified time frame. Hashed timelock contracts use private keys, or preimages, and cryptographic hashes to control access to funds, and are bound by time and the conditions set by each participant.
Here’s how an atomic swap typically plays out:
- Two parties agree to trade different cryptocurrencies, such as Bitcoin for Litecoin, specifying the amounts, exchange rate and time frame in which the transaction should be completed.
- After the contract conditions are agreed upon, the first participant locks their funds in a virtual vault by creating a hashed timelock contract on the blockchain network of the cryptocurrency they are trading — let’s say Bitcoin. The participant generates a private cryptographic key, known as a preimage, and computes its hash, which is embedded into the HTLC as the condition required to unlock the funds.
- Once submitted, the contract is recorded on the blockchain as part of the transaction, making it publicly accessible to anyone, including the second participant.
- The second participant verifies the amount and then locks their funds in a separate HTLC on their native blockchain, such as Litecoin, using the hash of the first participant's private key (preimage).
- Using their secret key, the first participant unlocks the HTLC to claim the Litecoin. This action simultaneously reveals the preimage to the second participant, who can then use it to unlock the Bitcoin stored in the first participant's hashed timelock contract.
If at any point one of the participants walks away from the exchange or fails to complete their end of the deal within the allotted time frame, the contract is void and all deposited funds are returned to the respective wallets of their original owners.
Are Atomic Swaps Anonymous?
Atomic swaps are not inherently anonymous, as all crypto transactions are recorded on the immutable public ledger of their respective blockchains — meaning they can be traced. However, they offer more privacy than centralized exchanges or custodial services because they enable direct peer-to-peer trades without intermediaries. Swaps involving privacy-focused coins, like Monero or Zcash, can enhance the anonymity of a transaction, but won’t guarantee it.
Advantages of Atomic Swaps
There are several reasons why crypto traders turn to atomic swaps.
Cross-Chain Interoperability
Crypto traders use atomic swaps primarily because they make it possible to exchange different cryptocurrencies across various blockchain networks without relying on a centralized exchange. This expands market access, increasing the liquidity of tokenized assets, while also offering greater control over funds.
Trustless, Low-Risk Transactions
Atomic swaps are all-or-nothing exchanges. Their main component, the hashed timelock contract, guarantees that transactions are either fully completed or canceled entirely. Because the protocols are automated and only unlock when both parties meet predetermined criteria, trust between participants isn’t necessary, allowing transactions to happen seamlessly between strangers.
More Privacy
Since atomic swaps occur directly between peers, forgoing intermediaries altogether, they reduce exposure to third parties typically involved in centralized exchanges. Additionally, swaps involving platforms like the Lightning Network, which only records the final balance of bundled transactions settled off-chain, or privacy-focused cryptocurrencies like Monero or Zcash, can further obscure transaction details. Complete anonymity is never guaranteed, though.
Lower Fees
Atomic swaps aren’t exactly fee-less — but their associated costs are a fraction of what’s charged by a centralized exchange. Crypto traders using an exchange platform will incur trading, withdrawal and deposit fees, and have to relinquish control over their deposited coins to the exchange. In contrast, atomic swappers only pay a transaction fee when locking their funds into a smart contract.
Disadvantages of Atomic Swaps
Still, there are some drawbacks to atomic swaps that may lead crypto traders to seek out alternative methods.
Limited Compatibility
Atomic swaps require compatibility between all blockchains involved in the transaction. This means that, in order for an atomic swap to work, these blockchains must use the same hashing algorithms and smart contract features. This restricts atomic swapping to only certain cryptocurrencies and their possible combinations.
Complex Setup
Setting up and executing atomic swaps requires technical knowledge and understanding of smart contracts, which may be challenging for average users. And that’s after the lengthy process of negotiating the terms.
Scalability Issues
One atomic swap involves multiple blockchain transactions. As a result, factors like transaction size and network congestion may cause the exchange to take longer or become more expensive than expected. The multi-step factor alone eats into an atomic swap’s ability to handle large volumes of transactions or high-frequency trading, as each swap requires time and confirmation on every blockchain involved.
Frequently Asked Questions
Is atomic swap safe?
Yes, atomic swaps are considered safe. They use smart contracts and cryptographic hashes to secure the transaction, guaranteeing it will either be completed as planned or canceled entirely.
Can atomic swaps be traced?
Yes, atomic swaps can be traced on the blockchain, as all transactions are recorded on a network’s public ledger. Without third-party involvement, atomic swaps are generally considered more private than those conducted on centralized exchanges.
What is the main advantage of atomic swaps?
Atomic swaps are a low-cost, trustless trading method that allows peers to exchange cryptocurrencies directly across different blockchains without the need for third-party intermediaries or centralized exchanges.
