Crypto
How The United States Weaponizes The Dollar To Retain Global Hegemony
This is an opinion editorial by Luke Mikic, a writer, podcast host and macro analyst.
This is the first part in a two-part series about the Dollar Milkshake Theory and the natural progression of this to the “Bitcoin Milkshake.”
Introduction
- “The dollar is dead!”
- “The Petrodollar system is breaking down!”
- “The Federal Reserve doesn’t know what it’s doing!”
- “China is playing the long game; the U.S. is only planning four years ahead.”
How many times have you heard claims like these from macroeconomists and sound money advocates in recent times? These types of comments have become so prevalent, that it’s now a mainstream opinion to declare that we’re about to see the imminent death of the U.S. dollar and subsequent fall of the great U.S. empire. Is modern America about to suffer the same fate as Rome, or does the country still have an economic wild card hidden up its sleeve?
Similarly dire predictions were made about the U.S. dollar in the 1970s during the
“Great Inflation,” after the abandonment of the gold standard in 1971. It took the dynamic duo of Richard Nixon and Henry Kissinger to pull a rabbit out of the hat to save the U.S. dollar. They effectively backed the USD with oil in 1973, birthing the petrodollar experiment.
It was an ingenious move that prolonged the life of the dollar and the hegemonic reign of the U.S. as the world’s dominant superpower. The lesson we should take away from this example in the 1970s is to never underestimate a great empire. They’re an empire for a reason. Could the United States be forced to play another monetary wild card today to retain their power as the global hegemon in the face of de-dollarization?
History doesn’t repeat, but it often rhythms.
Another similarity to the 1970s is emerging today as Federal Reserve Chair Jerome Powell is aggressively raising interest rates in an attempt to fight the most ravaging inflation we’ve seen since that time. Is Powell simply fighting inflation or is he also attempting to save the credibility of the U.S. dollar in the midst of a 21st-century currency war?
I believe we are on the precipice of the implosion of a globally interconnected, fiat-based financial system. There are currently over 180 different currencies all around the world, and in these two articles I’ll outline how we will end the decade with two currencies left standing. Another dynamic duo, if you will.
Most people assume these two currencies left standing will be in violent opposition to each other, but I’m not so sure. I believe they will form a symbiotic relationship where they compliment each other, the same way a plump cherry compliments a milkshake on a warm, sunny day.
But how do we get there, and why do I believe the U.S. dollar will be one of the last dominos to fall? Simple gravity! Yes, the U.S. is running the largest fiscal deficits of all time. Yes, the U.S. has $170 trillion of unfunded liabilities. But gravity is gravity, and there’s an estimated $300 trillion of economic gravity around the world making it likely that the U.S. dollar will be the last fiat currency to hyperinflate. This is the biggest mistake people make when they analyze the dollar. We often only look at the supply of dollars and an exponentially growing Fed balance sheet.
However, everyone is forgetting the first lesson of Economics 101: supply and demand. There is an enormous demand for dollars all around the world.
This is a Bitcoin publication, so I will also be discussing the role that bitcoin may have in the cascading fiat currency collapse that I expect to unfold in the coming months and years.
If you accept the hypothetical assumption that one day the world will operate on a bitcoin standard, most people will then assume this is bad for the United States, as it is the current global reserve status holder. However, the monetization of bitcoin benefits one country disproportionally more than any other: the United States.
- A strong dollar will lead to hyperdollarization.
- A consequence of hyperdollarization is increased bitcoin adoption.
- A consequence of increased bitcoin adoption is increased stablecoin adoption.
- A consequence of increased stablecoin adoption is increased U.S. dollar adoption!
This dynamic feedback loop will ultimately become an all-consuming, fiat currency black hole.
Welcome to the “Bitcoin Milkshake Thesis,” the delicious macroeconomic dessert you haven’t heard of.
Let me explain many of these complicated-sounding macroeconomic theories prevalent today: petrodollars, eurodollars, dollar milkshakes, bitcoin milkshakes, Ray Dalio’s “Changing World Order.”
Most importantly, I will explain how they all relate to the most delicious dynamic duo in the macroeconomic dessert place: the Dollar Milkshake meets the Bitcoin Milkshake.
The Dollar Milkshake Theory
By now, you’ve probably at seen the effects that the “Dollar Milkshake Theory” had on financial markets. The Dollar Milkshake Theory, created and proposed by Brent Johnson in 2018, helps to explain why every asset class in the world is cratering. From global equities, blue chip tech stocks, real estate and bonds, money is flowing out of assets and the currencies of sovereign nations and into the global safe haven: the U.S. dollar.
If there is one chart that explains the Dollar Milkshake, this is it.
Distilled into its simplest format, the Dollar Milkshake Theory explains how the macroeconomic endgame will unfold for our debt supercycle. It details in what order Johnson believes the dominos will fall as we transition to a new monetary system.
The “milkshake” part of this delicious dessert consists of trillions of dollars in liquidity that global central banks have printed over the past decade. Johnson articulates that the USD will be the straw that sucks up all of that liquidity when capital seeks safety in times of financial risk. Capital flows to where it is treated best. Johnson proposes that the U.S. dollar will be the last fiat currency standing, as sovereign nations are forced to devalue and hyperinflate their own national currencies to source the U.S. dollars they need during a global sovereign debt crisis.
Put very simply, the Dollar Milkshake Theory is a manifestation of the structural imbalances present in our monetary system. These imbalances were expected and even predicted by John Maynard Keynes at the Bretton Woods conference in 1944 and critiqued by Robert Triffin in the 1950s and 1960s. The consequences of abandoning the gold standard without using a neutral reserve asset was eventually going to come back to haunt the global economy.
With the dollar wrecking ball currently wreaking havoc on our financial system and bankrupting governments all around the world, I thought it would be timely to revisit what I said over a year ago:
That quote originated from an article I published in a series titled “Bitcoin The Big Bang To End All Cycles.” In the piece, I analyzed the history of 80-year, long-term debt cycles and the history of hyperinflation to conclude that the inflation that had just reared its head in 2021 was not going to be transitory, and instead would be an accelerating catalyst that would propel us toward a new monetary system by the end of the decade. Despite expecting acceleration, the acceleration we’ve seen since mid-2021 has still surprised me.
Here, I will take a more granular look at the intermediary steps involved in this global sovereign debt crisis, exploring the role bitcoin will play as this unfolds. That will give us hints as to which is likely to be the next global reserve currency after the unwinding of this debt supercycle.
Many are puzzled by the U.S. dollar decimating every other fiat currency on the globe. How is this possible? There are two major systems that have led to the structural imbalances present in our global economy: the eurodollar market and the petrodollar system.
Much of the dollar-denominated debt mentioned above was created by banks outside of the U.S. This is where the term “eurodollars” comes from. I’m not going to bore you with an explanation of the eurodollar market, rather just give you the basics that are relevant to this thesis. The key takeaway we need to understand is that the eurodollar market is rumored to be in the tens and even hundreds of trillions of dollars!
This means there is actually more debt outside the U.S. than there is within the country. Lots of countries either chose, or were forced, to take on U.S. dollar-denominated debt. For them to repay that debt, they need to access dollars. In times of an economic slowdown, lockdown of the global economy or when exports are low, these other countries sometimes have to resort to printing their own currencies to access U.S. dollars in the foreign exchange markets to pay their dollar-denominated debts.
When the dollar index rises — indicating that the U.S. dollar is getting stronger against other currencies — this puts even more pressure on these countries with large dollar-denominated debts. This is exactly what we’re witnessing today as the dollar index (DXY) reached 20-year highs.
The one-month chart for the dollar index (DXY) going back to 1981 shows 20-year highs.
For a more detailed breakdown on the Dollar Milkshake Theory and the devastating effects it’s having on markets today, I dedicated a blog to explaining the thesis.
This milkshake dynamic creates an enormous demand for U.S. dollars outside of the country, which enables and actually requires the Fed to create enormous amounts of liquidity in order to supply the world with the dollars the world needs to service its debts. If the Fed wants the global economy to function effectively, it simply must supply dollars to the world. This is a key point. In a globally interconnected world during peacetime, it makes sense the Fed would supply the world with the needed dollars.
Since we’ve been on the petrodollar system for the past 50 years, we’ve experienced many calls for the death of the dollar. However, the most threatening times our financial system faced have emerged when there’s been a shortage of U.S. dollars, and the DXY has strengthened relative to other currencies.
The Deadly Dollar Bull Runs
The dominant narrative in the macroeconomic environment over the past decade has surrounded the Fed and central banks with historically unprecedented loose monetary policy. However, this appears to be changing in 2022.
As we watch the Fed and central banks around the world raise interest rates in an attempt to control inflation, many are shocked and confused as to what this new paradigm of tightening monetary policy will mean for our deglobalizing global economy. It’s paramount to remember: All fiat currencies are losing purchasing power against goods and services.
All currencies are being rapidly devalued and will eventually return to their intrinsic value of 0. Of the hundreds of currencies that have existed since 1850, most have gone to 0. Currently, we’re in the process of witnessing the final 150 or so trend to 0 in a globally competitive debasement to the bottom.
One of the major measurements everyone uses to measure this relative strength is the dollar index. It is measured against six major currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
The DXY has had three major bull runs since 1971 that have threatened the stability of the global financial system. Every time the U.S. dollar has rallied, it’s destroyed the balance sheets of emerging market countries that have taken on too much U.S. debt with too little reserves.
In this dollar bull cycle, it’s not just fringe emerging markets that are suffering from the soaring U.S. dollar. Every single currency is being decimated against the mighty greenback. The Japanese yen has long been regarded as a safe haven alongside the U.S. dollar and for years it’s been held up as the poster currency by Keynesian economists. They’ve had the joy of pointing toward Japan’s enormous 266% debt-to-GDP ratio, alongside the Bank of Japan’s enormous 1,280-trillion-yen balance sheet with decades of low inflation.
Japan held $1.3 trillion of U.S. Treasurys as of January 2022, beating out China as the largest foreign holder of U.S. debt.
Both the Japanese and the Chinese have recently resorted to selling their U.S. Treasury holdings as they suffer from the global dollar shortage.
A weak Japanese yen is typically bad for China because Japanese exports become more attractive the weaker the yen gets. This is why every time the yen has significantly weakened, the yuan has typically followed. There appears not to be an exception to this rule in 2022, and close attention should be paid to the other exporting Asian currencies, like the South Korean won and the Hong Kong dollar.
Then we have the Hong Kong dollar peg, which is also on the brink of a major breakout, as it continues to knock on the 7.85 peg.
This peg has been held for over 30 years.
This peg has been held for over 30 years.
Shifting our attention to another energy-impoverished area, we can see that the USD is also showing enormous strength against the euro, which is the second-largest currency in the world. The EUR/USD has broken a 20-year support line and has recently traded below parity with the dollar for the first time in 20 years. The eurozone is suffering tremendously from a fragile banking system and energy crisis with its currency losing 20% of its value against the dollar in the past 18 months alone.
The euro has lost 20% of its value against the dollar in just 18 months.
The European Central Bank looks to be in crisis mode as they’ve barely gotten interest rates into the positive realm, while the Fed has moved its federal funds rate to almost 4%.
The Fed has moved its federal funds rate to almost 4%.
This has caused significant capital flight out of Europe, and due to the recent volatility in their bond market, ECB President Christine Lagarde was forced to announce a new form of quantitative easing (QE). This “anti-fragmentation” tool is a new form of QE where the ECB sells German bonds to buy Italian bonds in an attempt to keep the fracturing eurozone together.
This dollar bull run is wreaking havoc on the world’s largest and safest currencies. The yen, euro and the yuan are the three largest alternatives to the U.S. dollar and all are competitors if the U.S. were to lose its reserve currency status. But the emerging market currencies are where the real pain is being felt the most. Countries like Turkey, Argentina and Sri Lanka are all experiencing 80%-plus inflation and serve as great examples of how the dollar wrecking ball hurts the smaller countries the most.
What Comes Next?
The DXY has had a hell of a run over the past 12 months, so a pullback wouldn’t surprise me. Both the DXY and the more equally-weighted broad dollar index are very extended after having parabolic rises in 2022 and are both now breaking down from their parabolas.
One-day chart of the DXY showing a parabolic increase
One-day chart of the trade-weighted broad dollar index, also showing a parabolic increase
Could we see a Fed balance sheet shoot to $50 trillion while simultaneously seeing hyperdollarization as the eurodollar market is absorbed?
It’s possible, but I think the Fed is racing the clock. The petrodollar system is breaking down rapidly as the BRICS nations are racing to set up their new reserve currency.
It’s important to notice, this milkshake scenario was always going to unfold. The structural imbalances in our financial system would’ve always inevitably manifested themselves in this domino effect of currency collapses that Brent Johnson articulated.
Interestingly, I believe some recent events have actually accelerated this process. Yes, I see all the signposts that the dollar doomsayers are pointing out; the dollar will die eventually, just not yet. However, let’s entertain the idea that the dollar is in fact dying, and the USD will lose reserve currency status.
Who would take over the global reserve currency of the world?
For the economic reasons I’ve mentioned above, I don’t believe the euro, the yen or even the Chinese yuan are viable replacements for the U.S. dollar. In a recent article titled, “The 2020s Global Currency Wars,” I explored the theses of Ray Dalio and Zoltan Pozsar and explained why I believed both were ignoring the geopolitical, demographic and energy-related headwinds facing all the competitors to the U.S.
I do believe that commodities are significantly undervalued and that we will see a 2020s “commodities supercycle,” due to decades of underinvestment in the industry. I also believe securing commodities and energy will play a key role in a nation’s security, as the world continues to deglobalize. However — disagreeing with Pozsar here — backing money with commodities isn’t the solution to the problem the world is facing.
I believe the U.S. dollar will be the last fiat currency to hyperinflate, and I actually expect it to hold on to the reserve currency status until this long-term debt cycle concludes. To go one step further, I actually think there’s a strong possibility that the United States will be the last country ever to hold the title of “global reserve currency issuer” if they play their cards right.
We will explore the Bitcoin Milkshake Theory in part two.
This is a guest post by Luke Mikic. 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.
