What does ‘Token Swap’ Mean?
The term ‘token swap’ is similar to the financial term ‘currency swap’, which is essentially a futures contract for exchanging one currency for another at a fixed price.
‘Token swapping’ has two main meanings. Broadly, it refers to exchanging one cryptocurrency for another via a smart contract. Another meaning is exchanging a coin from one crypto project for the same coin but on a different blockchain. In this case, it's also called token migration.
How do Token Swaps Work?
Token swaps can happen both within a single blockchain (on-chain) or between two blockchain networks (off-chain). In both cases, a smart contract or even multiple smart contracts are needed for the operation. Swaps can happen on centralized exchanges (CEX) or decentralized exchanges (DEX). Swaps also happen outside exchanges, like transferring tokens from the mainnet to the testnet. Even buying a specific token for Ethereum/USDT is a swap.
Essentially, it's an automated exchange at a fixed price at the time of the operation. The ability to perform this exchange automatically is the main advantage. Here are several possible ways to perform an operation like this.
A classic swap involves exchanging one cryptocurrency for another on a centralized exchange. To perform it, the user needs a verified account on the platform. During the operation, digital assets are under the control of the exchange. In return, the platform guarantees the security of the transaction and protects clients from fraud.
An atomic swap involves instant exchange of one cryptocurrency for another without intermediaries. In this process, coins are transferred between blockchains. In 2013, Tier Nolan described the theoretical side of this process, but the technology became widely used only after 2017. Atomic swaps are carried out using smart contracts and hashed time-locked contracts (HTLC). The transaction can be secured by setting a time frame within which the deal must be closed.
Cross-chain bridges allow assets to be moved between different networks. This technology is suitable for tokens of different standards, and some platforms provide transfers between blockchains using different technologies and L2 solutions.
Swaps on decentralized exchanges happen within a specific liquidity pool. Decentralized exchanges allow these operations without transferring assets to the exchange directly from the user's wallet. To simplify the exchange process, they use automated market makers (AMM) and pools. Sometimes wrapped tokens are used to simplify exchanges from one blockchain to another. Some cold wallet developers have integrated swap functions and the ability to use them on DEX.
There are certain drawbacks to DeFi swaps. Firstly, if the liquidity pool for a pair of coins is low, there will be slippage, and part of the funds will be lost. Secondly, if the token swap smart contract has vulnerabilities, it can be hacked by attackers. This also applies to interchain bridges. The fact is that protocols like this often become victims of cybercriminals.
Token Migration
An important case where the term ‘token swap’ is used is the migration of the same token from one blockchain to another, or ‘token migration’. The blockchain network hosting the token usually changes when a crypto project decides to move from one blockchain to another or transfer its tokens from an external blockchain to its own. Most crypto projects set a specific period for token migration, requiring users to complete the operation within a certain timeframe. Failure to meet this requirement results in losing access to the tokens, as they’re usually burned after the specified period.
The first major token migration case was the Ethereum community split in 2015 due to disagreements between the Ethereum Foundation developers and the community. One outcome of this event was the creation of the Ethereum Classic (ETC) coin, and each ETH holder received ETC in a 1:1 ratio.
During the ICO boom in 2017, many crypto projects raised funds by issuing ERC20 tokens on the Ethereum blockchain. Some of these projects aimed to create their own blockchains, and the process of transferring user-participant ICO coins from the Ethereum network to the project's new blockchain became a basic case for token migration. Token migration can also happen for other reasons, like transferring tokens from one third-party blockchain to another.
One of the largest token swap cases was the BNB exchange. This Binance exchange coin was launched in 2017 on the Ethereum platform, and in 2019, the native Binance Smart Chain (now BNB Chain) appeared. Binance then launched the process of exchanging ERC-20 standard tokens for BEP. However, some holders still keep their BNB on Ethereum, so the swap is not yet complete. Other well-known projects that completed migration from Ethereum to their own blockchains after ICOs include Tron, EOS, Crypto.com, Golem, KIN, and Aeternity. The Ontology platform moved from the NEO blockchain to its own blockchain.
F.A.Q.
Why are crypto swaps needed?
Swaps allow exchanging one token for another without first converting it to fiat. They’re useful for those who need to quickly exchange assets at the best rate or participate in other crypto projects. With an like this exchange, you can choose the required number of tokens for the swap and instantly perform the exchange.
What is needed for a token swap?
A registered wallet supporting the required platform and a sufficient number of tokens considering fees are needed for a swap. The platform itself determines the exchange rate. It's important to choose a platform with transparent conditions and a good reputation to minimize potential risks.
What are the risks of swaps?
High volatility of rates, unforeseen changes in fees, the likelihood of insufficient liquidity, which may prevent the swap from happening at the optimal price. Some platforms may have security issues, so it's important to choose trusted services.
How to choose the best platform for a token swap?
The platform should have transparent conditions, low fees, and a high level of security. Pay attention to trading volumes and liquidity to ensure a profitable swap and the exchange rate at which the swap is made. Study reviews and make sure the platform supports the required number of tokens for the transaction.
