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What Is A Token Swap: An In-Depth Guide

BlockchainJul 13, 2022
What Is A Token Swap

The huge success the emerging cryptocurrency industry has enjoyed over the last few years is largely a result of continual innovation. The economy has been forever changed by cryptocurrency, and it has in turn created a number of new, seamless ways to buy, store, manage and use digital assets. Early investors in crypto were met with many obstacles and complexities in handling digital assets, which have now been mitigated thanks to the above. One particular advancement is the introduction of token swaps, designed to reduce overhead costs and time spent exchanging digital tokens. It may sound simple but it can be hard to wrap your head around exactly what is a token swap, so let’s explore this guide to token swaps!

What Is A Token Swap?

The token swap process, also known as token migration, was initially quite a cumbersome task that cost a lot of money and took a lot of time to do. But this has become a much more seamless process. The concept of token swaps has two different definitions within the crypto industry.

Direct Crypto Trades

The first definition suggests an instantaneous exchange of one cryptocurrency token for another. This is aimed at those trading with two tokens. This is most often undertaken through popular crypto swapping services like Airswap, Changelly and Shapeshift, which often allow for multiple coin swaps. It is important to note old tokens and less popular tokens do not have this functionality due to their restricted availability, therefore such tokens cannot be swapped.

Migration of Projects

The second definition refers to transferring digital tokens from one blockchain project to another. This most often occurs when a project raises funds using one blockchain, and then at a later stage chooses to migrate to a different one. This can be for a number of reasons ranging from stability to scalability. The project’s native token is swapped for new tokens supported by the new blockchain network. So tokens from one blockchain are swapped for tokens from another blockchain.

A token swap and token migration are the same thing, much like a coin swap and coin migration mean the same thing. An atomic swap, however, involves exchanging cryptocurrencies on different blockchains using a token swap smart contract, eliminating the need for intermediaries. As you know, atoms are indivisible hence where the name of this type of exchange comes from. Atomic swaps must be all or nothing and follow the exact exchange laid out by the smart contract, or the exchange doesn’t happen.

Token migration doesn’t mean exchanging one token for another, but instead the replacement of one token with another that only comes into existence once the token swap occurs. Atomic swaps are therefore more geared towards buying and selling tokens through a token swap smart contract. Token swap involves a blockchain network upgrade or complete change of tokens.

How Do Token Swaps Work?

You are probably wondering, “how does a token swap work?” If you are an investor on crypto swapping sites and new to token swaps, breathe a sigh of relief as you will not need to actively do anything if a token swap occurs. These platforms enable exchanging by processing the token swaps and crediting your account with the new tokens. This simplifies the token swap process.

Before crypto took off, crypto trading was a lot more complex and time-consuming. You would need to convert your digital asset to fiat currency and then use the fiat to buy your coin. This is called a crypto to fiat exchange. For example, perhaps you have COMP coins and wish to trade them for ZIL. You will find that a COMP/ZIL pairing is very rare and hard to come by. So you will have to trade your COMP tokens for a fiat currency or more established coin first and only then can you exchange the more popular coin for ZIL.

Along the way, you would have been required to pay transaction fees a number of times. You could have also been making a risky move to a volatile crypto asset, impacting the profitability of the trade. I am sure you can agree this is not cost-effective and a tedious process.

These challenges forced the crypto industry to innovate and as a result, platforms began facilitating instant token swaps. You can now do direct crypto trades by exchanging one crypto asset for another. Simply plug in the amount you want to exchange and the exact token pair to trade and you’re set - the platform instantly converts your coin. This way, you will only pay transaction fees once.

The token swap process varies depending on the exact swap pair and the method of the swap.

Here are two ways to swap tokens:

Through An Exchange

Using an exchange is the most popular way to carry out a token swap. Old tokens are stored securely in a wallet and once the swap is complete, swapped tokens are transferred to a new wallet. The wallet with the old tokens is destroyed. You can choose to withdraw or trade the new tokens. This is normally a better option because you avoid hidden fees and the process is straightforward. Exchanging crypto assets on exchange platforms automate and accelerate swapping tokens, making it a popular and convenient choice amongst new and experienced token holders.

DIY token swaps

This is a more complex approach to crypto exchange as you facilitate the token swap yourself. The token issuer will provide you with a wallet to download or prompt you to register on a site. You will, either way, receive two wallets - one for the old coins and one for the new. You will have to transfer the old token to a specific address, only after which your new wallet will be credited. This carries more risk than an automated exchange because the wallets and websites created for swapping tokens specifically can be very complicated for beginners.

If you are new to token swaps, it is easy to make a mistake, which is often irreversible. Manual token swaps are best left to those well-versed in the crypto space rather than newbies, and even they still make mistakes. Manual token swaps are considered out of date and very time-consuming.

As we mentioned above, sometimes you might want to execute an exchange between a rare token pairing. Only a few exchanges may ever happen directly between these coins, making them very hard to come by. Then you need to go via the cumbersome fiat exchange route which impacts your profits. Token swapping services eliminate these complexities by automating the entire process.

What do We Need Token Swaps For?

Traditionally, companies would issue shares, but blockchain and tokens open up new ways of investing with a variety of options and more control. In order to build up these blockchains and provide tokens, investment is needed. This can be mitigated by creating tokens on an existing blockchain by creating a second layer token on the native token, through smart contract functionality. An organization can therefore have their own custom tokens on other blockchains while they build their own blockchain. An example of a blockchain well-known for creating bespoke tokens is Ethereum.

For example, a blockchain project would start off using the Ethereum blockchain to raise capital and distribute their custom tokens. Tokens distributed at this stage of the project would be placeholder tokens for the ones that will eventually be used when the project goes live.

A token holder’s balances are then migrated from their Ethereum wallets to the new project’s wallets. Effectively, the tokens have been moved from one blockchain to another. This can be helpful when a project has reached a stalemate using its current tokens and needs to move to a new protocol in order to scale up.

Benefits of Token Swaps

There is great value in token swapping. Exchange platforms with token swapping functionalities offer crypto traders convenient, dynamic and secure trading gateways. Token swaps allow for a much speedier trade. Ensure smooth blockchain migrations

When you are a token holder, you are required to register your tokens ahead of the token swap deadline to ensure they are migrated to the new blockchain. This is a process called mapping and can be complicated. Some wallets and exchanges don’t require transferring the coins prior to the token swap date, providing greater flexibility and ease-of-use for traders in the crypto space.

Promote Cross-chain Interoperability

Atomic swaps can promote the token swap’s atomicity. Cross chain token swapping opens the door for improved interoperability. The token swap smart contract functionality eliminates the need for third-party transaction fees, saving crypto investors money.

Guarantee Data Integrity of Transactions

The entire token swap and related transactions are kept on the blockchain, a highly secure gateway, thereby promoting data integrity and privacy.

Smart contracts can be cost-effective as the transaction fees are transparent and expertly executed, saving traders money in the long run.

Potential Risks

Despite the need for token swapping and its many benefits, there are also risks to token swaps. Numerous exchange services exist, so when choosing a token swapping service, do your due diligence and choose wisely. When selecting a token swapping platform, always consider the availability of token swapping functionalities like which blockchain projects are supported, cross token swapping, availability of token pairings, speed of token swap processes and of course, platform security. Increased speed decreases the likelihood of slippage, which saves token holders from price fluctuations when performing a token exchange. Certain cryptocurrency exchange platforms offer fixed exchange rates, mitigating the risk of token value slippage, however increasing the cost of the transaction considerably. It is always important to be aware of the risks associated with crypto swapping exchanges.

Depending on the platform used to exchange crypto assets, the transfer of virtual tokens can be visible to the public, impeding on the token holder’s privacy.

Sometimes token swaps supported by smart contracts can limit the flexibility of the token swap. You are limited to hard deadlines and specific token pairings when swapping tokens this way. If you miss the deadline, the tokens will be sent back to token issuers or frozen, making it an all or nothing approach to cryptocurrency exchange as tokens will then be permanently inaccessible to users. If you find it hard to stick to these types of deadlines when trading, opting for open-ended migration may be a better option.

When token swaps happen using a public blockchain, the use of a smart contract will be more expensive. The specified exchange rate may also add additional fees to an already expensive transaction, affecting the profitability of the token swap.

Bottom Line

There will always be flashy new crypto tokens on the market, attracting traders' attention away from traditional currencies. Token swap services make it possible for token holders to trade the current token for the desired token. It is now easier than ever to do token swapping with a number of exchanges, wallets and platforms designed to facilitate the token swap processes. It is important to always do thorough research before using an exchange in order to be aware of the associated risks and costs.

These token swapping services play an important part in perpetuating the ongoing cryptocurrency renaissance by eliminating common barriers to entering the crypto space, facilitating traders to swap tokens with ease. Often, they provide an easy gateway to cryptocurrencies with low market capitalization.

Using an automated token swapping service is a faster, easier, less complicated and more secure approach to trading crypto assets. It is because of this that token swaps will continue to feature prominently in the years to come.

Matias Lapuschin
Matias Lapuschin
Head of Content Marketing

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