Bitcoin Atomic Swaps: What Are They & How Do They Work?

While decentralized exchanges enable you to swap tokens on the same blockchain in a trustless manner, they don’t typically allow you to exchange one cryptocurrency for another from a different blockchain. For that, you typically have to use a centralized exchange, which involves the cumbersome process of registering an account, completing KYC, and funding your exchange wallet. 

Fortunately, there is an easier way to trade crypto assets across different blockchains. That’s where atomic swaps come in!

Read on to learn what atomic swaps are and how they work.

Atomic swaps are an innovative method of exchanging cryptocurrencies directly with one another across chains without the need for a centralized intermediary such as a crypto exchange. 

An atomic swap can occur on-chain (directly on the blockchains involved) or off-chain (using layers like the Lightning Network). 

The key advantage of atomic swaps is that you don’t have to trust anyone else with your assets. Neither of the parties relinquishes ownership of their funds until the swap is complete, and no centralized exchange is required to process the trade. 

These swaps are called “atomic” because they are designed so that they either execute fully and successfully or not at all. That is, an atomic swap is a single, indivisible unit, analogous to an atom being the irreducible building block of matter.

Bitcoin atomic swaps rely on cryptography and scripts to ensure that cross-chain transfers are safe and don’t require a third party. 

Here’s a simplified breakdown of how an atomic swap works:

1. Initiation: Let’s say you want to trade bitcoin (BTC) for someone’s litecoin (LTC). You (Alice) first generate a random value v, and a hash of this value h(v), and send h(v) to Bob. 
2. Locking funds: You then create a Hashed Time-Locked Contract (HTLC) on the Bitcoin blockchain, where you lock your BTC. This contract states that Bob can only get the BTC if he provides the secret value within a certain time. If not, you simply get your BTC back.
3. Counter transaction: After observing the transaction, Bob creates a similar HTLC on the Litecoin blockchain with the same conditions to lock his LTC.
4. Revealing the secret: In order to get the LTC, you have to disclose the secret value. For this, you send a transaction on the Litecoin blockchain. This reveals the secret value v to Bob.
5. Completing the swap: Once the secret number you provided has been shared, Bob finalizes the transaction on the Bitcoin blockchain to get the funds you locked. This way, when you disclose the secret value, Bob can use it to get the BTC without having to trust you. 

Therefore, the swap is performed with both parties remaining anonymous and without the requirement of trust, as both have employed the same secret number for the release of the respective currencies.

This process ensures that either both parties complete the trade or the trade is not completed at all, thus making it a secure method of exchanging cryptocurrencies.

Atomic swaps provide unique benefits but also face specific challenges. Let’s take a look at them. 

Benefits

• Trustlessness: You don’t need to trust the other party. HTLCs ensure that either both transactions are completed or neither is, eliminating the risk of fraud.
• Decentralization: Atomic swaps don’t compromise the decentralized nature of cryptocurrencies since they don’t require central exchanges that can be hacked or banned.
• Lower costs: Without intermediaries, you can avoid the fees and commissions that crypto exchanges typically charge for trades.
• Increased privacy: Atomic swaps are more privacy-conscious than centralized exchanges, which ask for user information and identification.

Drawbacks

• Complexity: Atomic swaps can be quite complex due to the need for knowledge about smart contracts and blockchains.
• Limited support: Although atomic swaps enable the trading of various cryptocurrencies, not all of them are compatible with the required features, meaning that the choice of assets is currently restricted.

Time constraints: The time lock aspect of HTLCs is inflexible and may not be suitable for volatile markets that require quick actions.

Atomic swaps are expected to help in the integration of cross-chain functionality of various blockchains, boosting blockchain interoperability. 

By allowing direct and trustless asset swaps, Bitcoin atomic swaps can contribute to the growth of Bitcoin as more liquidity can flow into the broader Bitcoin ecosystem. 

A key issue in today’s market is the fragmentation of liquidity across different exchanges and platforms. Atomic swaps can address this by enabling you to exchange assets straight from your wallet, which may remove the need to have multiple accounts across various centralized exchanges.

However, the technology is still in its nascent stage, and issues like complexity and lack of asset support are still a problem. 

It will be interesting to see how user behavior will lead to the adoption of atomic swaps or whether cross-chain bridges or other near-trustless rails will drive interoperability between Bitcoin, Bitcoin layers, and other blockchain ecosystems. 

BitcoinOS, a new Bitcoin layer pioneered by Sovryn, is arguably the most promising solution to take interoperability to a new level.

Once it launches later this year, the smart layer will enable interoperability between Bitcoin and Ethereum thanks to EVM compatibility and enable interoperability across decentralized applications (dapps) due to its interoperable Bitcoin rollups.

What is the difference between atomic swaps and bridges?

Atomic swaps and bridges have the same goal but are implemented in different ways. Atomic swaps are transactions that allow for direct peer-to-peer exchange of one cryptocurrency for another without the use of a centralized exchange. Blockchain bridges, on the other hand, enable cross-chain transfers of assets using wrapped tokens or centralized or semi-centralized entities to manage the process.

Are atomic swaps trustless?

Yes, atomic swaps are intended to be trustless. They use smart contracts to ensure that the trade is completed by both parties or not at all without the need for a trusted third party to process the swap. 

How to do an atomic swap?

In order to conduct an atomic swap, both parties must be using a compatible wallet that supports HTLCs and the two cryptocurrencies chosen. The process usually involves creating a secret value, creating hash-locked transactions on both blockchains, and then disclosing the secret to perform the swap.