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Bitcoin is the forerunner and by far the most widely used cryptocurrency. In what follows we will use the customary notation of referring to the Bitcoin network/protocol as Bitcoin (Capitalized) and to the units of currency flowing in the Bitcoin network as bitcoins (lowercase). Sometimes we will be using smaller units called satoshis.
By design, bitcoins have several highly desired technical attributes
- Fixed supply
- Easily transportable
On top of that, Bitcoin is decentralized. Decentralization adds an extra layer of robustness because the Bitcoin network has no single point of failure.
Any and all Bitcoin transactions are publicly available on the a ledger a.k.a “The Blockchain”, and are immutable.
While originally designed to be a currency, Bitcoin supports a limited scripting language that can be used to store metadata on the blockchain. Colored Coins is a concept that allows attaching metadata to Bitcoin transactions and leveraging the Bitcoin infrastructure for issuing and trading immutable digital assets that can represent real world value. The value of such digital assets is tied to a real-world promise by the asset issuers that they are willing to redeem those digital tokens for something of value in the real world.
Digital asset on top of the Bitcoin's Blockchain can be used to issue Financial assets (securities like shares, commodities like Gold or new currencies), Prove of ownership (A digital key to a house or a car, a concert ticket), store information (Documents, Certificates, Contracts) or creating smart contracts (CFDs, Loans, Bets, Derivatives).
The advantage given by using the blockchain as the backbone for such asset manipulation is that one can rely on the blockchain’s transparency, immutability, ease of transfer and non-counterfeitability to transfer and trade such digital tokens with unprecedented security and ease.
Desired attributes of a colored coins protocol
- Embed the maximal amount of data with minimal amount of load on the blockchain
- Be decentralized
- Allow for sending arbitrary amounts of metadata with every colored transaction
- Allow for both locked assets (can be reissued) and unlocked assets (cannot be reissued)
Over the past few years we have seen several colored coins implementations (which are part of the larger Bitconi 2.0 movement.
The Colored Coins Protocol
This document describes the Colored Coins protocol specification for issuing and transacting digital asset on top of the Bitcoin Blockchain.
This Document consists of two main parts
1. The coloring scheme
The coloring scheme describes the encoding used to encode/decode the Colored Coins data that is stored in a bitcoin transaction after the OP_RETURN operator (and sometimes in one additional multisignature output). This coloring scheme is optimized for robust functionality by inserting the most data within the current size constraints of the OP_RETURN operator (80 Bytes).
2. Asset Metadata and the Rule engine
This document introduces the first specification for handling metadata for digital assets. Because of the 80 Bytes limit of the OP_RETURN field, any metadata that is attached to a transaction is hashed and stored in torrents to allow decentralized access to the information. By hashing the metadata for every transaction, Colored Coins actually expands dramatically the basic Bitcoin functionality by allowing to insert rules that exist outside the blockchain and can be publicly accessed via torrents and verified against a specific transaction thus creating a rule engine with basic smart contract functionality.