Transferring Assets via Blockchain Technology

Another feature that has generated lots of excitement within the Blockchain 2.0 realm is the ability to transfer assets using the blockchain. While bitcoins have provided people with the ability to send money through the Internet, without the fees of middlemen such as banks, the ability to transfer assets through the blockchain would allow people to trade their houses, cars, or shares of stock without using traditional middlemen such as realtors, stock brokers, or auto salesman. This would also mean that assets would transfer immediately after they were purchased, which would prevent incidents like this from occurring. Colored coins and Counterparty are two technologies that I found that seemed to be the most talked about among Bitcoin and blockchain forums.

Colored coins function as regular Bitcoin transactions. To create a colored coin that represents some asset, all one has to do is take a bitcoin and add metadata to this “coin.” This added data would represent some asset such as one share of Ford or a house in Florida.¹ (Bitcoins do not actually exist because Bitcoin is really just a ledger of inputs and outputs into somebody’s Bitcoin wallet. When computers check to see if an account has enough bitcoins, they are just searching for previous inputs into that account. Adding data to a bitcoin is really adding data to some bitcoin transaction in which all parts of that transaction are colored with this added data.²) This new coin functions just like a regular bitcoin transaction. Here is a link if you want to learn how to add this metadata to create a colored coin.

There are some companies such as Overstock.com that have received SEC approval to issue their publicly traded stock as colored coins.¹ Most colored coins are not backed by a legal contract and are based on trust that the other party has the physical asset to back their colored coin.

             From scrolling through Reddit and Quora forums, it seems that many people are opposed to colored coins because they believe they will cause blockchain bloat. Blockchain bloat is classified as transactions within the Bitcoin blockchain that are not used for currency transactions, like colored coins.³ While the added data to Bitcoin transactions will increase the amount of information being processed on the network, which could slow processing speeds down, miners who process colored coin transactions are still receiving a processing fee from these transactions.⁴ This view that blockchain bloat is akin to email spam is held among some purists that believe that the Bitcoin blockchain should be kept for only pure Bitcoin transactions.

Another downside of using colored coins is that if one sends a colored coin to an address that does not have colored coin capabilities, the colored coin will be lost forever. There are specific computers within the blockchain that can understand which bitcoin transactions are colored coins. This is how colored coin wallets operate as well.⁴

            In an article by Richard Gendal, he discusses how the exchange process of colored coins works. When someone agrees to buy a colored coin from another party, there needs to be a system in which the buyer is guaranteed that they will receive this asset coin when they send their money. Colored coin technology ensures this by having the seller put their asset coin into a escrow account of sorts, which functions outside the blockchain.⁵ This goes against Bitcoin ideology because there is now a third party that the individual must put their faith in. The problem with trusting a third party is that if this company failed while holding someone’s assets, those assets could be lost.

Counterparty, a competing technology to colored coins, uses a bid/ask system to complete the exchange process. A seller will make an ask price, and a buyer will make a bid price. When these two offers are matched, the seller is required to honor the price they said they would sell the shares at, and the buyer must honor the price they stated they would pay for the shares. Like stock exchanges, Counterparty locks these assets into place until the offer has expired. Coded into the protocol is an automatic exchange system that forgoes a party outside of the blockchain. But Richard Gendal states that the problem with this system is that all these bid/ask prices are stored in the blockchain, meaning that temporary transactions are stored permanently.⁵

            Unlike Colored Coins, Counterparty uses its own currency to digitize assets onto the blockchain. This native currency is called XCP. XCP came into existence when individuals sent bitcoins to a Bitcoin wallet in return for XCP. The bitcoins that were sent to this wallet were destroyed, so that Counterparty and the creation of XCP would not be viewed as a get rich quick scheme.¹² The Counterparty website likens this to the process of mining bitcoin as “Bitcoin miners also destroy one resource [Energy] to get another [Bitcoins].”

            While Counterparty has its own currency, the transactions within Counterparty are merged onto the traditional blockchain network. There is special computer code that recognizes Counterparty transactions and establishes an independent Counterpary ledger. Since the same nodes that mine bitcoin process Counterparty transactions, there is a bitcoin fee for every transaction within Counterparty. Besides the bitcoin transaction fee, it costs 0.5 XCP to create an asset token. This 0.5 XCP that is used to create an asset token is burned (See issuance strategy above), causing XCP to be deflationary.⁷

Bibliography:

1) Digiconomist. "Adding Metadata to the Blockchain, Part 1 - Digiconomist." Digiconomist. 2015. Accessed August 09, 2016. http://digiconomist.net/adding-metadata-blockchain-part-1.

2) "How Do Bitcoin Transactions Work? - CoinDesk." CoinDesk. http://www.coindesk.com/information/how-do-bitcoin-transactions-work/.

3) Wagner, Andrew. "Ensuring Network Scalibility: How to Fight Blockchain Bloat." Bitcoin Magazine. 2014. https://bitcoinmagazine.com/articles/how-to-ensure-network-scalibility-fighting-blockchain-bloat-1415304056.

4) "Beginners." Coloredcoins. 2015. Accessed August 03, 2016. http://coloredcoins.org/inner-page-3-1/.

5) Brown, Richard Gendal. "A Decentralized Securities Trading and Settlement System Is Being Built Hidden in Plain Sight." Richard Gendal Brown. 2014. Accessed August 02, 2016. https://gendal.me/2014/06/10/a-decentralized-securities-trading-and-settlement-system-is-being-built-hidden-in-plain-sight/.

6) "Why Proof-of-Burn." Counterparty. March 23, 2014. Accessed August 06, 2016. http://counterparty.io/news/why-proof-of-burn/.

7) "Assets." Counterparty. Accessed August 05, 2016. http://counterparty.io/docs/assets/.

Intro to Smart Contracts

I first became interested in smart contracts after reading the book The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order.  The book doesn't explain how smart contracts work well, but I was fascinated by the future Blockchain 2.0 technology.  

Smart contracts function like regular contracts that are created when two people make a bet or a customer takes out a loan from a bank. There is some variable term, such as if the patriots win or if you fail to make your interest payments, and a consequence, then you owe your friend ten dollars or the bank can take ownership of your house. But what’s unique about smart contracts is that they are based on the blockchain. The essence of the blockchain is that it creates a way to establish trust among untrusted parties. First, the blockchain creates a system in which there is no central authority that controls the servers that data is stored on because the blockchain is run off of thousands of independent computers around the globe. This means that nobody can corrupt stored data or change the terms of a contract without the other party knowing, since each computer’s ledger must agree with the other computers’ ledgers in the blockchain. Second, the blockchain publishes a public ledger of all transactions that have taken place within its network. This allows people to verify that a person actually posses the assets they claim to have.

Smart contracts could be very beneficial to underprivileged groups such as the unbanked. Unbanked people are not able to receive service by traditional financial institutions such as banks. This means that they are restricted in their ability to get loans and other forms of capital. By using smart contracts, the unbanked could digitize their assets* and post them as collateral to loans that individuals make to them. When the smart contract is being established, the person receiving the loan would place their asset token into an independent escrow account that is controlled by the smart contract code. The loan provider would do the same with the money being loaned, and this money would be sent to the customer. But if the customer failed to deposit their monthly interest payment into an escrow account managed by the smart contract code, this could trigger the escrow account to move the asset token into the loan provider’s account. Smart contracts on the blockchain provide a secure and unbiased way for people to enter into agreements, contracts, or bets.

Many people use the example of a bank being able to take control of a borrower’s home if they neglect to pay their loan payments as a great use case of smart contracts. People believe that this would greatly reduce litigation costs and efforts because the code would automatically process the change in ownership of the house. But if this change in ownership of the owner’s house takes so much time and effort to conduct after the customer defaults in the traditional system, I believe using smart contracts would just shift the workload of this litigation process to the front end when the contract is being created.

The Bitcoin blockchain cannot support smart contracts due to the fact that it does not allow “computer language to carry out a wider array of more precise instruction” beyond Bitcoin transactions, which is known as Turing completeness.¹ Firms such as Ethereum are developing a blockchain that contains these Turing completeness capabilities that would allow for the programmability of programs like smart contracts.²

Here is a link to an interesting article on why the absolutism of smart contracts is an undesirable feature.

*See next post for description of asset tokens on the blockchain

1) DeRose, Chris. "'Smart Contracts' Are the Future of Blockchain." American Banker RSS. 2016. Accessed August 06, 2016. http://www.americanbanker.com/bankthink/smart-contracts-are-the-future-of-blockchain-1078705-1.html.

2) DonaldMcIntyre. "What Is Ethereum? How Does It Work? • /r/ethereum." Reddit. Accessed August 07, 2016. https://www.reddit.com/r/ethereum/comments/3krr3s/what_is_ethereum_how_does_it_work/.

Book Review: The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order

I recently finished a book called The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Michael Casey and Paul Vigna. This book gives a complete overview of Bitcoin as a technology (the blockchain) and as a currency (BTC). It covers a very wide range of topics from the white paper published by Satoshi Nakamoto and his unknown identity to the regulatory hurdles that Bitcoin entrepreneurs have faced. (I have linked a website that I believe does a very good job of describing how blockchain technology works). The authors of this book emphasize the future implications of Bitcoin’s blockchain technology, which they refer to as the Blockchain 2.0. The Blockchain 2.0 is an umbrella term for all applications that are using Bitcoin’s core technology, the blockchain, in ways that go beyond transferring money. There were two main applications of the Blockchain 2.0 that the authors mentioned: smart contracts and asset transfers. I did not understand how these blockchain applications worked, after reading this book, and hope to explain them in following posts.

            The authors approached the challenge of explaining what Bitcoin is by first attacking the underlying question, “What is Money?” According to the authors, there are two contrasting views to this question. The ideology of metallism is founded on the belief that money has have some underlying value, think the Gold Standard, while chartalism is founded on the ideas that currency is an intricate network of trust and has value due to its characteristic as a medium of exchange.¹

I really enjoyed the author’s description of the Yapese monetary system. It is a great example of chartalist theory of currency, as well as an analogy for Bitcoin. The Yapese currency is based upon large round stones known as fei. Since these objects are so massive, it is very inefficient to transfer them to the new owner after each transaction, so they usually remain in the possession of the previous owner. But even while the physical stone may not move into possession of the new owner, the new owner is recognized as possessing the value of the stone. ¹ This example does a great job of illuminating how money is based upon a system of trust that other people will accept it as a unit of exchange and how Bitcoin is based on a public ledger where people acknowledge each other’s credits and debits, even though there is no physical asset.  

            While I don’t believe the authors do a great job of describing how the technology behind the blockchain and Bitcoin works, this book is a fascinating and informative read. I had very limited knowledge about Bitcoin and did not even know that the blockchain existed before reading this. Now, I am intrigued by both of these technologies and believe they will have a large impact on the future of financial networks. I also think Bitcoin is a fascinating experiment to think about in terms of a new monetary system. Bitcoin is deflationary and has no central bank, unlike most every other currency that we use today, and I am curious how this will impact monetary economics.

1) Vigna, Paul, and Michael Casey. The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order. New York: St. Martins Pr.