Rational Exchange: Incentives in Atomic Cross Chain Swaps

Abstract

Protocols based on Hash Time Lock Contracts (HTLCs) show tremendous potential to enable a truly decentralized exchange of digital currencies. In contrast to traditional financial systems and centralized crypto-exchanges, HTLC protocols provide a method to trade crypto-currencies in a peer-to-peer manner. However, considering the elimination of a third-party authority, remarkable price fluctuations and the protocol’s extensive time-to-completion, involved parties might be incentivized to deviate from the protocol and cancel a trade midway. Thus, this paper analyzes the protocol’s incentive structure based on a model of rationality to further quantify its impact on potential trades, using historical exchange rates. By analyzing different crypto-currency trading pairs, this paper highlights the probabilistic nature of a typical HTLC protocol. The results show that although the protocol does not offer a guarantee for a successful trade, it is applicable in scenarios of exchange-rates with low drift, low volatility, and an optimized time-to-completion.