We have previously discussed the ability to exchange cryptocurrencies via a trusted decentralized third party know as a DEX, but in this post, we aim to explain how cryptocurrencies can be exchanged without the need of a trusted third party through what is known as “atomic swaps”. Even more unlike DEXs, atomic swaps can occur between cryptocurrencies hosted on different blockchains. Hence, they are also known as atomic cross-chain trading. How is this possible without trust?
Atomic-swaps are able to do this through the utilization of a smart contract that restores holdings to the originating owners if not all terms are satisfied. The name is derived from the all-or-none approach that is indivisible, hence “atomic”. These swaps, usually both quantity and time sensitive, guarantee an efficient and fair exchange with minimal to no slippage in value between entry and execution. How does it work?
First and foremost, the blockchains supporting the cryptocurrencies must be capable of supporting smart contracts capable of implementing the atomic swaps. Often times atomic-swaps utilize a hash time-locked contract (HTLC), a smart contract that guarantees the funds will be swapped and receipt confirmed by a specific time. If all parties do not confirm receipt of the correct quantity of the new cryptocurrency within the specified timeframe then the HTLC cancels the swap and refunds participants. So, besides this being new and innovative technology, why would anyone use an atomic swap over a DEX?
Well, there are several reasons why individuals would want to utilize an atomic swap over a DEX or a traditional exchange:
- No slippage due to low liquidity for larger orders
- No amount based fee or commission for filling the order
- Fewer attack vectors
- Ability to exchange between pairs not offered on an exchange
- Asset not offered by exchanges allowing users from your country access
- Greater privacy
- Greater security of funds
- The fastest process from exchange to custody
Both ZCash and Decred released atomic swap tools in 2017, and the Lightning Network was released in March of this year by Lighting Labs. The Lightning Network is a second layer payment protocol, many view as a Bitcoin scaling solution- due to its claims of instantaneous transactions without mining fees. The Lightning Network allows for cross-chain trading between network nodes for supported currencies. Kyber Network, another player, is attempting to serve as a mechanism for atomic swaps between supported Ethereum tokens through creating an on-chain liquidity pool posting transactions to Ethereum Mainnet. We expect to see many more atomic swap tools emerge in the coming years.
This style of technology is very exciting as it allows for the maximum of flexibility for the end user — they have the ability to swap anything for something else at a fair rate as long as the items to be exchanged are agreed upon. Everest continues to evaluate this exciting technology as a potential feature to add to the EverWallet product offering in the future.