Sunday Long Post: Liquid! It's been a while since I have done a Sunday long read... And I wanted to share some thoughts on Liquid.
I have been thinking a LOT about it. Liquid has so much going for it. A very flexible security model that is arguably one of the most interesting uses of trust in a post Bitcoin world. Confidential Transactions (ala nullc/Monero) by default. Asset issuance. Multi-sig, and smart contract features including token/security issuance and decentralized exchanges all with a native token that is strongly pegged to Bitcoin on the base layer rather than a floating shitcoin.
Liquid is all ETH has been the testbed for, but without the gigantic architectural flaws. Spread the responsibility of hosting potential behemoth databases of smart contracts and other large size uses of block space to a federation who is ready to host this data, rather than to every single user and node runner (though ANYONE can run a Liquid node). It does not wreck the world if Liquid fails. And it would have no serious effect on Bitcoin. The database IS SOMEWHAT DECENTRALIZED, while being more distant from the ideal of fully distributed, it can leave that ideal to the base layer and play with things like NFTs, the storage of legal or medical records, tokens, and so on.
What is liquid anyway?
Blockstream defines it this way:
“The Liquid Network is a Bitcoin layer-2 enabling the issuance of security tokens and other digital assets. Execute trustless swaps using non-custodial orderbooks and protect your financial privacy through confidential transactions.” - (
https://blockstream.com/liquid/)
First of all. We will call the Bitcoin base chain “Layer 1” or the base layer. This is the absolute foundation of bitcoin and is optimized for security and maximum distribution, or decentralization. What we mean by “layer 2” is fairly well established and understood now. But here is a reminder: Bitcoin layers, or scaling layers, are a way to abstract the use of bitcoin to another method of accounting that does not require a transaction to be written to the Bitcoin global database (blockchain). The best ideas so far are cryptographically based systems that still do not require a central authority. Lightning is one example. In that model two parties will form a payment channel and can send messages to each other to keep a tally on who owns what, and those channels can be used in chains of payment between strangers in this way. Another Layer 2 is an OPENDIME (
https://opendime.com/). This layer uses meatspace to physically exchange the bitcoin. The bitcoin is stored on an address for which the unit holds the private key in a way that cannot be known by the owner without destroying the device. But as long as the device is working people can just physically hand the unit to another person. This can go on practically forever until someone wants to destroy the device and move the bitcoin to another address on the base layer.
Liquid is based on Free Open Source Software (FOSS). The underlying system is maintained by Blockstrream as “Elements” (
https://blockstream.com/elements/). Anyone who wants too can spin up their own sidechain using the software, or run a node on the Liquid network (though only Fedaration members can sign blocks). Liquid works much more closely to the way that the base layer works. It stores it’s transactions in a blockchain just like Bitcoin. But there are some very important differences.
Liquid has 1 minute blocks. And there is no mining done, nor is there “proof of work”. Instead the members of the liquid federation take turns writing each new block to the chain at the top of each minute.
The native asset of the blockchain is L-BTC. L-BTC is issued (by the federation) by means of locking BTC on the base layer into a multisig address and creating the matching L-BTC on the liquid chain. This is called a “peg in”. And the process is done in reverse by destroying the L-BTC on the liquid chain while simultaneously moving the BTC back out of the multisig to a regular address.
It is important to understand there is trust in play here. We must trust that the Liquid chain continues to be run by the members of the federation, and that those members will continue to execute their role in creating and destroying L-BTC, signing transactions on both layers, as well as creating the next block each minute. But even though Liquid introduces this trust, it does so in a way in which no single federation member can act alone. Instead blocks must be signed by multiple parties. This reduces the risk that a rogue member would steal someones bitcoin or write malicious data to the liquid blockchain. Though the liquid blockchain IS more centralized than the base layer, that trust is still distributed among the federation members. There are currently around 60 members. Exchanges, wallets, Bitcoin focused businesses and other financial institutions. Much like a group of banks who are issuing scrip to be used among anyone who chooses to trade in the federation's token (L-BTC in our case).
Why should we use a model like this? Isn’t Bitcoin better since it is the maximum distribution of trust? Why would we take a step back and introduce ANY amount of centralization?
These are important questions. And let’s answer them by looking at what we gain and lose.
There is an old saying in business: “Price, speed, and quality. Pick any two.” Want something to be made cheaply? Well it will need to be made slowly, and/or have reduced quality. Similarly if you need something TOMORROW, and it is meant to be the highest quality, then you can guarantee that it will be expensive.
Bitcoin scaling is a similar set of trade offs. We can express the three legs of Bitcoin’s security model as
• Distribution (decentralization)
• Efficiency
• Cost
Distribution is the choice that on Bitcoin we always want the least centralized security model. This also means the minimization of trust. Efficiency encompasses both the speed and size of transactions, and cost is the fees paid to the miners. Again you can only have two of these.
And since we will NEVER want to increase the centralization then we are in a constant war between Cost and Efficiency. Want to write giant transactions into the base layer? (Like JPGs?) Then you must be prepared to pay dearly for it. Want to make sure your transaction is in the next block? Then price, again will suffer. Want the cheapest possible transaction? Then you need to write the least amount of data to the chain as you can, and be willing to wait for confirmation. We are in a constant 3 way battle, like Rock Paper Scissors, but in this model the three dimensions are continuums rather than binary, and rock (decentralization) always gets extra points.
Liquid basically softens the Bitcoin security model to offer more flexibility in the other two dimensions. By introducing the federated security model we are enabling the use of more block space (token issuance), Confidential Transactions, and fast, cheap transactions.
So we are not junking up the base chain with monkey JPGs or “BRC-20” tokens, rather we segregate this usage to the second layer where it can be executed with much less overhead on the base.
So with all this functionality Liquid must be a very successful project, right?
Well… not really. Currently Liquid is a ghost town. Nic Carter has famously called it “completely irrelevant” (
https://twitter.com/nic__carter/status/1542295652436262913) and presumably believes Ethereum has already won the fight for the smart contract/token issuance platform simply by network effect.
But there are other opinions on this including my own. It has been said said Adam Back (founder of Blockstream) tends to see things early. And there is proof he does. He was already thinking about bitcoin and even inventing parts of its technology years before Satoshi finally cracked the combination.
In my opinion what Blockstream has done is set up the Liquid platform ahead of the need for it’s use. And with a little luck it will be ready when the rest of us finally come around to the needs for it.
Bitcoin, and Ethereum are each on their own trajectory. And will continue forward on their paths.
Bitcoin will continue to become more and more expensive to use because more and more people will be using it. It is already well beyond the “buy a cup off coffee” use case but continuing to be the de facto gold standard for securely storing and transmitting value. Payment layers are inevitable, and lightning is becoming better and better for payments while we see other payment, saving, and privacy tech being developed in real time. Ark is an interesting emerging tech (
https://medium.com/coinmonks/bitcoin-ark-a-layer-2-protocol-for-fast-and-efficient-payments-acb6504207) and Chaumian Mints are beginning to be developed for privacy and secure transfer as well (
https://fedimint.org/)
Ethereum, on the other hand, will one day collapse under it’s own weight. With no brakes on the “efficiency” part of the scaling model ETH will necessarily sacrifice decentralization and price. Eventually the node runners and stakers (in the POS model) will centralize. And it is already happening. Even new coin creation is centralizing to the largest staked nodes and the rich will get richer? Sound familiar? It should because it is basically the current fiat central bank model on digital steroids. Unfortunately this experiment has a long way to go before it becomes common knowledge that it is a flawed model from the start.
Liquid on the other hand is just waiting. It has the potential to fulfill all of ETHs promises with a negligible footprint on the base layer. Will this happen? It is hard to say. But one thing is for sure. Ethereum is crushing Liquid as far as network effect goes. And new platforms do not generally replace the first-runners no matter how many times you speak forth the Myspace incantation.
But here is where the ease of transition to Liquid COULD in fact perform the nearly impossible. It is extremely simple to peg-in and have L-BTC which will allow you to transact on this 2nd layer. It takes a matter of seconds to send Bitcoin to the “SideSwap” wallet (
https://sideswap.io/) and peg in. Then using Liquid is almost exactly like using Bitcoin with the added features of Monero-like privacy and the ability to create securities and other functional tokens. Many exchanges will already take deposits and make withdrawals in L-BTC. And all the tools that are written for Bitcoin can fairly easily be updated to include Liquid. And even Tether (USDT) has been issued on the Liquid network.
It’s just that no one really uses it yet. That is Liquid’s one problem. People can use BTC for storage and commerce, ETH for monkys, and Monero for privacy. So Liquid has a pretty big hurdle to jump. If people started to pay each other in L-BTC and thus save on BTC fees then all the infrastructure will become clearly useful. There are already decentralized exchanges (DEXes), and a LOT of big players are already on board.
Another question we have looming is what happens if Liquid does keep being used? There is no real fee market currently since there is little demand for blockspace. But if we start filling up the hard drives of the Fesaration members and other nodes, then Liquid will face it’s own version of the block space/fees issue. It will become more expensive to transact on this network too. Will Blockstream and the Fedaration continue to try to keep fees as low as possible? We do not know.
So, in conclusion, I believe Liquid might have a bright future. I really do think Adam Back might just be early on this, and once people see that Liquid can be used for all the things that the base layer shuns by means of fees usage might increase. So far there has been no notable “depegging” of the L-BTC value. The system is designed from the very bottom up to lock the value of the native token to that of the base layer. And though you can always buy LBTC on an exchange. Pegging in is currently a very lof fee (0.1%) action. Of course there are risks. Nothing, even BTC is without risk. But personally I store a non-trival amount of value in Liquid. And I hope that it will become useful as people start to experiment with the platform. If not I will just “peg-out” for that same 10 basis points.
the empty cup waits
for Liquid to take it’s shape
where will you be then?
his game.
