What is a crypto swap in cryptocurrency?

A token swap, or crypto swap, is like trading your favorite Pokemon cards with anyone you like online. But instead of trading cards, you can trade digital crypto assets in exchange for your favorite crypto tokens, often, without a conventional centralized crypto exchange.

In this article, we take a deep dive into crypto token swaps, common types of swaps, how they work, and how you can perform a crypto swap easily.

What is a crypto swap?

A crypto swap is an exchange of cryptocurrencies usually performed on dedicated swap platforms, or decentralized exchanges (DEX). 

Instead of going the traditional way of selling a fiat currency for a crypto token, you can directly swap crypto tokens. This is helpful especially if you want to avoid KYC restrictions and don’t want to pay additional fees associated with centralized crypto exchanges.

Swapping tokens in crypto can be done on the same blockchain or across different blockchains, a feature offered by almost every decentralized crypto swap platform. Swapping cryptocurrencies is an ideal way to rebalance your crypto holdings, or step foot into the exciting world of decentralized finance (DeFi) where lending and borrowing can be a game changer for many users.

Types of Token Swaps

Token swaps can have many types, but the most common and important categories include on-chain and off-chain swaps.

Centralized exchanges usually carry out off-chain swaps, facilitating the transaction inside their own database as opposed to on a public ledger. Although this kind of token swap is quicker and might have cheaper costs, it presupposes confidence in a centralized exchange.

On the other hand, on-chain swaps take place solely on the blockchain and manage user-to-user transactions via smart contracts. These on-chain swaps are very common on DEX platforms like Uniswap and PancakeSwap, where buyers and sellers conduct on-chain transactions with each other via decentralized processes.

Both types of cryptocurrency swaps have special benefits: off-chain swaps give efficiency and speed, while on-chain swaps offer transparency and decentralization. You can choose any type of token swap based on your comfort level with speed, security, and control over your assets.

Common use cases

For several reasons, token swaps are becoming more and more common, particularly in the DeFi community. Portfolio diversification is one of the main use cases; investors can simply exchange crypto tokens to distribute their funds among several projects without leaving the cryptocurrency market. Yield farming, in which users exchange tokens needed to engage in yield-generating activities on DeFi platforms, is another popular application.

Since some projects only work with particular crypto tokens, swapping tokens in cryptocurrency is also useful for accessing decentralized applications (dApps) and making NFT purchases. For example, a token swap allows you to join a gaming platform that requires a specific cryptocurrency asset with little difficulty. As a result, token swaps are now an essential component of the crypto toolbox, facilitating user interaction with a variety of applications.

How do crypto swaps work?

There are some key fundamental ways in which cryptocurrency swaps work, and they frequently differ depending on whether they are off-chain or on-chain. 

Smart contracts play a key role in on-chain swaps. The smart contract returns the swapped token to the user after locking the original token in escrow when a user initiates a swap. Because these transactions are decentralized and trustless, users maintain complete control over their money throughout the transaction, negating the need for an intermediary. 

Cryptocurrency traders provide liquidity to liquidity pools provided by decentralized exchanges (DEXs). This allows other users to swap their favorite tokens and essentially creates an organic marketplace of buyers and sellers, which eliminates the need of traditional order books.

On the other hand, off-chain swaps are purely conducted on centralized exchanges, hence their data is not recorded on any public blockchain. This method allows users to benefit from lower fees and faster transaction processing times.

Both on-chain and off-chain swaps have different benefits when it comes to transparency, speed, and cost, which allows users the liberty to choose the method that suits their needs. With crypto swaps explained, let’s move on to why they’re important.

Why are token swaps important in crypto?

The crypto ecosystem can only thrive if its accessibility and functionality become at par with the understanding of crypto users. This is where token swaps come into the picture, as they fulfill both these parameters. 

Token swaps give users the liberty to adapt to volatile crypto market conditions as they can easily get new tokens by participating in DeFi activities including staking, lending, and yield farming. In addition, users can also diversify their portfolios and swap tokens through liquidity pools. All of this opens up a new pathway for new crypto users to get familiar with the world of web3.

The benefits of token swaps aren’t just limited to the crypto user. Blockchains also benefit from token swaps, as their interoperability is enhanced, thanks to cross-chain swaps, that facilitate the exchange of assets between blockchains.

This entire procedure attracts new investment and promotes innovation across blockchain projects that start to provide a more diverse amount of tokens and DeFi platforms to the end users. 

Crypto token swap vs token migration

A token swap is defined as exchanging one cryptocurrency for another, which can be on the same blockchain or across different blockchains. The process of token swapping allows users to diversify their crypto asset holdings and reposition themselves in the volatile cryptocurrency markets.

On the other hand, token migration is the process of a cryptocurrency project moving from one blockchain to another. For example, a layer-1 protocol can decide to move to a layer-2 blockchain to get additional benefits of lower transaction costs and increased speeds.

When token migration happens, usually a cryptocurrency project issues a new token with a new ticker, and all users have the option to seamlessly transition their current holdings to the new one. A recent example of this is $MATIC which was migrated to $POL, and the spot holdings of $MATIC tokens held by users were converted into $POL automatically.

Risks and considerations

Token swaps do offer a certain level of comfort to users, however, they are associated with some risks as well. For example, while doing on-chain swaps cryptocurrency traders can experience issues like slippage, where a swap doesn’t get executed at the intended price levels, which can lead to potential losses. 

Another risk is that users have to evaluate the security of the platform on which they are conducting these token swaps. This is because if smart contracts running behind a token-swapping platform are compromised, all funds can be lost. 

In off-chain token swaps, users can face the risk of counterparty default, which means that the centralized exchange sometimes fails to execute the transaction properly. While the fees and speed of a transaction might be lower on off-chain token swaps, users still have to analyze the security aspect of the centralized exchange.

In token migrations, users can face issues related to wallet compatibility, lack of support during the transition process, and the crypto exchange not supporting the token migration to begin with. All of these risks can lead to potential losses, and to avoid this, users can make sure that the cryptocurrency project’s team is reliable and has announced a partnership with the exchange before doing the token migration. 

How to perform a token swap: step-by-step guide?

A token swap is a simple process, here are some steps you can follow to complete a token swap. 

Connect your wallet: Connect or create a digital crypto wallet from scratch, for example, Metamask. Make sure you have the crypto token you want to swap in it.

Choose your swap tokens: Go on any decentralized exchange, for example, Uniswap, and select both tokens, i.e. the token you want to swap and the token you want to get in return.

Enter the amount: Enter the amount of tokens you want to swap. 

Double-check the amount and fees: Check the fees displayed on Uniswap that will occur for the entire swap process.

Accept the transaction: Accept the transaction in your digital crypto wallet.

Wait for confirmation: Wait for a few seconds to minutes for the transaction to complete and for the tokens to show in your digital crypto wallet. You have now swapped a token in the cryptocurrency market!