Crypto-to-crypto swaps, explained.
What are crypto-to-crypto exchanges?
A crypto-to-crypto swap is a direct exchange of one currency for another at the current market rate. Unlike traditional exchanges, which require fiat currency deposits and lengthy processing, crypto-to-crypto exchanges facilitate seamless exchange.
Swaps play an important role in enhancing the liquidity and efficiency of currencies. The feature allows users to exchange their cryptocurrencies with other coins in their wallets, increasing the efficiency of the ecosystem as a whole and reducing the risk of censorship or regulation.
Thanks to Swap, users can multiply their crypto holdings, take advantage of new investment opportunities and easily exchange between cryptocurrencies without saving fiat.
Is Crypto Exchange Better Than Trading?
Newbies in the field of cryptocurrencies may consider the terms “exchange” and “trading” synonymous. However, while the result may be the same, the process is different.
In crypto trading, trades are made based on the order book by limiting the pairs available on the exchange. Typically, trading involves first exchanging crypto for fiat currency and then buying another coin using fiat. This process results in the trader paying a commission at each stage: first, selling cryptocurrency and second, buying another coin.
Exchanges, on the other hand, allow for seamless exchanges between cryptocurrencies. The process happens simultaneously, first eliminating the need to convert crypto to fiat and then, buy another currency. Exchange allows users to exchange one asset for another.
How do crypto-to-crypto swaps work?
Crypto-to-crypto swaps can be done on centralized exchanges (CEXs) or decentralized exchanges (DEXs). However, under the belly, the method is different.
On CEXs, acting as intermediaries, users connect to the liquid pool, and exchange payments to facilitate exchanges. For example, on Coinbase, the user is connected to the order book when making an exchange. When placing an exchange order, Coinbase matches their request with the amount of liquidity in the pool, essentially acting as a trading partner. Fees are typically fixed and transparent but higher than DEXs to facilitate exchange.
DEX exchanges are peer-to-peer (P2P). Automated smart contracts manage pools of liquidity – provided by users – eliminating the need for intermediaries in the exchange process. This usually means lower payouts but can have slippage risks if liquidity is low. Uniswap, for example, uses liquidity pools consisting of cryptocurrency pairs contributed by users.
Smart contracts in DX execute swaps based on the ratio of assets in a pool. The user contributes one asset and receives an equivalent amount of the other instead of direct transactions. Fees are paid to liquidity providers and are usually lower than those on a central exchange, but users should consider drift.
Users connect their wallets to the DX platform, select the desired assets and amounts, and authorize the transaction. Smart contracts facilitate the exchange by automatically executing the transaction based on predetermined parameters such as price and amount.
In both CX and DX, the exchange process involves determining a cryptocurrency pair, specifying the amount to be exchanged, and confirming the transaction. Once done, the exchanged cryptocurrencies are transferred to the user's wallet or managed within the exchange's infrastructure.
Things to consider before switching
Before switching, consider aspects such as security, liquidity, volatility, transaction fees, network congestion, regulatory issues and jurisdictional differences.
Before a user can proceed with switching, it is important to consider a few things to ensure a seamless process.
Security
Review the security measures of the platform. When using CEX, users should consider the platform's security credentials and whether it uses cold storage for their assets. If the user wants to execute a swap in the DEX, they must perform a security audit of the DEX and its track record.
fluid and slippery
Users should assess the liquidity of the assets they are exchanging to avoid large price fluctuations during trading, which could lead to slippage.
Transaction fees and network congestion
Network congestion has a role in determining the exchange rate and speed. Investigate the fees charged by the platform and consider the state of the blockchain network to prevent any delays or additional costs.
Regulatory considerations and jurisdictional differences
Regulatory issues and jurisdictional differences are aspects that the user should not ignore. The user must ensure compliance with the relevant laws and regulations governing cryptocurrency transactions in their local area.
What are the risks and challenges in crypto-to-crypto exchanges?
Anyone who engages in crypto exchanges must consider opportunities such as price volatility, liquidity risks, collateral risks, regulatory risks, and market manipulation.
Crypto exchanges have their own set of risks and challenges.
Price volatility
Cryptocurrency prices are very volatile, with rapid and unpredictable changes. This volatility can affect the value of the assets which can lead to huge gains or losses in a short period of time.
liquid risks
Liquidity refers to the ease with which a crypto asset can be bought or sold without significantly affecting its price. If a cryptocurrency has low liquidity, there may not be enough buyers or sellers in a given period of time, causing delays in the exchange process or unfavorable prices.
The threat of the opposition party
When exchanging cryptocurrencies on CEXs, users rely on the exchange to facilitate the transaction. There is a possibility that the exchange may experience technical issues, suffer losses or engage in fraudulent activities.
Regulatory risks
The regulatory landscape of cryptocurrencies is still evolving and varies widely across jurisdictions. Changes in regulation may affect the legality or operational aspects of crypto-swapping platforms.
Market fraud
In less regulated markets, there is a risk of market manipulation where large traders or groups of traders artificially raise or lower prices to exploit other market participants. This can have unexpected consequences for users involved in crypto swapping.
