Despite the fact that at the dawn of development, blockchain (initially designed mostly for Bitcoin) perfectly managed with primary tasks within the same ecosystem, time has shown that the possible use case of it is much wider. Thus, according to their ideas and needs, users started to create their new blockchains. And today there are many separate blockchain platforms, ranging from the first-generation blockchain type Bitcoin to the third-generation like Avalanche. All of these projects have separated and isolated chains with their limitations in terms of scalability and innovation within ecosystems. Then there is a major problem of exchanging assets or trading cryptocurrency designed on different protocols.
Despite the capabilities provided by platforms such as Ethereum, where tons of decentralized chains running on its protocol are compatible and can easily interact in exchanging cryptocurrencies, assets, and trades, they are still isolated from other platforms. The exchange issue is still open and there is no freedom to exchange tokens running on different protocols. So what if you want coins on one blockchain and have coins on another system. This is where cross-chain swaps come in handy.
What Is a Cross-Chain Swap?
A cross-chain swap, also known as an atomic swap, is a completely decentralized smart contract technology of exchanging two different cryptocurrencies that run on their own blockchain without any escrow or intermediary. In other words, it allows users to swap different crypto between two chains directly.
To better understand the basic principle of these online crypto swaps, consider the following example. Each country has its legal means of payment. Dollars cannot be used in China and yuans in America. That is, currency systems are independent of each other, and different ecosystems of blockchains are also independent. Without using the cross-chain you cannot transfer BTC directly to ETH, since there is no interoperability between these assets.
In the traditional financial system, this problem is solved by automatic currency conversion. So if two people (one with USD and the other with CNY) want to exchange their currencies for each other, each of the parties can give the other the number of coins equivalent to the change according to a certain rate. For example, $ 100 would be equivalent to about ¥ 636,099.
The same happens with crypto, cross-chain swap allows individuals to exchange tokens (BTC for LTC, for example, as Charlie Lee first did in 2017 and explained the mechanism of cross-chain swap) with crypto holders of different chains. Moreover, the crypto swap takes place directly at the wallet, fastening the process.
How Does Cross-Chain Work?
As it’s been said before, cross-chain swaps use smart contacts, enabling the exchange of two different tokens running on single blockchains. These smart applications are called Hash Time Lock Contracts (HTCLs), which lock the assets with a key within a specified time to ensure that each party consents. To reduce the counterparty risk the HTCL protocols have two main features:
Hashlock technology allows smart contracts to lock the deposits with a hash key. When the transaction on both ends is verified, each participant gets a hash key and exchanges them to unlock the coins.
Timelock system sets time limits to secure the operations in the blockchain. The transaction is executed if deposits are made within a timeframe. If not the deposited amounts are returned.
Advantages of a Cross-Chain Swap
Today decentralization is a world high trend, and many upcoming blockchains are being introduced. Cross-chain swaps provide a multi-cryptocurrency exchange and independence on centralized or decentralized exchanges.
HTCL smart contracts technology provides improved security and guarantees users a refund if something goes wrong.
Cost-friendly P2P Transactions
As no centralized network manages the protocol, there are no high switching fees and no need for compliance like registration, KYS, finding a reliable exchange, and more. That's the way how you can save funds and time on swapping your coins.
Cryptos still outstrip traditional forms of investments in the long run and are an excellent means of hedging wealth. High interest in DeFi brings in more and more investors. In contrast with a centralized exchange system, cross-chain swaps give users the freedom of discovering previously inaccessible markets by dealing with different isolated currencies fast, safely, and without intermediaries. Due to this, organizations nowadays prefer a decentralized system, with blockchain-based solutions developed on multiple protocols. Positive competition and decentralization between them will ensure the profitable development of cross chains, as well as make many digital assets very flexible in their application. All in all, the general idea of the growth of the audience of crypto through simplification makes cross-chain protocols the logical choice.