Tuesday, September 6, 2016

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/.