Crypto
How The FTX Collapse Spiked Fees On Popular Bitcoin Exchanges
This is an opinion editorial by Michael Chapiro, a materials engineer, an aerospace and defense executive and founder of Caliber.
On Wednesday, November 9, in the aftermath of the collapse of FTX, reports began emerging on Twitter of prices for buying bitcoin being quoted and subsequently executed for about $1,000 dollars above the spot market price on Swan and Strike, while the bitcoin price traded primarily in the $16-18k range, a small drop on the order of 10-20% from the prior week before the FTX debacle. One tweet claimed a discrepancy as high as $1,600, though they do not provide a screenshot to confirm. These problems remain ongoing with screenshots showing price discrepancies mostly in the $600-1200 range, indicating spreads in the range of 3.5-7%, well in excess of the highest fees charged by any major exchange even on their fee-boosted consumer interfaces.
Link to embedded tweet.
It quickly became apparent that the tight correlation in this deviation on Swan and Strike meant that the common backend liquidity provider, Prime Trust, was the ultimate culprit. Prime Trust facilitates bitcoin trading for a number of platforms, the rest of their self-reported 700 clients presumably are all sh*tcoin casinos. Prime Trust highlights crypto.com, OKCoin, Abra, and Bittrex among other flagship customers (though Prime Trust offers a number of services so this does not imply all platforms are necessarily affected).
Many people were quick to identify River and CashApp as two well-known bitcoin-only platforms that do not rely on Prime Trust — however, fewer people were discussing the underlying structural problems that led to this happening in the first place. The logic being: Prime Trust has problems — give me something that meets the criteria of “not Prime Trust” and I will be happy. There is a certain group of people that seem to not learn their lesson and just jump from one thing to the next without understanding the underlying principles, and we call those people sh*tcoiners. So perhaps it would be prudent to figure out why this is happening, and the aspects of why it is happening that actually matter to end users.
The conclusion might end up the same, but unless you actually know how each thing works, you are still trusting a third party based on signaling. It is akin to saying “Well, FTX blew up; guess I’ll leave my bitcoin on Coinbase from now on.” No, you fool! The problem was leaving “your” bitcoin with a third-party custodian and satisfying the parameter of “not FTX” would do absolutely nothing to solve this problem if you were in that situation.
Before we get into that, let us consider what we might call the four major epochs of sh*tcoinery as follows:
1. Monetary illiteracy — in the first couple years, exceedingly few people saw the big picture for Bitcoin, and many people did not understand the economic forces that made Bitcoin’s total absorption of 100% of monetary premium inevitable (note: when I say inevitable, I do not mean complacency is warranted, but that in the 0.1% possible outcome of totalitarianism beating Bitcoin in our lifetimes, that it will always be inevitable that it resurges even if it takes 10,000 years — even if all but 6.15 bitcoin are lost, the UTXO set will not be “reset”. Fiat has an absorbing barrier; Bitcoin does not.)
2. “Better than bitcoin,” really hit its stride in 2017 as can be observed clearly in the bitcoin dominance chart.
3. “I like bitcoin, but I also like my shitcoin,” was the catchphrase of the latest shitcoin wave.
The fourth and seemingly final epoch is, “This is bitcoin…” — but it isn’t bitcoin, not if your node doesn’t say it is.
Stacks probably comes to mind as the shitcoin platform that takes the “this is bitcoin,” grift the furthest with many of the scammers self-identifying on Twitter by appending “.btc” to their Twitter name in the same style as mETH-heads. No serious person falls for this. No serious person leaves bitcoin on exchanges. No serious person does not at least generate their own entropy or use generic hardware if they are not using multi-sig with at least two keys each generated on devices from different vendors. It actually is tautological.
So why would companies be trusted purely because they are perceived as good actors? And to be clear, despite various disagreements I have as to particular methods, I see Strike, Swan, CashApp, River and others as ethical companies run by ethical people who are all working to accelerate the great transition to Bitcoin (I really like a lot of what all these companies are doing! As I write this, I am missing a lot of the second day at Pacific Bitcoin, a great conference being put on by Swan Bitcoin). But that is not enough to appease our scrutiny. I prefer to verify what is going on under the hood, and push for things to get even better. I will not speculate as to whether it might “actually be a good thing” that some KYC platforms run into problems and how that might increase non-KYC bitcoin acquisition. Though it is of course worth pointing out that if you think illiquidity is problematic now in a small dip to the downside, wait until you see what happens when there is a hyperbolic (a literal math term) crash to the upside. Growth in non-KYC infrastructure is paramount, but largely outside the scope of this article.
So where did things go wrong?
First, it is necessary to understand that out of Swan, Strike, CashApp and River, not a single one of these is actually an exchange. Many Bitcoiners will however use the term exchange since the largest platforms where people are buying and selling bitcoin are exchanges. What these entities are is brokerages: in fact, brokerages are the more typical thing for a retail customer to use. If you trade stocks, you are almost certainly using a broker such as Schwab, Fidelity or Robinhood, and these entities will take your orders and route them to an exchange on your behalf. You probably cannot easily place an order to buy a share of some stock directly on the New York Stock Exchange, but you can easily place orders for bitcoin directly on a KYC exchange, or a non-KYC exchange such as Bisq.
Now, there is nothing inherently wrong or necessarily disadvantageous for a retail, or even business customer to use a brokerage rather than an exchange (sidenote: Why the hell are you calling every business that opens a bitcoin exchange or brokerage account an “institution?” That’s weird. It emboldens fiat and insinuates that bitcoin is somehow not for every business). Exchanges are often more confusing to navigate, with live data feeds of orders, and people who simply want to acquire or liquidate their bitcoin usually do not need this information. A brokerage might provide a nicer interface, and they could in principle do this with thin margins — but they do not always do that. In large, more mature markets, the fees charged by brokers are razor thin, and even brokers such as Robinhood who came under fire for payment-for-order-flow, where they sell order info before they submit them, are not making that much money off their customers. That is on the order of a single basis point, which is a hundredth of a percent. In bitcoin (and sh*tcoin land), even the exchanges will offer a simplified interface where suddenly the fees jump from tens of basis points to 2-3%.
So brokerages versus exchanges is mostly just a matter of price, convenience and features. There is one critical feature that is not found in any major exchange: being bitcoin only. I find sh*tcoins viscerally unpleasant. I do not like sh*tcoiners in my presence. I do not like to hear about the comings and goings of sh*tcoiners or sh*tcoins (OK, maybe the goings when it is to zero). I certainly do not want sh*tcoin ads in the corner of my screen when I need to buy or spend bitcoin or sh*tcoin ads emailed to me from Kraken, Coinbase or whomever. For friends and family, it is not just unpleasant, but a serious risk, so many Bitcoiners send people they care about to bitcoin-only platforms.
A competing exchange upstart that attempts to be bitcoin only would find itself struggling to match the liquidity depth and trading volumes of sh*tcoin exchanges, so bitcoin-only brokerages actually can be a good solution, but all of the ones that exist today have a fundamental flaw that enabled the current problems facing Prime Trust based services. Enter request-for-quotation (RFQ.) RFQ is the process you go through every time you buy bitcoin through one of these platforms (as well as various other apps, including many outside the U.S.). As a user, you say you want to buy (or sell) a certain amount of bitcoin, and you are given a price. You can take it or leave it, you do not place an order, you swap between bitcoin and dollars at a firm, fixed price. Now, this is exchange in the sense that you are literally exchanging your dollars for bitcoin, which is likely where the incorrect usage of the term “exchange” comes from. On the backend of this process, when you specify the amount of bitcoin you want to purchase, there is an opaque set of over-the-counter (OTC) entities that are given the right to bid for your order.
That is RFQ, and RFQ sucks. What mature markets use is called central limit order books (CLOB), and it is what you get when you use any of the major exchanges. Limit orders are submitted, which is what “makes the market” as opposed to market orders that “take the market.” So what about you, anon? Will you take it, or are you gonna make it? (Jokes aside, as long the order books are not exceedingly thin, there is not that much of a difference between market or limit at spot orders.) The limit orders are a mix of buy and sell offers that have a price specified. The spot price lies in the range of the highest offer to buy bitcoin and the lowest price someone is willing to sell bitcoin. If no one is willing to pay as much as someone is willing to sell for, no trades occur, but if a market order is submitted, it gets one of the edges, and if a limit results in a “negative gap,” it also gets an edge. As the spot price moves, orders fill sequentially based on price. The spread refers to the bid-ask spread, and if you look at the spreads on real exchanges, they are usually below 10 basis points, even when markets are volatile.
Link to embedded tweet.
CLOB is inherently more efficient than RFQ can ever possibly be, which is why it is used. CLOB is a free market and RFQ will always be more expensive, which is why even when Strike was working properly with zero fees, it was not really zero fees because there was a spread that Prime Trust would charge of 30 basis points, exceeding what many exchanges have as fees even after adding in their real spreads. Pretty much everyone ignored this difference in effective fees because it seemed negligible, but the problem with RFQ runs deeper than this. In CLOB, every single market participant can trade with any other market participant on the exchange. RFQ only allows a select set of entities to be on the counterparty side to all the users, and it leads one to ask — which side is the product, and which is the customer? It is reminiscent of traditional infrastructure. Freedom matters. Freedom to participate here means that if you see bitcoin being bought at $17,000 while the spot price is $16,000, you can sell bitcoin at $16,900, but if you checked the sell price on Strike (or if you called in a sell on Swan since they don’t have a sell button), you might get a price of $15,000 so you cannot arbitrage. Exchanges allow orders of customers to be matched to the order of any other customer. In free markets, you would in fact come in and do this, but then someone else would come in at $16,800, and so forth, until the massive gap vanished.
Did the OTC parties on the other side of Prime Trust have problems? Were these OTCs shitcoin speculators that blew themselves up in the fallout from FTX? Did Prime Trust blow itself up speculating on shitcoins and now is nefariously trying to recoup cash? Are there a small set of OTCs left that are all colluding on price to prevent arbitrage? I have absolutely no idea, but I also do not care in the slightest. This massive spread and illiquidity that you cannot arbitrage as a customer is only possible due to RFQ. That is all I need to know. If someone loses “their” bitcoin because they left it on an exchange, you might ask how precisely did they get hacked? What was the exact vulnerability, or was it an inside job? But none of those questions really matter. The problem would be leaving coins on an exchange. The particulars are noise.
River and CashApp are operating fine, for now, but are they doing anything fundamentally different? Well, somewhat. Instead of an opaque set of who knows how many OTC counterparties, they are completely transparent: you get exactly one counterparty, which you, dear user, are allowed to trade with — it is them! You are buying and selling directly with them, which is why, for instance, CashApp reported close to a couple billion dollars in quarterly revenue: they literally sell you their bitcoin. Now that is a single point of failure if I have ever seen one. Do I trust CashApp and River more than Prime Trust? Is it possible that their underlying infrastructure is extremely robust, connecting to every major exchange such that they always have as much liquidity as exists in markets globally and would survive perfectly fine if bitcoin were at either $1,000 or $1 million next week? Sure, lots of things are possible. But I do not actually know, and neither do you. Trust cannot be fully eliminated when using services from some company, but transparency can be maximized so that trust can be minimized. River’s terms of service claim that they have the right to buy or sell bitcoin from you at whatever price they see fit. They could offer a guarantee to have honest pricing: if global markets actually become illiquid, as will be the case whenever bitcoin goes no-offer from no one wanting to sell, then trading will be halted regardless. Any decent lawyer would be able to provide guidance on how an assurance can be made to the effect of making “best, *reasonable* efforts” that would not be unduly burdensome or risky for the company.
Link to embedded tweet.
I do not mean to be too hard on Bitcoin companies, but the rest simply do not even merit much discussion and are of course far worse. Prime Trust has about 700 customers, and has raised more than $100 million from VCs. ZeroHash has roughly the same business model, has raised about the same amount of capital, and counts among their customers Interactive Brokers. Coinbase some months ago announced a zero fee trading service with a monthly fee, and zero fee debit card spending with just-in-time selling of bitcoin. In the small print you would find 2% spreads. Fidelity announced they are adding “bitcoin” trading with a 1% spread. NYDIG is facilitating the buying and selling of “bitcoin” in bank accounts with an RFQ model plus an unverified spread. Quotation marks must be used since neither supports deposits or withdrawals for now. Let me be perfectly clear: these companies are blatantly lying to customers when they charge 1% or 2% spreads. These are fees. I do not think companies will come for me. I speak the truth and as an American am free to do so. In fact, in the aftermath of the FTX blowup, I suspect the Consumer Financial Protection Bureau and other agencies may come for them.
And before anyone tries to get clever and says “I thought you Bitcoiners liked free markets?” as sh*tcoiners are fond of replying, let us not forget that every regulation, just like taxation, is enforced at the barrel of the gun. Non-serious people who like to get slick might find they rather dislike the sort of “regulatory forces” they may run into under truly and totally free markets without the buffer of courts and rule of law to protect them from the consequences of their actions.
At the end of the day, there is no such thing as safety with custody. So go with the sketchiest thing you can if it is brief. It is easier to cut yourself with a dull knife than a sharp one, and if the ethical companies are not aligned with those that are the performant ones, beware that by using the ethical company, you may be holding a dull knife. The best option is likely to have more than one at the ready, and to be able to switch at the drop of a hat if need be. This includes knowing how to use various non-KYC channels. We are not even seeing all that much of a price dip now.
Until things get better, sh*tcoin casinos and various non-KYC methods are where I will go for my bitcoin/dollar liquidity needs, and I will continue to feel torn when people ask me where to get bitcoin.
Sound money is about efficiency. Bitcoin is about efficiency. We have mathematical certainty that any civilization’s first difficulty-adjusted proof-of-work blockchain is the only way that civilization can operate efficiently, for this provides an information transfer system that has thermodynamically provable minimal information losses. It is a coordination system (“money” or “currency” are terms that are themselves metaphors, which allow for people to misunderstand due to their baggage around those terms, while increasing the attack surface — Bitcoin is just Bitcoin, deal with it, a=a cannot be disputable). Unlike others that use metaphors around energy, I mean this in a literal sense and am also not wrong, but it is beyond the scope of this article. The point is, Bitcoin values things being done correctly. Bitcoin values that the right thing is done. Bitcoin punishes those who do the wrong thing. There is absolutely no moralizing or religiosity to those statements, they are made literally, in a technical sense. The fiat world makes people forget that there are absolute truths. A ball is a surface which has the minimum surface necessary to enclose a certain volume. There is no room for opinion, or for an honest business to venture off into the activity of finding alternative shapes that might have less surface area. We are finished.
Just because the truth is intractable, does not mean it does not exist. All of life, and all that is subjective, exists within that window of intractability that quickly arises in considering more complex problems with a large number of variables, the curse of dimensionality dooming the possibility of ever having absolute certainty about the future. That does not mean we are without the capacity for reason, deduction and intelligent prediction.
I assert that various aspects of what is happening over the past few days and the infrastructure that allowed it is not right.
We shall see if Bitcoin “agrees.”
Update:
This article was originally written Friday morning, November 11, 2022, shortly after which spreads normalized on both Strike and Swan.
Strike wrote a thread acknowledging the situation and their commitment to doing right by their users. There were multiple tweets verifying that Strike users were credited “for the inconvenience,” as Strike put it, but it is unclear if the credit amounts were equal to the effective losses each user faced, which Strike could easily compute by checking the price history versus prices at which trades executed for Wednesday through Friday until the additional OTC desks were added.
While the crisis was ongoing on November 10, Yan Pritzker, CTO and co-founder of Swan claimed that the prices were true market prices and that complaints were comparable to left-wing politicians asserting that energy companies across the entire United States are mispricing gasoline. This is a flawed comparison as the situation would be closer to a winter storm shutting down a single state that sees a local price surge since other OTC platforms did not see even a fraction of the jumps in spreads.
In addition to not retracting this statement, Swan Bitcoin has been eerily silent on the matter so far aside from mentioning when pricing had normalized. Swan prides itself on serving and providing white-glove support to high net worth individuals. I find it hard to imagine the sort of individual who might smash buy a million dollars and end up with three to four less bitcoin than they would have had buying somewhere else will simply be willing to walk away and accept that as being “normal.” As one Bitcoin OG mentioned, it is their turn.
Prime Trust admitted that their RFQ architecture was the fundamental thing that led to this happening (they also wrote a thread explaining how this is completely orthogonal to maintaining 100% reserves in segregated accounts).
Mike Brock, who leads TBD at Block (CashApp’s current parent company), and previously was instrumental to developing CashApp’s architecture mentioned on November 12 in a Clubhouse room that robustness under volatility had been a top priority for him, and that though it held up this time, “It is possible if all our OTC desks went under … we would be unable to fulfill orders.”
Conflict of interest disclosure: Michael Chapiro is the CEO and founder of @runCaliber.
This is a guest post by Michael Chapiro. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.
El Salvador’s Minister of the Economy Maria Luisa Hayem Brevé submitted a digital assets issuance bill to the country’s legislative assembly, paving the way for the launch of its bitcoin-backed “volcano” bonds.
First announced one year ago today, the pioneering initiative seeks to attract capital and investors to El Salvador. It was revealed at the time the plans to issue $1 billion in bonds on the Liquid Network, a federated Bitcoin sidechain, with the proceedings of the bonds being split between a $500 million direct allocation to bitcoin and an investment of the same amount in building out energy and bitcoin mining infrastructure in the region.
A sidechain is an independent blockchain that runs parallel to another blockchain, allowing for tokens from that blockchain to be used securely in the sidechain while abiding by a different set of rules, performance requirements, and security mechanisms. Liquid is a sidechain of Bitcoin that allows bitcoin to flow between the Liquid and Bitcoin networks with a two-way peg. A representation of bitcoin used in the Liquid network is referred to as L-BTC. Its verifiably equivalent amount of BTC is managed and secured by the network’s members, called functionaries.
“Digital securities law will enable El Salvador to be the financial center of central and south America,” wrote Paolo Ardoino, CTO of cryptocurrency exchange Bitfinex, on Twitter.
Bitfinex is set to be granted a license in order to be able to process and list the bond issuance in El Salvador.
The bonds will pay a 6.5% yield and enable fast-tracked citizenship for investors. The government will share half the additional gains with investors as a Bitcoin Dividend once the original $500 million has been monetized. These dividends will be dispersed annually using Blockstream’s asset management platform.
The act of submitting the bill, which was hinted at earlier this year, kickstarts the first major milestone before the bonds can see the light of day. The next is getting it approved, which is expected to happen before Christmas, a source close to President Nayib Bukele told Bitcoin Magazine. The bill was submitted on November 17 and presented to the country’s Congress today. It is embedded in full below.
This is an opinion editorial by Joakim Book, a Research Fellow at the American Institute for Economic Research, contributor and copy editor for Bitcoin Magazine and a writer on all things money and financial history.
I don’t.
That’s it. That’s the article.
In all sincerity, that is the full message: Just don’t do it. It’s not worth it.
You’re not an excited teenager anymore, in desperate need of bragging credits or trying out your newfound wisdom. You’re not a preaching priestess with lost souls to save right before some imminent arrival of the day of reckoning. We have time.
Instead: just leave people alone. Seriously. They came to Thanksgiving dinner to relax and rejoice with family, laugh, tell stories and zone out for a day — not to be ambushed with what to them will sound like a deranged rant in some obscure topic they couldn’t care less about. Even if it’s the monetary system, which nobody understands anyway.
Get real.
If you’re not convinced of this Dale Carnegie-esque social approach, and you still naively think that your meager words in between bites can change anybody’s view on anything, here are some more serious reasons for why you don’t talk to friends and family about Bitcoin the protocol — but most certainly not bitcoin, the asset:
- Your family and friends don’t want to hear it. Move on.
- For op-sec reasons, you don’t want to draw unnecessary attention to the fact that you probably have a decent bitcoin stack. Hopefully, family and close friends should be safe enough to confide in, but people talk and that gossip can only hurt you.
- People find bitcoin interesting only when they’re ready to; everyone gets the price they deserve. Like Gigi says in “21 Lessons:”
“Bitcoin will be understood by you as soon as you are ready, and I also believe that the first fractions of a bitcoin will find you as soon as you are ready to receive them. In essence, everyone will get ₿itcoin at exactly the right time.”
It’s highly unlikely that your uncle or mother-in-law just happens to be at that stage, just when you’re about to sit down for dinner.
- Unless you can claim youth, old age or extreme poverty, there are very few people who genuinely haven’t heard of bitcoin. That means your evangelizing wouldn’t be preaching to lost, ignorant souls ready to be saved but the tired, huddled and jaded masses who could care less about the discovery that will change their societies more than the internal combustion engine, internet and Big Government combined. Big deal.
- What is the case, however, is that everyone in your prospective audience has already had a couple of touchpoints and rejected bitcoin for this or that standard FUD. It’s a scam; seems weird; it’s dead; let’s trust the central bankers, who have our best interest at heart.
No amount of FUD busting changes that impression, because nobody holds uninformed and fringe convictions for rational reasons, reasons that can be flipped by your enthusiastic arguments in-between wiping off cranberry sauce and grabbing another turkey slice. - It really is bad form to talk about money — and bitcoin is the best money there is. Be classy.
Now, I’m not saying to never ever talk about Bitcoin. We love to talk Bitcoin — that’s why we go to meetups, join Twitter Spaces, write, code, run nodes, listen to podcasts, attend conferences. People there get something about this monetary rebellion and have opted in to be part of it. Your unsuspecting family members have not; ambushing them with the wonders of multisig, the magically fast Lightning transactions or how they too really need to get on this hype train, like, yesterday, is unlikely to go down well.
However, if in the post-dinner lull on the porch someone comes to you one-on-one, whisky in hand and of an inquisitive mind, that’s a very different story. That’s personal rather than public, and it’s without the time constraints that so usually trouble us. It involves clarifying questions or doubts for somebody who is both expressively curious about the topic and available for the talk. That’s rare — cherish it, and nurture it.
Last year I wrote something about the proper role of political conversations in social settings. Since November was also election month, it’s appropriate to cite here:
“Politics, I’m starting to believe, best belongs in the closet — rebranded and brought out for the specific occasion. Or perhaps the bedroom, with those you most trust, love, and respect. Not in public, not with strangers, not with friends, and most certainly not with other people in your community. Purge it from your being as much as you possibly could, and refuse to let political issues invade the areas of our lives that we cherish; politics and political disagreements don’t belong there, and our lives are too important to let them be ruled by (mostly contrived) political disagreements.”
If anything, those words seem more true today than they even did then. And I posit to you that the same applies for bitcoin.
Everyone has some sort of impression or opinion of bitcoin — and most of them are plain wrong. But there’s nothing people love more than a savior in white armor, riding in to dispel their errors about some thing they are freshly out of fucks for. Just like politics, nobody really cares.
Leave them alone. They will find bitcoin in their own time, just like all of us did.
This is a guest post by Joakim Book. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
This is an opinion editorial by Federico Tenga, a long time contributor to Bitcoin projects with experience as start-up founder, consultant and educator.
The term “smart contracts” predates the invention of the blockchain and Bitcoin itself. Its first mention is in a 1994 article by Nick Szabo, who defined smart contracts as a “computerized transaction protocol that executes the terms of a contract.” While by this definition Bitcoin, thanks to its scripting language, supported smart contracts from the very first block, the term was popularized only later by Ethereum promoters, who twisted the original definition as “code that is redundantly executed by all nodes in a global consensus network”
While delegating code execution to a global consensus network has advantages (e.g. it is easy to deploy unowed contracts, such as the popularly automated market makers), this design has one major flaw: lack of scalability (and privacy). If every node in a network must redundantly run the same code, the amount of code that can actually be executed without excessively increasing the cost of running a node (and thus preserving decentralization) remains scarce, meaning that only a small number of contracts can be executed.
But what if we could design a system where the terms of the contract are executed and validated only by the parties involved, rather than by all members of the network? Let us imagine the example of a company that wants to issue shares. Instead of publishing the issuance contract publicly on a global ledger and using that ledger to track all future transfers of ownership, it could simply issue the shares privately and pass to the buyers the right to further transfer them. Then, the right to transfer ownership can be passed on to each new owner as if it were an amendment to the original issuance contract. In this way, each owner can independently verify that the shares he or she received are genuine by reading the original contract and validating that all the history of amendments that moved the shares conform to the rules set forth in the original contract.
This is actually nothing new, it is indeed the same mechanism that was used to transfer property before public registers became popular. In the U.K., for example, it was not compulsory to register a property when its ownership was transferred until the ‘90s. This means that still today over 15% of land in England and Wales is unregistered. If you are buying an unregistered property, instead of checking on a registry if the seller is the true owner, you would have to verify an unbroken chain of ownership going back at least 15 years (a period considered long enough to assume that the seller has sufficient title to the property). In doing so, you must ensure that any transfer of ownership has been carried out correctly and that any mortgages used for previous transactions have been paid off in full. This model has the advantage of improved privacy over ownership, and you do not have to rely on the maintainer of the public land register. On the other hand, it makes the verification of the seller’s ownership much more complicated for the buyer.
Source: Title deed of unregistered real estate propriety
How can the transfer of unregistered properties be improved? First of all, by making it a digitized process. If there is code that can be run by a computer to verify that all the history of ownership transfers is in compliance with the original contract rules, buying and selling becomes much faster and cheaper.
Secondly, to avoid the risk of the seller double-spending their asset, a system of proof of publication must be implemented. For example, we could implement a rule that every transfer of ownership must be committed on a predefined spot of a well-known newspaper (e.g. put the hash of the transfer of ownership in the upper-right corner of the first page of the New York Times). Since you cannot place the hash of a transfer in the same place twice, this prevents double-spending attempts. However, using a famous newspaper for this purpose has some disadvantages:
- You have to buy a lot of newspapers for the verification process. Not very practical.
- Each contract needs its own space in the newspaper. Not very scalable.
- The newspaper editor can easily censor or, even worse, simulate double-spending by putting a random hash in your slot, making any potential buyer of your asset think it has been sold before, and discouraging them from buying it. Not very trustless.
For these reasons, a better place to post proof of ownership transfers needs to be found. And what better option than the Bitcoin blockchain, an already established trusted public ledger with strong incentives to keep it censorship-resistant and decentralized?
If we use Bitcoin, we should not specify a fixed place in the block where the commitment to transfer ownership must occur (e.g. in the first transaction) because, just like with the editor of the New York Times, the miner could mess with it. A better approach is to place the commitment in a predefined Bitcoin transaction, more specifically in a transaction that originates from an unspent transaction output (UTXO) to which the ownership of the asset to be issued is linked. The link between an asset and a bitcoin UTXO can occur either in the contract that issues the asset or in a subsequent transfer of ownership, each time making the target UTXO the controller of the transferred asset. In this way, we have clearly defined where the obligation to transfer ownership should be (i.e in the Bitcoin transaction originating from a particular UTXO). Anyone running a Bitcoin node can independently verify the commitments and neither the miners nor any other entity are able to censor or interfere with the asset transfer in any way.
Since on the Bitcoin blockchain we only publish a commitment of an ownership transfer, not the content of the transfer itself, the seller needs a dedicated communication channel to provide the buyer with all the proofs that the ownership transfer is valid. This could be done in a number of ways, potentially even by printing out the proofs and shipping them with a carrier pigeon, which, while a bit impractical, would still do the job. But the best option to avoid the censorship and privacy violations is establish a direct peer-to-peer encrypted communication, which compared to the pigeons also has the advantage of being easy to integrate with a software to verify the proofs received from the counterparty.
This model just described for client-side validated contracts and ownership transfers is exactly what has been implemented with the RGB protocol. With RGB, it is possible to create a contract that defines rights, assigns them to one or more existing bitcoin UTXO and specifies how their ownership can be transferred. The contract can be created starting from a template, called a “schema,” in which the creator of the contract only adjusts the parameters and ownership rights, as is done with traditional legal contracts. Currently, there are two types of schemas in RGB: one for issuing fungible tokens (RGB20) and a second for issuing collectibles (RGB21), but in the future, more schemas can be developed by anyone in a permissionless fashion without requiring changes at the protocol level.
To use a more practical example, an issuer of fungible assets (e.g. company shares, stablecoins, etc.) can use the RGB20 schema template and create a contract defining how many tokens it will issue, the name of the asset and some additional metadata associated with it. It can then define which bitcoin UTXO has the right to transfer ownership of the created tokens and assign other rights to other UTXOs, such as the right to make a secondary issuance or to renominate the asset. Each client receiving tokens created by this contract will be able to verify the content of the Genesis contract and validate that any transfer of ownership in the history of the token received has complied with the rules set out therein.
So what can we do with RGB in practice today? First and foremost, it enables the issuance and the transfer of tokenized assets with better scalability and privacy compared to any existing alternative. On the privacy side, RGB benefits from the fact that all transfer-related data is kept client-side, so a blockchain observer cannot extract any information about the user’s financial activities (it is not even possible to distinguish a bitcoin transaction containing an RGB commitment from a regular one), moreover, the receiver shares with the sender only blinded UTXO (i. e. the hash of the concatenation between the UTXO in which she wish to receive the assets and a random number) instead of the UTXO itself, so it is not possible for the payer to monitor future activities of the receiver. To further increase the privacy of users, RGB also adopts the bulletproof cryptographic mechanism to hide the amounts in the history of asset transfers, so that even future owners of assets have an obfuscated view of the financial behavior of previous holders.
In terms of scalability, RGB offers some advantages as well. First of all, most of the data is kept off-chain, as the blockchain is only used as a commitment layer, reducing the fees that need to be paid and meaning that each client only validates the transfers it is interested in instead of all the activity of a global network. Since an RGB transfer still requires a Bitcoin transaction, the fee saving may seem minimal, but when you start introducing transaction batching they can quickly become massive. Indeed, it is possible to transfer all the tokens (or, more generally, “rights”) associated with a UTXO towards an arbitrary amount of recipients with a single commitment in a single bitcoin transaction. Let’s assume you are a service provider making payouts to several users at once. With RGB, you can commit in a single Bitcoin transaction thousands of transfers to thousands of users requesting different types of assets, making the marginal cost of each single payout absolutely negligible.
Another fee-saving mechanism for issuers of low value assets is that in RGB the issuance of an asset does not require paying fees. This happens because the creation of an issuance contract does not need to be committed on the blockchain. A contract simply defines to which already existing UTXO the newly issued assets will be allocated to. So if you are an artist interested in creating collectible tokens, you can issue as many as you want for free and then only pay the bitcoin transaction fee when a buyer shows up and requests the token to be assigned to their UTXO.
Furthermore, because RGB is built on top of bitcoin transactions, it is also compatible with the Lightning Network. While it is not yet implemented at the time of writing, it will be possible to create asset-specific Lightning channels and route payments through them, similar to how it works with normal Lightning transactions.
Conclusion
RGB is a groundbreaking innovation that opens up to new use cases using a completely new paradigm, but which tools are available to use it? If you want to experiment with the core of the technology itself, you should directly try out the RGB node. If you want to build applications on top of RGB without having to deep dive into the complexity of the protocol, you can use the rgb-lib library, which provides a simple interface for developers. If you just want to try to issue and transfer assets, you can play with Iris Wallet for Android, whose code is also open source on GitHub. If you just want to learn more about RGB you can check out this list of resources.
This is a guest post by Federico Tenga. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
