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GUIDE: What You Should Know about Hashed Timelock Contracts

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hashed timelock traders

The initial purpose of cryptocurrencies was a simple one. The aim was to create a channel where two parties could make digital payments in a trustless manner. Trustless means that in the encrypted mode of payment, no mutual trust is necessary between any of the participating parties. One of the ways that cryptocurrencies present this benefit is through the use of hashed timelock contracts.

Understanding Hashed Timelock Contracts

The standard definition of a hashed timelock contract/ HTLC is that of payments making use of ‘timelocks’ and ‘hashlocks’. These features ensure that the beneficiary acknowledges receipt of the payment by a stipulated deadline. The person acknowledges by generating a cryptographic payment proof. If proof is not provided on time, the recipient forfeits their claim on the payment and the funds return to the sender.

Additionally, the recipient can also utilize this cryptographic payment proof for other other payments. Therefore, this makes HTLC a powerful method to produce conditional payments with Bitcoin.

Through HTLC both parties enter in a financial agreement where payment is made through Bitcoin, Ethereum or other cryptocurrencies. The ‘time-locked’ nature of these contracts compels the receiving party to make payment only within a stipulated time.

How does Hashed Timelock Contracts work?

In an HTLC, a hash represents the sum of money that the receiver has to pay. The person making the payment is responsible for creating the specific hash. On the other hand, the recipient has to perform two functions in order for the contract to work. First, they have to create a cryptographic payment proof within a certain time frame. This time period for payment-acceptance differs considerably from one time-locked contract to another.

In short, if the beneficiary meets the deadline, they get the money; when they don’t, they lose it. This implies that such time-locked contracts bestows a lot of responsibility on the recipient of the cryptocurrency.

The Scope Of Hash time-locked contracts

By nature, HTLC have wide ranging implications and scope. They can be highly beneficial while making use of atomic swaps for cross-chain trading. The added benefit here is HTLC enables traders to exchange cryptocurrencies even when they are on different blockchains. However, this can only be accomplished within a specific time frame.

For instance, a trader wishing to exchange 25 Bitcoins with Litecoins can use time-locked contracts to make the exchange within 15 minutes.

This can result in a dramatic improvement in the ability of traders and investors  in conducting the rapid trade of cryptocurrencies. They can even use HTLC to respond swiftly to the market news, and improve their profits.

Also, atomic swaps is a recent trend starting in 2017. Therefore, contracts like HTLC can herald a new era for the ecosystem of cryptocurrency trading

In fact, hash time-locked contracts can prove to be a big advantage for businesses needing to make offers while adhering to certain time constraints. For instance, HTLC can be a big help when businesses need to choose from a host of contractors, fast.

For example, imagine that one business needs to complete a job and has many vendors to choose from. This business could create a hash time-locked contract and offer it to one vendor, with three hours to finalize the deal. Should this vendor finalize the said deal within the three hour time frame, the job and money is theirs. However, if they don’t, the money will revert to the original business. They, in turn, can make another HTLC and offer the work to another vendor.

Benefits of Hash Time-Locked Contracts

Such time bound contracts offer a slew of benefits to traders and investors. Since they are time-sensitive, they prevent the senders from wasting time waiting to determine the status of their contract. Second, since the money returns if the contract is not completed in a specific period, there will be no loss of money. The party making the payment will get their money back if the other party fails to accept the payment.

Third, the recipient has to provide a cryptographic payment proof for accepting the payment. This need of a proof from the recipient leads to an improved validation process of the payment on the blockchain. Fourth, the hashes created by the payer in the HTLC are easy to add on the Blockchain. Last but not the least, it creates a total trustless system. None of the parties involved in the HTLC transaction need to know or trust each other to ensure that the payment commences smoothly. The execution of the contract is efficient in every case and there is little or no counter-party risk.

Potential Challenges

Despite having a wide range of benefits, HTLC faces an equal number of challenges. One of the biggest challenges is the resistance from most individuals and businesses who are not familiar with the process. Most industries are not used to such time-bound payment structures. Consequently, it will take time before the mass adoption of such hash time-locked contracts occurs.

More than a decade ago Satoshi Nakamoto introduced Bitcoin, the first cryptocurrency. Since then, various financial institutions and investors have used and shown an interest in digital assets. However, the majority of the global population is still wary of using cryptocurrencies.

Therefore, only when these people are comfortable with and trust digital assets, will they try hash time-locked contracts. Although, with the market cap of cryptocurrencies rapidly rising, the adoption of HTLC may happen faster than expected.

Another danger to HTLC is the regulation issues from government. It’s possible that governments consider the bank-less and law-less contracts as a major threat to their country’s economy. This  could result in increased regulations and scrutiny, and create greater complications for the adoption of HTLC.

Finally, another challenge is the increase in the scaling complexity of HTLC that occurs due to the increased use of cryptocurrencies. However, solutions like a lightning network can make a difference in solving these scaling challenges.

Conclusion

The concept of HTLC is a fascinating payment development. They have a range of benefits for individuals as well as businesses. By completing deals faster and more efficiently, they help the payer as well as the recipient, therefore, their usefulness and convenience could make them a popular option for traders, and further drive the growth of cryptocurrencies.

 

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