Crypto
How The State Of Global Markets Could Be Pushing The Federal Reserve To Adopt Bitcoin
This is an opinion editorial by Mike Hobart, a communications manager for Great American Mining.
In the wee hours of the morning on Friday, September 23, 2022, markets saw yields on the U.S. 10-year bond (ticker: US10Y) spike up over 3.751% (highs not seen since 2010) shocking the market into fears of breaching 4% and the potential for a run in yields as economic and geopolitical uncertainty continued to gain momentum.
Yields would slowly grind throughout the weekend and at approximately 7:00 a.m. Central Time on Wednesday, September 28, that feared 4% mark on the US10Y was crossed. What followed, approximately three hours later, around 10:00 a.m. on Wednesday, September 28, was a precipitous cascade in yields, falling from 4.010% to 3.698% by 7:00 p.m. that day.
Now, that may not seem like much cause for concern to those unfamiliar with these financial instruments but it is important to understand that when the U.S. bond market is estimated to be about $46 trillion deep as of 2021, (spread across all of the various forms that “bonds” can take) as reported by SIFMA, and taking into consideration the law of large numbers, then to move a market that is as deep as the US10Y that rapidly requires quite a lot of financial “force” — for lack of a better term.
It’s also important to note here for readers that yields climbing on the US10Y denotes exiting of positions; selling of 10-year bonds, while yields falling signals purchasing of 10-year bonds. This is where it is also important to have another discussion, because at this point I can hear the gears turning: “But if yields falling represents buying, that’s good!” Sure, it could be determined as a good thing, normally. However, what is happening now is not organic market activity; i.e., yields falling currently is not a representation of market participants purchasing US10Ys because they believe it to be a good investment or in order to hedge positions; they are buying because circumstance is forcing them to buy. This is a strategy that has come to be known as “yield curve control” (YCC).
“Under yield curve control (YCC), the Fed would target some longer-term rate and pledge to buy enough long-term bonds to keep the rate from rising above its target. This would be one way for the Fed to stimulate the economy if bringing short-term rates to zero isn’t enough.”
–Sage Belz and David Wessel, Brookings
This is effectively market manipulation: preventing markets from selling-off as they would organically. The justification for this is that bonds selling off tend to impact entities like larger corporations, insurance funds, pensions, hedge funds, etc. as treasury securities are used in diversification strategies for wealth preservation (which I briefly describe here). And, following the market manipulations of the Great Financial Crisis, which saw the propping up of markets with bailouts, the current state of financial markets is significantly fragile. The wider financial market (encompassing equities, bonds, real estate, etc.) can no longer weather a sell-off in any of these silos, as all are so tightly intertwined with the others; a cascading sell-off would likely follow, otherwise known as “contagion.”
The Brief
What follows is a brief recount (with elaboration and input from myself throughout) of a Twitter Spaces discussion led by Demetri Kofinas, host of the “Hidden Forces Podcast,” which has been one of my favorite sources of information and elaboration on geopolitical machinations of late. This article is meant solely for education and entertainment, none of what is stated here should be taken as financial advice or recommendation.
Host: Demetri Kofinas
Speakers: Evan Lorenz, Jim Bianco, Michael Green, Michael Howell, Michael Kao
What we have been seeing over recent months is that central banks across the world are being forced into resorting to YCC in an attempt to defend their own fiat currencies from obliteration by the U.S. dollar (USD) as a dynamic of the Federal Reserve System of the United States’ aggressive raising of interest rates.
An additional problem to the U.S.’s raising of interest rates is that as the Federal Reserve (the Fed) hikes interest rates, which also causes the interest rates that we owe on our own debt to rise; increasing the interest bill that we owe to ourselves as well as those who own our debt, resulting in a “doom loop” of requiring further debt sales to pay down interest bills as a function of raising the cost of said interest bills. And this is why YCC gets implemented, as an attempt to place a ceiling on yields while raising the cost of debt for everyone else.
Meanwhile this is all occurring, the Fed is also attempting to implement quantitative tightening (QT) by letting mortgage-backed securities (MBS) reach maturity and effectively get cleared off their balance sheets — whether QT is “ackchually” happening is up for debate. What really matters however is that this all leads to the USD producing a financial and economic power vacuum, resulting in the world losing purchasing power in its native currencies to that of the USD.
Now, this is important to understand because each country having its own currency provides the potential for maintaining a virtual check on USD hegemony. This is because if a foreign power is capable of providing significant value to the global market (like providing oil/gas/coal for example), its currency can gain power against the USD and allow them to not be completely beholden to U.S. policy and decisions. By obliterating foreign fiat currencies, the U.S. gains significant power in steering global trade and decision making, by essentially crippling the trade capabilities of foreign bodies; allied or not.
This relationship of vacuuming purchasing power into the USD is also resulting in a global shortage of USD; this is what many of you have likely heard at least once now as “tightening of liquidity,” providing another point of fragility within economic conditions, on top of the fragility discussed in the introduction, Increasing the likelihood of “something breaking.”
The Bank Of England
This brings us to events around the United Kingdom and the Bank of England (BoE). What transpired across the Atlantic was effectively something breaking. According to the speakers in Kofinas’ Spaces discussion (because I have zero experience in these matters), the U.K. pension industry employs what Howell referred to as “duration overlays” which can reportedly involve leverage of up to twenty times, meaning that volatility is a dangerous game for such a strategy — volatility like the bond markets have been experiencing this year, and particularly these past recent months.
When volatility strikes, and markets go against the trades involved in these types of hedging strategies, when margin is involved, then calls will go out to those whose trades are losing money to put down cash or collateral in order to meet margin requirements if the trade is still desired to be held; otherwise known as “margin calls.” When margin calls go out, and if collateral or cash is not posted, then we get what is known as a “forced liquidation”; where the trade has gone so far against the holder of the position that the exchange/brokerage forces an exit of the position in order to protect the exchange (and the position holder) from going into a negative account balance — which can have the potential of going very, very deeply negative.
This is something readers may remember from the Gamestop/Robinhood event during 2020 where a user committed suicide over such a dynamic playing out.
What is rumored to have occurred is that a private entity was involved in one (or more) of these strategies, the market went against them, placing them in a losing position, and margin calls were very likely to be sent out. With the potential of a dangerous cascade of liquidations, the BoE decided to step in and deploy YCC in order to avoid said liquidation cascade.
To further elaborate on the depth of this issue, we look to strategies deployed in the U.S. with pension management. Within the U.S., we have situations where pensions are (criminally) underfunded (which I briefly mentioned here). In order to remedy the delta, pensions are either required to put up cash or collateral to cover the difference, or deploy leverage overlay strategies in order to meet the returns as promised to pension constituents. Seeing how just holding cash on a corporate balance sheet is not a popular strategy (due to inflation resulting in consistent loss of purchasing power) many prefer to deploy the leverage overlay strategy; requiring allocating capital to margin trading on financial assets in the aim of producing returns to cover the delta provided by the underfunded position of the pension. Meaning that the pensions are being forced by circumstance to venture further and further out onto the risk curve in order to meet their obligations.
As Bianco accurately described in the Spaces, the move by the BoE was not a solution to the problem. This was a band-aid, a temporary alleviation strategy. The risk to financial markets is still the threat of a stronger dollar on the back of increasing interest rates coming from the Fed.
Howell brought up an interesting point of discussion around governments, and by extension central banks, in that they do not typically predict (or prepare) for recessions, they normally react to recessions, giving credit to Bianco’s consideration that there is potential for the BoE to have acted too early in this environment.
One very big dynamic, as positioned by Kao, is that while so many countries are resorting to intervention across the globe, everybody seems to be expecting this to apply pressure on the Fed providing that fabled pivot. There’s the likelihood that this environment actually incentivizes individualist strategies for participants to act in their own interests, alluding to the Fed throwing the rest of the world’s purchasing power under the bus in order to preserve USD hegemony.
Oil
Going further, Kao also brought up his position that price inflation in oil is a major elephant in the room. The price per barrel has been falling as expectations for demand continue to slide along with continual sales of the U.S.’s strategic petroleum reserve washing markets with oil, when supply outpaces demand (or, in this case, the forecast of demand). Then basic economics dictate that prices will diminish. It is important to understand here that when the price of a barrel of oil falls, incentives to produce more diminish, leading to slow downs in investment in oil production infrastructure. And what Kao goes on to suggest is that if the Fed were to pivot, this would result in demand returning to markets, and the inevitability for oil to resume its ascent in price will place us right back to where this problem began.
I agree with Kao’s positions here.
Kao continued to elaborate on how these interventions by central banks are ultimately futile because, as the Fed continues to hike interest rates, foreign central banks simply only succeed in burning through reserves while also debasing their local currencies. Kao also briefly touched on a concern with significant levels of corporate debt around the world.
China
Lorenz chimed in with the addition that the U.S. and Denmark are really the only jurisdictions that have access to 30-year fixed rate mortgages, with the rest of the world tending to employ floating-rate mortgages or instruments that institute fixed rates for a brief period, later resetting to a market rate.
Lorenz went on, “…with rising rates we’re actually going to be crimping spending a lot around the world.”
And Lorenz followed up to state that, “The housing market is also a big problem in China right now… but that’s kind of the tip of the iceberg for the problems…”
He went on, referring to a report from Anne Stevenson-Yang of J Capital, where he said that she details that the 65 largest real estate developers in China owe about 6.3 trillion Chinese Yuan (CNY) in debt (about $885.5 billion). However, it gets worse when looking at the local governments; they owe 34.8 trillion CNY (about $4.779 trillion) with a hard right hook coming, amounting to an additional 40 trillion CNY ($5.622 trillion) or more in debt, wrapped up in “local financing vehicles.” This is supposedly leading to local governments getting squeezed by China’s collapse in its real estate markets, while seeing reductions in production rates thanks to President Xi’s “Zero Covid” policy, ultimately suggesting that the Chinese have abandoned trying to support the CNY against USD, contributing to the power vacuum in USD.
Bank Reserves
Contributing to this very complex relationship, Lorenz re-entered the conversation by bringing up the issue of bank reserves. Following the events of the 2008 Global Financial Crisis, U.S. banks have been required to maintain higher reserves in the aim of protecting bank solvency, but also preventing those funds from being circulated within the real economy, including investments. One argument could be made that this could be helping to keep inflation muted. According to Bianco, bank deposits have seen reallocations to money market funds to capture a yield with the reverse repurchase agreement (RRP) facility that is 0.55% higher than the yield on treasury bills. This ultimately results in a drain on bank reserves, and suggested to Lorenz that a furthering of the dollar liquidity crisis is likely, meaning that the USD continues to suck up purchasing power — remember that shortages in supply result in increases in price.
Conclusion
All of this basically adds up to the USD gaining rapid and potent strength against nearly all other national currencies (except perhaps the Russian ruble), and resulting in complete destruction of foreign markets, while also disincentivizing investment in nearly any other financial vehicle or asset.
Now, For What I Did Not Hear
I very much suspect that I am wrong here, and that I am misremembering (or misinterpreting) what I have witnessed over the past two years.
But I was personally surprised to hear zero discussion around the game theory that has been occurring between the Fed and the European Central Bank (ECB), in league with the World Economic Forum (WEF), around what I have perceived as language during interviews attempting to suggest that the Fed needs to print more money in order to support the economies of the world. This support would suggest an attempt to maintain the balance of power between the opposing fiat currencies by printing USD in order to offset the other currencies being debased.
Now, we know what has played out since, but the game theory still remains; the ECB’s decisions have resulted in significant weakening of the European Union, leading to the weakness in the euro, as well as weakening relations between the European nations. In my opinion, the ECB and WEF have signaled aggressive support and desire for developments of central bank digital currencies (CBDCs) as well as for more authoritarian policy measures of control for their constituents (what I see as vaccine passports and attempts at seizing lands held by their farmers, for starters). Over these past two years, I believe that Jerome Powell of the Federal Reserve had been providing aggressive resistance to the U.S.’s development of a CBDC, while the White House and Janet Yellen have ramped up pressures on the Fed to work on producing one, with Powell’s aversion to development of a CBDC seeming to wane in recent months against pressures from the Biden administration (I’m including Yellen in this as she has, in my opinion, been a clear extension of the White House).
It makes sense to me that the Fed would be hesitant to develop a CBDC, aside from being hesitant to employ any technology that is not understood, with the reasoning being that the U.S.’s major commercial banks share in ownership of the Federal Reserve System; a CBDC would completely destroy the function that commercial banks serve in providing a buffer between fiscal and monetary policy and the economic activity of average citizens and businesses. Which is precisely why, in my humble opinion, Yellen wants production of a CBDC; in order to gain control over economic activity from top to bottom, as well as to gain the ability to violate every citizens’ rights to privacy from the prying eyes of the government. Obviously, government entities can acquire this information today anyway, however, the bureaucracy we have currently can still serve as points of friction to acquiring said information, providing a veil of protection for the American citizen (although a potentially weak veil).
What this ultimately amounts to is; one, a furthering of the currency war that has been ensuing since the start of the pandemic, largely going underappreciated as the world has been distracted with the hot war occurring within Ukraine, and two, an attempt at further destruction of individual rights and freedoms both within, and outside of, the United States. China seems to be the furthest along in the world with regards to development of a sovereign power’s CBDC, and its implementation is much easier for it; it has had its social credit score system (SCS) active for multiple years now, making integration of such an authoritarian wet dream much easier, as the invasion of privacy and manipulation of the populace via the SCS is providing a foot in the door.
The reason I’m surprised that I did not hear this make it into discussion is that this adds a very, very important dynamic to the game theory of the decision making behind the Fed and Powell. If Powell understands the importance of maintaining the separation of central and commercial banks (which I believe he does), and if understands the importance of maintaining USD hegemony with regards to the U.S.’s power over foreign influence (which I believe he does), and he understands the desires for bad actors to have such perverse control over a population’s choices and economic activity via a CBDC (which I believe he might), he would therefore understand how important it is for the Fed to not only resist the implementation of a CBDC but he would also understand that, in order to protect freedom (both domestically and abroad), that this ideology of proliferation of freedom would require both an aversion to CBDC implementation and a subsequent destruction of competition against the USD.
It’s also important to understand that the U.S. is not necessarily concerned with the USD gaining too much power because we largely import the majority of our goods — we export USD. In my opinion, what follows is that the U.S. utilizes the crescendo of this power vacuum in an attempt to gobble up and consolidate the globe’s resources and build out the necessary infrastructure to expand our capabilities, returning the U.S. as a producer of high quality goods.
This Is Where I May Lose You
This therefore opens up a real opportunity for the U.S. to further its power… with the official adoption of bitcoin. Very few discuss this, and even fewer may recall, but the FDIC went around probing for information and comment in its exploration of how banks could hold “crypto” assets on their balance sheets. When these entities say “crypto,” they more often than not mean bitcoin — the problem is that the general populace’s ignorance of Bitcoin’s operations cause them to see bitcoin as “risky” when aligning with the asset, as far as public relations are concerned. What’s even more interesting is that we have not heard a peep out of them since… leading me to believe that my thesis may be more likely to be correct than not.
If my reading of Powell’s situation were correct, and this all were to play out, the U.S. would be placed in a very powerful position. The U.S. is also incentivized to follow this strategy as our gold reserves have been dramatically depleted since World War II, with China and Russia both holding signficant coffers of the precious metal. Then there’s the fact that bitcoin is still very early in its adoption with regards to utilization across the globe and institutional interest only just beginning.
If the U.S. wants to avoid going down in history books as just another Roman Empire, it would behoove it to take these things very, very seriously. But, and this is the most important aspect to consider,I assure you that I have likely misread the environment.
Additional Resources
- “Introduction To Treasury Securities,” Investopedia
- “Bond Traders Relish Idea Of Fed Rates Above 4%,” Yahoo! Finance
- “10-Year Treasury Note And How It Works,” The Balance
- “Bond Market,” Wikipedia
- “Fixed Income — Insurance And Trading, First Quarter 2021,” SIFMA
- “How Much Liquidity Is In The US Treasury Market,” Zero Hedge
- “What Is Yield Curve Control?” Brookings
- “Using Derivative Overlays To Hedge Pension Duration,” ResearchGate
This is a guest post by Mike Hobart. 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.
