Crypto
An Argument Against KYC Bitcoin That Everyone Can Understand
This is an opinion editorial by Heady Wook, privacy advocate and contributor to Bitcoin Magazine. This work is licensed under CC BY 4.0. To view a copy of this license, visit https://creativecommons.org/licenses/by/4.0/. Bitcoin Magazine has made several grammatical and formatting changes.
Introduction
In the Bitcoin white paper, Satoshi Nakamoto cited the need for a cash system over the internet without the need for a trusted third-party. A few months later, Nakamoto introduced the Bitcoin network to the world. In block zero (the “genesis block”) of the Bitcoin blockchain, the following message was included: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” On one hand, the quote references a UK news piece outlining Chancellor Alistair Darling’s consideration of a second bailout for banks, which meant pumping billions more British pounds into the economy. On the other hand, the quote references Nakamoto’s frustration and distrust of the traditional financial system and, more broadly, trusted third parties. This is made clear in the white paper abstract and the first paragraph’s opening lines. In another section of the white paper, Nakamoto compares the traditional finance privacy model with Bitcoin’s privacy model. In Bitcoin’s model, trusted third-parties are no longer responsible to safeguard an individual’s privacy by limiting access to information. In fact, no personal information is required at all. With Bitcoin, individuals can maintain privacy simply by “keeping public keys anonymous.” In an early Bitcoin forum post, Nakamoto wrote:
“We have to trust them with our privacy, trust them not to let identity thieves drain our accounts […] placing trust in the system administrator to keep their information private. Privacy could always be overridden by the admin based on his judgment call weighing the principle of privacy against other concerns, or at the behest of his superiors. […] It’s time we had the same thing for money. […] without the need to trust a third party middleman, money can be secure and transactions effortless. […] The result is a distributed system with no single point of failure. Users hold the [private] keys to their money and transact directly with each other.”
Nakamoto was concerned about trusting third parties with both privacy and money. Specifically, Nakamoto cited a few points of failure of the traditional finance privacy model: bad actors or identity thieves, lack of administrator integrity, and authoritative demands from “superiors,” such as a government. One manifestation of these failures is showcased by the long history of currency-debasing governments (see: The Bitcoin Standard) and includes the event cited within the genesis block. Alluding to Bitcoin, Nakamoto suggested these issues are solved with “a distributed system with no single point of failure.”
Bitcoin has been a long time coming. The conversation about “private,” “sovereign” or “electronic” currency had gone on by others at least a decade before Bitcoin’s inception. For instance, “A Cypherpunk’s Manifesto” discusses anonymous transaction systems on the internet, “The Sovereign Individual” predicts a private and permissionless internet currency, and “Cryptonomicon” describes an anonymous digital gold. Nakamoto designed Bitcoin with such properties: Bitcoin is pseudonymous, it can be used privately and it is permissionless. However, “know your customer” regulations1 (KYC) have proven to be pervasive, persistent and problematic for users looking to benefit from such properties.
Along with bitcoin’s price action from 2020 through 2021, bitcoin companies have experienced lots of growth. Coinbase, for example, reported reaching over 35 million users in over 100 countries by the end of 2020. Furthermore, in 2022 Coinbase took out a 60-second Super Bowl ad featuring a floating QR code which reached over 20 million hits within just one minute. Surojit Chatterjee, chief product officer at Coinbase, went so far as to call it “historic and unprecedented.” However, Coinbase is only one of many successful companies. According to CoinGecko, Coinbase ranks sixth in terms of the most trusted exchanges with Binance (#1), OKX, FTX, KuCoin and Huobi Global (#5) respectively taking the lead. Together, these exchanges have KYC’d millions upon millions of users. These massive KYC efforts are in direct contrast with the pseudonymous, permissionless, P2P, cash system with no third parties developed by Nakamoto. Furthermore, KYC creates honeypots of user information and gives rise to a permissioned social system.
KYC Creates Honeypots Of User Information
Every time an individual signs up for an exchange or related service they are likely asked to KYC themselves — that is, provide personally identifiable information (PII). PII typically consists of a selfie, drivers license, social security number, address, email and phone number. PII is usually stored by an outside service, such as Prime Trust. When Nakamoto said, “We have to trust them with our privacy [and] trust them not to let identity thieves drain our accounts,” the reference to “them” can be thought of as exchanges and their partner service providers. All these third parties come with inherent risks, such as bad actors (e.g. insider job; BitThumb, 2019), lack of administrator integrity (e.g. BitConnect exit scam) and susceptibility to government demands (e.g. IRS forces compliance). When Nakamoto references “identity thieves,” he refers to data breaches in which hackers gain access to and profit from PII, either by directly stealing funds, selling the PII to interested parties or extortion. Given all the PII provided, KYC creates a honeypot of user information that is ripe for exploitation.
Data breaches have become more and more prevalent over the years:
- 2016 Data Security Incident
- T-Mobile Data Breach Exposed The Personal Info Of More Than 47 Million People
- A Hacker Gained Access To 100 million Capital One Credit Card Applications And Accounts
- U.S. Postal Service Exposes 60 Million Users in API Snafu
- Equifax Data Breach May Affect Nearly Half The U.S. Population
- Target Settles 2013 Hacked Customer Data Breach For $18.5 Million
- JPMorgan Chase Hacking Affects 76 Million Households
- CVS And Walmart Canada Are Investigating A Data Breach
- Sony Pictures Website Hacked, 1 Million Accounts Exposed
- 235 Million Instagram, TikTok And YouTube User Profiles Exposed In Massive Data Leak
According to Statista, data breaches have increased over 500% from 2005 through 2020. Furthermore, according to the Cost of Data Breach Report, 80% of all data breaches in 2019 included customer PII (name, credit card information, health records and payment information). Data breaches may also include more sensitive types of PII, such as social security number, driver’s license number or biometrics.
All trusted-required third-parties are susceptible to a data breach, including bitcoin companies. For instance, consider the Ledger hack of July 2020. In an official statement by the Ledger CEO, “1 million email addresses had been stolen as well as 9,532 more detailed personal information (postal addresses, name, surname and phone number).” That same year, the Ledger customer database was dumped onto Raidforum, a database sharing and marketplace forum. Thereafter, several Ledger users reported phishing attempts, extortion and threatening emails, including threats of kidnapping and violence, such as murder.
Reddit user Cuongnq received a phishing email prompting him to “download the latest version of Ledger Live” and to follow the instructions to set up a “new PIN” for his wallet. Another Reddit user, Silkblueberry, received an email stating that hackers had videos of him “masturbating to porn” and that they would post the videos publicly unless he sent them bitcoin as payment. Silkblueberry saw through the ploy. However, the hackers resorted to more extreme measures, threatening to associate his email with “child porn sites” and frame him as a “child predator” if he did not send them $500 in bitcoin. Yet another user received a phone call from an unknown man demanding payment. The man threatened he would “show up to [his] house, kidnap [him], and ‘stab to death’ any relatives living at [his] address” if he did not send a payment by midnight that night.
The Ledger hack is one example that illustrates how damaging an exploited KYC honeypot can be. Still, some might suggest that KYC services are needed because they offer an easy on-ramp for newcomers and that exposure is worth the risk. To this, one can point to the many non-KYC alternatives known to preserve individual privacy and security. Furthermore, these non-KYC alternatives have become easier over time with the help of several guides and resources. These non-KYC alternatives include: (1) Using decentralized peer-to-peer exchanges like Bisq Network or Hodl-Hodl to buy bitcoin; (2) buying privately from a bitcoin ATM; (3) buying or selling face-to-face or selling goods and services at a bitcoin meetup; and (4) mining for bitcoin at home.
Others might cite the use of bitcoin in criminal activity and suggest KYC provides individuals with the peace of mind that one is not inadvertently supporting illicit activity. However, bitcoin’s use in criminal activity is small compared to that of the U.S. dollar. In 2017 during a judiciary committee hearing, Deputy Assistant Secretary of the Office of Terrorist Financing and Financial Crimes, Jennifer Fowler, testified that “although virtual currencies are used for illicit transactions, the volume is small compared to the volume of illicit activity through traditional financial services.” Given the differences in volume, it is unlikely one may inadvertently support criminal activity by buying non-KYC bitcoin. This becomes even more unlikely when one buys or sells peer-to-peer at a local bitcoin meetup or buys from a bitcoin ATM.
Bitcoin was designed in part as pseudonymous, yet there is an alarming level of KYC taking place which completely undermines this property. Millions of users all over the world are tying their identity to their bitcoin and every one of them is contributing to the creation of honeypots of user information. This remains true even in the face of overwhelming evidence that data breaches have become almost an everyday occurrence. Rather than sacrificing pseudonymity, taking on additional risk or contributing to the problem, users should instead be part of the solution and take back their pseudonymity, reduce risks and protect PII by using non-KYC alternatives.
KYC Gives Rise To A Permissioned Social System
The Bitcoin network is a permissionless cash system outside the control of any third party. However, the majority of individuals are not using bitcoin this way. Instead, individuals have become reliant on third-party KYC services, such as bitcoin exchanges, yield platforms and hosted mining, among others. Not only does KYC undermine your pseudonymity, it also undermines your transactional privacy. This is true even after taking custody of your bitcoin. Unlike physical cash, where a bank cannot track what you do with it after withdrawal, a third-party, such as an exchange, is able to track what you do with your bitcoin after it has been withdrawn. That is, until the proper privacy measures are taken, such as participating in a coinjoin2.
Even if an identity can be obfuscated from an individual’s bitcoin transactions, the KYCing third party still retains all the user’s personally identifiable information (PII), including name, address, selfies and total purchase amount. Armed with PII and the ability to spy on transactional behavior, KYC gives rise to a permissioned social system. There are many examples for how KYC gives rise to a permissioned social system (e.g. limits and restrictions; intrusive verification measures; address whitelisting; and state interventions). This section focuses on CoinJoin as an example of a forbidden behavior within a permissioned social system. CoinJoin was selected given the important role it plays in everyday privacy.
Since Bitcoin is a public ledger, it is good practice to “make every spend a CoinJoin.” This is true for two reasons. First, CoinJoining limits any inferences a spying third-party might be able to draw up from one’s transaction history. Second, CoinJoining protects others from peering into one’s personal finances. Reason one is important because, as discussed above, a KYCing third-party can track what one does with their bitcoin and CoinJoining can help users gain forward-looking privacy. Reason two is important because, unlike cash or debit/credit cards where a merchant ( the payee) cannot peer into a payer’s finances (e.g. bank account totals), with bitcoin payee’s can peer into a payer’s finances — at least, the UTXO being spent. This is akin to handing out one’s bank statement with every transaction.
If you take a moment to ponder some of the situations that may arise from such a situation, you will quickly realize the implications this has on privacy. One caricatured example is put forth by Samourai Wallet: “Imagine if your church pastor was able to see your OnlyFans subscription when you place a dollar bill into the offering plate.” The dollar bill here represents a typical bitcoin transaction. A CoinJoin would have provided the user in this example the privacy needed to avoid this awkward situation by obfuscating the payment’s transaction history. In another more extreme example, imagine paying someone a small amount but using a large UTXO (akin to taking out an enormous gold coin just to shave a tiny portion off). The person receiving the payment would be able to see that the payer holds a significant amount of bitcoin. This might place the payer at a higher risk for a five-dollar wrench attack. A CoinJoin would have broken up a large UTXO into smaller UTXOs, reducing the payee’s ability to determine a payer’s holdings; they only see that you’re spending from pocket change. Given these examples, it becomes clear that Bitcoin lacks essential qualities found in physical cash that CoinJoin can make up for. Despite the benefits that CoinJoin provides users, KYC third-party services operate on the false premise that CoinJoining is malicious or risky and prohibit its use. With CoinJoin prohibition as a common practice among some of the most popular exchanges, a permissioned social system has effectively designated CoinJoins as “bad.”
Take BlockFi for example. They have a “prohibited uses” page stating the intent to maintain “a policy of strict regulatory compliance” and therefore prohibits deposits and withdrawals to or from: Mixing services, peer-to-peer and other exchanges which do not have KYC, gambling sites and dark net marketplaces. Furthermore, BlockFi “retains the right to return funds and freeze/close accounts as necessary.” BlockFi is only one of many exchanges known to prohibit or flag CoinJoins. For instance, in one of the more extreme examples, Reddit user Bujuu reported his exchange account was closed due to the “amount and frequency” of his CoinJoin transactions. The exchange, Bitvavo, claimed Bujuu posed an “unacceptable risk” and closed his account as a measure of mitigation. Later Bujuu said, “It kinda bugs me that I’m not allowed to do what I want with my BTC, that it’s all being monitored.” CoinJoin prohibition is perhaps one of the clearest examples of how KYC gives rise to a permissioned social system.
Several other users have reported milder experiences. One user claimed, “@bottlepay [has] rejected my incoming btc transaction due to the coins having been in samourai wallet and/or mixed with @SamouraiWallet #Whirlpool / If you have sent mixed coins you will get stung.” This user reported this issue upon the deposit of funds which demonstrates a backward-looking analysis on his coin’s history. A similar level of intrusion has been reported by others. For instance, another user received an email from Paxos stating, “We noticed that a BTC withdrawal from your account has potentially been sent to a known bitcoin mixing service. This type of transaction is not permitted on the platform. Please confirm whether the funds have been sent to a mixing service.” This time the issue arose upon the withdrawal of funds which demonstrates a forward-looking analysis on the coin’s history. Furthermore, Riccardo Masutti claimed “@bitwala sent [him] an email 3 days ago about a couple of post-CoinJoin transactions that happened almost 6 MONTHS AGO” and Kristapsk claimed he received “an e-mail from @BitMEX about [an] old #Bitcoin deposit transaction (last summer) that ‘may be connected with activity that is against 1.1(a) of the HDR Terms of Service.’, it was @joinmarket coinjoin.” These last two examples demonstrate the depth of chain analysis conducted by KYCing third parties.
Taken together, one can see how pervasive a permissioned social system can be. Users want to reap the benefits of a CoinJoin yet CoinJoining is considered prohibited behavior by many major third-party KYC exchanges (or related services). This general distaste for CoinJoin, along with blatant chain analysis, places individuals who KYC in a vulnerable position. Individuals who KYC are prohibited from exercising basic privacy rights or they face punitive measures if they do. In either case, KYC’d individuals are being spied on. Any reasonable individual would agree this is not a good position to be in, especially when participating in an independent and alternative cash system with no third parties. Despite the clear benefits that CoinJoin has to offer, the current view is that CoinJoins are too “risky.” On a CoinJoin panel at the Bitcoin 2022 conference, Craig Raw, founder of Sparrow Wallet, said:
“If we use the tools [i.e. CoinJoin] that we have today, it changes the mindset of people and it changes how society views it. If CoinJoin becomes a widely used thing today, then that will change the way that society views it and I think that it is important not to wait too long and to actually use the tools because… it changes the way that the rules and regulations of the world will form.”
According to Raw, CoinJoin normalization is a function of its use. Therefore, individuals must take it upon themselves to exercise their rights to privacy. This cannot be accomplished from within a permissioned system, nor will it be granted. Rather, CoinJoin normalization must be accomplished outside of a permissioned system, such as within the Bitcoin network as it was designed to be used — without permission.
Conclusion
KYC creates honeypots of user information and gives rise to a permissioned social system. When you KYC, you must provide a lot of sensitive personal information which contributes to the honeypot. This action alone is enough to negate pseudonymity given an identity has been associated with your bitcoin holdings. Furthermore, individuals must trust that third parties will keep sensitive information safe. Further, when you KYC, you voluntarily enter into a permissioned relationship with a third party. That is, you must abide by the rules set in place by the third party or potentially face punitive measures, such as asset seizure, account closure or frozen assets. Given the important role it plays in everyday privacy, CoinJoin is an example of a forbidden behavior within a permissioned social system. Upon examination of the evidence it becomes clear that KYC indeed creates honeypots of user information and gives rise to a permissioned social system.
References
1 “KYC” refers to the confirmation of identity of an account holder via the collection of documents (e.g. driver’s license, social security number, employment record, selfies, etc; Federal Reserve, 1997) by financial third-party services (e.g. bitcoin exchanges) on behalf of the Internal Revenue Service (Internal Revenue Service, 2000).
2 CoinJoin “is a trustless method for combining multiple bitcoin payments from multiple spenders into a single transaction to make it more difficult for outside parties to determine which spender paid which recipient or recipients” (Bitcoin Wiki, 2015). In other words, CoinJoin is a privacy tool that obfuscates transaction history by undermining the common input heuristic. This effectively and reliably provides users with forward-looking transactional privacy at the application layer with no changes to the main bitcoin protocol.
This is a guest post by Heady Wook. 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.
