Blockstream to Launch First, Instant-Settlement Sidechain for Bitcoin Exchanges

Bitcoin Magazine
Blockstream to Launch First, Instant-Settlement Sidechain for Bitcoin Exchanges

Blockstream has announced it will launch its first commercial Bitcoin sidechain by early 2016. The sidechain, codenamed “Liquid,” offers instant transactions, providing a fast settlement layer for bitcoin exchanges, brokerages and other industry members.

As its main advantage, Liquid provides instant and secure transactions among all users of the sidechain. While Bitcoin transactions can typically take up to an hour to be sufficiently secured by the blockchain, Liquid offers a similar level of security within seconds.

Blockstream, which received a $21 million funding round last year and employs several Bitcoin Core developers, intends to deploy the sidechain among different exchanges and other Bitcoin service providers. Users with accounts at several of these exchanges will then be able to move bitcoin from one account to another within an instant, instead of having to wait for the transaction to confirm on the blockchain.

Speaking to Bitcoin Magazine, Blockstream CEO and co-founder Austin Hill explained the added advantages of using Liquid:

“Liquid is mostly targeted at exchanges, and through them at institutional traders. These traders are the market makers that continually move funds back and forth from one exchange to the other, making use of arbitrage opportunities, as such minimizing spreads and increasing liquidity. These more sophisticated traders look at bitcoin’s confirmation times as a negative, and really do need the type of speed of markets that Liquid can offer.”

But it’s not just exchanges and their users that can benefit from Liquid, Hill continued:

“We also have customers that are end users themselves. They buy and sell bitcoin on multiple exchanges for their own customers’ needs. A good example of that would be wallet provider Xapo; it is a huge benefit for them to have instant access to all the other markets. Another example could be companies that use bitcoin for remittances. Right now they need to adopt sophisticated hedging strategies to counteract the volatility of bitcoin; instant transactions can obviously even that out.”

Sidechains are basically alternative blockchains that use bitcoin as a currency unit. First conceived a year ago , they allow for bitcoin to move in and out of different “pegged” blockchains. As such, users of a sidechain can transfer bitcoin using varying rule-sets – not just those imposed by the original Bitcoin blockchain (such as the 10-minute confirmation time).

Much like Blockstream’s open-source testnet sidechain “Elements,” Liquid uses a “federated consensus” security model to confirm transactions. This holds that bitcoin sent to the sidechain are locked into a typical multisig address on the Bitcoin blockchain, requiring several private keys to unlock. The keys needed to unlock these bitcoin are effectively transferred to Liquid, where they can be used to transfer the pegged value within the sidechain.

As opposed to the Bitcoin blockchain, transactions on Liquid are not processed by miners. Instead, some of the companies using Liquid will act as as functionaries that validate transactions for each other using tamper-resistant hardware boxes with a special software stack embedded. Transactions confirm if a supermajority of these functionaries sign them. While this introduces a minimal level of trust in the system, it’s exceedingly difficult for functionaries to cheat the system, as no one entity is in charge. A supermajority of functionaries would need to be compromised at the same time in order to block transactions or steal funds.

“There have previously been a number of attempts by different exchanges to try and realize something like this,” Hill said. “Customers were asking for it, and these companies wanted to test the benefits. But previously, all attempts to do this included some form of counterparty credit agreements, or agreements to accept transactions with no confirmations. Because of the required trust involved in these kinds of solutions, they were never actually launched. By using a federated consensus sidechain, we can give exchanges the control of their own funds, but with the added functionality of instant transactions.”

Exchanges and other industry members that wish to join the Liquid sidechain must subscribe through Blockstream, which charges a monthly fee. So far, some of the world’s biggest bitcoin exchanges and other prominent industry leaders have joined the project. This includes Bitfinex, the world’s top U.S. dollar exchange by volume, Kraken, the world’s top euro exchange by volume, BTCC (formerly BTCChina), one of the leading Chinese yuan exchanges, Unocoin, a leading Indian ruble exchange and wallet service, and Xapo, one of the top funded wallet services in the space.

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Should Bitcoin Have Regularly Scheduled Hard Forks?

Hard forks are a rather contentious issue in Bitcoin. The controversy surrounding hard forks can be seen most prominently in the context of Bitcoin XT ’s implementation of BIP 101.

While there have been successful Bitcoin hard forks in the past, the problem with hard forks of the Bitcoin blockchain is that they’re, well, hard. Any change to the Bitcoin protocol that requires a hard fork essentially requires near-complete consensus to avoid a potential blockchain split.

For example, there are many individuals in the Bitcoin development community who do not believe that BIP 101’s use of a 75 percent majority vote by miners as a mechanism for enabling a larger block size limit is such a good idea.

Hard forks are difficult, but they have to happen from time to time in order for Bitcoin to grow and evolve. For this reason, some have proposed the idea of scheduled hard forks. This would essentially create a regular update schedule for the blockchain for changes that require a hard fork during the implementation process.

Problems with Regularly Scheduled Hard Forks

Bitcoin Foundation Chief Scientist Gavin Andresen and Bitcoin Core Contributor Peter Todd were both recently asked for their opinions on scheduled hard forks during the Bitcoin governance panel at Bitcoin Pacifica 2015, and neither of them seemed overly bullish on the concept. For one, Todd noted that the schedule may become useless because it is not set in stone.

“I would point out that — I would start by at least doing one,” he said. “Trying to go figure out what does a schedule actually look like. You can delay the schedule; it becomes very tricky.”

Todd, who always seems to be able to pick out the flaws in any proposal, also noted that miners could ultimately decide to veto any hard fork they don’t like.

“Let’s look at this from an adversarial point of view,” he said. “If we have a hard fork and some miners decide that the next hard fork they disagree with — the reality is they can go veto a hard fork.”

Measuring Consensus is Hard

A third issue pointed out by Todd had to do with figuring out what would be implemented in each individual hard fork. In his view, there does not exist a good mechanism for coming to consensus, nor measuring it:

“Well, again, we don’t have good methods for this other than to accept that hard forks are hard, and getting consensus is something that kind of needs to happen. Maybe we do need some technological measures, such as miner voting, maybe proof-of-stake voting, but beyond that, it’s really hard to imagine how you actually create durable social institutions when they’re so easily undermined at protocol, almost by design.”

Hard Forks Have to Be Hard

Gavin Andresen also shared his cynical view of regularly scheduled hard forks, mainly pointing out that there could be issues because “people are lazy and they don’t like upgrading.” According to Andresen, this could cause issues related to having proper validation between users on the network. The key point that Andresen made during his comments had to do with making sure that hard forks were hard to pull off:

“I think hard forks have to be hard. I actually do agree with Jeff Garzik. There has to be community consensus, and the community has to be aware of what’s going on with them. I don’t know, I’d have to think a little bit more of: Would it make sense to have a regular schedule, where if there was nothing in the hard fork, maybe the hard fork just doesn’t happen.”

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