You may have heard of a Token Swap, they have become an essential part of operating within crypto. A Token Swap is when a holder of cryptocurrency exchanges one token for another across different blockchains. Completing a Token Swap before there were dedicated platforms was a complicated multistep process unlike now where a single transaction is all it takes to complete a swap.
What are token swaps and how do they work?
A Token Swap is when you perform swaps on the same or different blockchains. Through smart contracts that automatically execute the transaction. A token swap might happen when a project uses a blockchain such as Ethereum to raise funds and then token swaps these tokens to another blockchain they might be running on such as Solana.
Before token swapping platforms such as Uniswap existed, if a user wanted to trade Token A for Token B they had to first identify an A/B pairing, if no pairing was available then exchanging the token for fiat currency was a necessary intermediary step which results in more transaction fees and loss in profits for the user.
With platforms such as Uniswap or Pancakeswap the transaction speed and cost is very fast and kept low as there is no multi-step process to complete, it is all done for you. However, with low liquidity tokens, there might be high slippage involved when trying to conduct a transaction.
There are a few different types of Token swaps such as Cross-Chain Bridge Swaps, Automated Market Maker (AMM) swaps and Atomic Swaps:
Cross-Chain Bridge Swaps
A Cross-Chain Bridge swap bridges the gap between different blockchain networks, this type of swap enables users to swap tokens from one blockchain network to another without the need for centralised exchanges or multiple transactions. One example would be exchanging Ethereum for Solana. One of the most well-known examples of a Cross-Chain Bridge is Wormhole.
Automated Market Maker
An Automated Market Maker (AMM) uses an algorithm to determine the price of the assets being traded based on supply and demand. This can be on the same blockchain or cross-chain.
Popular DeFi platforms such as Uniswap and PancakeSwap use AMM. When there is a trade the algorithm uses a mathematical formula to calculate the price based on the ratio of tokens in the liquidity pool, the price of the tokens changes dynamically as liquidity changes. This means that token swaps could provide users with more favourable prices than a centralised exchange.
Atomic Swaps are automatic exchange contracts that allow two parties to trade from different blockchain networks, without the need for centralised exchanges. Atomic Swaps use smart contracts and cross-chain compatibility to ensure both parties are able to receive the correct agreed amount of tokens by locking the funds of both parties until the transaction is completed.
Token Swaps in DeFi
Within the DeFi ecosystem Token Swaps play a crucial role, offering users a simple and efficient way to exchange cryptocurrencies as well as offering lending platforms. There are two well-known decentralised exchanges that use AMM they are Pancake Swap which is on the Binance Smart Chain and Uniswap which is on the Ethereum Blockchain.
There is also Curve which is a platform that focuses on stablecoin swaps providing users with a more efficient and cost-effective way to swap stable coins. Furthermore, there are bridging protocols that allow you to exchange cryptocurrencies between different blockchains, RenVM is a bridging protocol and is used by swaps platforms. Smart contracts allow the different decentralised exchanges to conduct these transactions without the need for a centralised authority.
Increasingly Token Swaps are becoming very important within the cryptocurrency ecosystem. Token swaps which are facilitated by smart contracts enable swaps in a single transaction, and thus token swapping platforms help to give users complete control over their assets.
The token-swapping process is much easier now that different platforms allow for this, with lower fees and faster transaction times. AMM, Atomic Swaps and Cross-Chain Bridge Swaps help to play a key role within DeFi, allowing users to trade tokens on the same blockchain, or a different blockchains, with each having their own strengths depending on what type of swap you want to do, they are essential within the cryptocurrency ecosystem and will help to fuel further growth.
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This article is intended for educational purposes and is not financial advice.