Crypto
Understanding Our Current Monetary System And Bitcoin’s Value Proposition
This is an opinion editorial by Taimur Ahmad, a graduate student at Stanford University, focusing on energy, environmental policy and international politics.
Author’s note: This is the first part of a three-part publication.
Part 1 introduces the Bitcoin standard and assesses Bitcoin as an inflation hedge, going deeper into the concept of inflation.
Part 2 focuses on the current fiat system, how money is created, what the money supply is and begins to comment on bitcoin as money.
Part 3 delves into the history of money, its relationship to state and society, inflation in the Global South, the progressive case for/against Bitcoin as money and alternative use-cases.
Bitcoin As Money: Progressivism, Neoclassical Economics, And Alternatives Part II
*The following is a direct continuation of a list from the previous piece in this series.
3. Money, Money Supply And Banking
Now onto the third point that gets everybody riled up on Twitter: What is money, what is money printing and what is the money supply? Let me start by saying that the first argument that made me critical of the political economy of Bitcoin-as-money was the infamous, sacrilegious chart that shows that the U.S. dollar has lost 99% of its value over time. Most Bitcoiners, including Michael Saylor and co., love to share this as the bedrock of the argument for bitcoin as money. Money supply goes up, value of the dollar comes down — currency debasement at the hands of the government, as the story goes.
I have already explained in Part 1 what I think about the relationship between money supply and prices, but here I’d like to go one level deeper.
Let’s start with what money is. It is a claim on real resources. Despite the intense, contested debates across historians, anthropologists, economists, ecologists, philosophers, etc., about what counts as money or its dynamics, I think it is reasonable to assume that the underlying claim across the board is that it is a thing that allows the holder to procure goods and services.
With this backdrop then, it doesn’t make sense to look at an isolated value of money. Really though, how can someone show the value of money in and of itself (e.g., the value of the dollar is down 99%)? Its value is only relative to something, either other currencies or the amount of goods and services that can be procured. Therefore, the fatalistic chart showing the debasement of fiat doesn’t say anything. What matters is the purchasing power of consumers using that fiat currency, as wages and other social relations denominated in fiat currency also move synchronously. Are U.S. consumers able to purchase 99% less with their wages? Of course not.
The counterarguments to this typically are that wages don’t keep up with inflation and that over the short-medium term, cash savings lose value which hurts the working class as it doesn’t have access to high yielding investments. Real wages in the U.S. have been constant since the early 1970s, which in and of itself is a major socioeconomic problem. But there is no direct causal link between the expansionary nature of fiat and this wage trend. In fact, the 1970s were the start of the neoliberal regime under which labor power was crushed, economies were deregulated in favor of capital and industrial jobs were outsourced to underpaid and exploited workers in the Global South. But I digress.
Let’s go back to the what is money question. Apart from a claim over resources, is money also a store of value over the medium term? Again, I want to be clear that I am talking only about developed nations thus far, where hyperinflation isn’t a real thing so purchasing power doesn’t erode overnight. I’d argue that it is not the role of money — cash and its equivalents like bank deposits — to serve as a store of value over the medium-long term. It is supposed to serve as a medium of exchange which requires price stability only in the short run, coupled with gradual and expected devaluation over time. Combining both features — a highly liquid, exchangeable asset and a long-term savings mechanism — into one thing makes money a complicated, and maybe even contradictory, concept.
To protect purchasing power, access to financial services needs to be expanded so that people have access to relatively safe assets that keep up with inflation. Concentration of the financial sector into a handful of large players driven by profit motive alone is a major impediment to this. There is no inherent reason that an inflationary fiat currency has to lead to a loss of purchasing power time, especially when, as argued in Part 1, price changes can happen because of multiple non-monetary reasons. Our socioeconomic setup, by which I mean the power of labor to negotiate wages, what happens to profit, etc., needs to enable purchasing power to rise. Let’s not forget that in the post-WWII era this was being achieved even though money supply was not growing (officially the U.S. was under the gold standard but we know it was not being enforced, which led to Nixon moving away from the system in 1971).
Okay so where does money come from and were 40% of dollars printed during the 2020 government stimulus, as is commonly claimed?
Neoclassical economics, which the Bitcoin standard narrative employs at various levels, argues that the government either borrows money by selling debt, or that it prints money. Banks lend money based on deposits by their clients (savers), with fractional reserve banking allowing banks to lend multiples higher than what is deposited. It comes as no surprise to anyone who is still reading that I’d argue both these concepts are wrong.
Here’s the correct story which (trigger warning again) is MMT based — credit where it’s due — but agreed to by bond investors and financial market experts, even if they disagree on the implications. The government has a monopoly on money creation through its position as the sovereign. It creates the national currency, imposes taxes and fines in it and uses its political authority to protect against counterfeit.
There are two distinct ways in which The State interacts with the monetary system: one, through the central bank, it provides liquidity to the banking system. The central bank does not “print money” as we colloquially understand it, rather it creates bank reserves, a special form of money that isn’t really money that is used to buy goods and services in the real economy. These are assets for commercial banks that are used for inter-bank operations.
Quantitative easing (those scary big numbers that the central bank announces it is injecting by buying bonds) is categorically not money printing, but simply central banks swapping interest bearing bonds with bank reserves, a net neutral transaction as far as the money supply is concerned even though the central bank balance sheet expands. It does have an impact on asset prices through various indirect mechanisms, but I won’t go into the details here and will let this great thread by Alfonso Peccatiello (@MacroAlf on Twitter) explain.
So the next time you hear about the Fed “printing trillions” or expanding its balance sheet by X trillion, just think about whether you are actually talking about reserves, which again don’t enter the real economy so do not contribute to “more money chasing the same amount of goods” story, or actual money in circulation.
Two, the government can also, through the Treasury, or its equivalent, create money (normal people money) that is distributed through the government’s bank – the central bank. The modus operandi for this operation is typically as follows:
- Say the government decides to send a one-time cash transfer to all citizens.
- The Treasury authorizes that payment and tasks the central bank to execute it.
- The central bank marks up the account that each commercial bank has at the central bank (all digital, just numbers on a screen — these are reserves being created).
- the commercial banks correspondingly mark up the accounts of their customers (this is money being created).
- customers/citizens get more money to spend/save.
This type of government spending (fiscal policy) directly injects money into the economy and is thus distinct from monetary policy. Direct cash transfers, unemployment benefits, payments to vendors, etc., are examples of fiscal spending.
Most of what we call money, however, is created by commercial banks directly. Banks are licensed agents of The State, to which The State has extended its powers of money creation, and they create money out of thin air, unconstrained by reserves, every time a loan is made. Such is the magic of double-entry bookkeeping, a practice that has been in use for centuries, where money comes into being as a liability for the issuer and an asset for the receiver, netting out to zero. And to reiterate, banks don’t need a certain amount of deposits to make these loans. Loans are made subject to whether the bank thinks it makes economic sense to do so — if it needs reserves to meet regulations, it simply borrows them from the central bank. There are capital, not reserve, constraints on lending but those are beyond the scope of this piece. The primary consideration for banks in making loans/creating money is profit maximization, not whether it has enough deposits in its vault. In fact, banks are creating deposits by making loans.
This is a pivotal shift in the story. My analogy for this is parents (neoclassical economists) telling children a fake birds and bees story in response to the question of where babies come from. Instead, they never correct it leading to an adult citizenry running around without knowing about reproduction. This is why most people still talk about fractional reserve banking or there being some naturally fixed supply of money that the private and public sectors compete over, because that’s what econ 101 teaches us.
Let’s revisit the concept of money supply now. Given that most of the money in circulation comes from the banking sector, and that this money creation is not constrained by deposits, it is reasonable to claim that the stock of money in the economy is not just driven by supply, but by demand as well. If businesses and individuals are not demanding new loans, banks are unable to create new money. This has a symbiotic relationship with the business cycle, as money creation is driven by expectations and market outlook but also drives investment and expansion of output.
The chart below shows a measure of bank lending compared to M2. While the two have a positive correlation, it does not always hold, as is glaringly evident in 2020. So even though M2 was surging higher post-pandemic, banks were not lending due to uncertain economic conditions. As far as inflation is concerned, there is the added complexity of what banks are lending for, i.e., whether those loans are being used for productive ends, which would increase economic output or unproductive ends, which would end up leading to (asset) inflation. This decision is not driven by the government, but by the private sector.
The last complication to add here is that while the above metrics serve as useful measures for what happens within the US economy, they do not capture the money creation that happens in the eurodollar market (eurodollars have nothing to do with the euro, they simply refer to the existence of USD outside the U.S. economy).
Jeff Snider gave an excellent run through of this during his appearance on the What Bitcoin Did podcast for anyone who wants a deep-dive, but essentially this is a network of financial institutions that operate outside the U.S., are not under the formal jurisdiction of any regulatory authority and have the license to create U.S. dollars in foreign markets.
This is because the USD is the reserve currency and required for international trade between two parties that may not have anything to do with the U.S. even. For example, a French bank may issue a loan denominated in U.S. dollars to a Korean company wanting to buy copper from a Chilean miner. The amount of money created in this market is anyone’s guess and hence, a true measure of the money supply is not even feasible.
This is what Alan Greenspan had to say in a 2000 FOMC meeting:
“The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode.”
Here he refers not just to the Eurodollar system but also the proliferation of complex financial products that occupy the shadow banking system. It’s hard to talk about money supply when it’s hard to even define money, given the prevalence of money-like substitutes.
Therefore, the argument that government intervention through fiscal and monetary expansion drives inflation is simply not true as most of the money in circulation is outside the direct control of the government. Could the government overheat the economy through overspending? Sure. But that is not some predefined relationship and is subject to the state of the economy, expectations, etc.
The notion that the government is printing trillions of dollars and debasing its currency is, to no one’s surprise at this point, just not true. Only looking at monetary intervention by the government presents an incomplete picture as that injection of liquidity could be, and in many cases is, making up for the loss of liquidity in the shadow banking sector. Inflation is a complex topic, driven by consumer expectations, corporate pricing power, money in circulation, supply chain disruptions, energy costs, etc. It cannot and should not be simply reduced to a monetary phenomenon, especially not by looking at something as one-dimensional as the M2 chart.
Lastly, the economy should be seen, as the post-Keynesians showed, as interlocking balance sheets. This is true simply through accounting identity — someone’s asset has to be someone else’s liability. Therefore, when we talk about paying back the debt or reducing government spending, the question should be what other balance sheets get affected and how. Let me give a simplified example: in the 1990s during the Clinton era, the U.S. government celebrated budget surpluses and paying back its national debt. However, since by definition someone else had to be getting more indebted, the U.S. household sector racked up more debt. And since households couldn’t create money while the government could, that increased the overall risk in the financial sector.
Bitcoin As Money
I can imagine the people reading till now (if you made it this far) saying “Bitcoin fixes this!” because it’s transparent, has a fixed issuance rate and a supply cap of 21 million. Here I have both economic and philosophic arguments as for why these features, regardless of the current state of fiat currency, are not the superior solution that they are described to be. The first thing to note here is that, as this piece has hopefully shown thus far, that since the rate of change of money supply is not equal to inflation, inflation under BTC is not transparent or programmatic and will still be subject to the forces of demand and supply, power of the price setters, exogenous shocks, etc.
Money is the grease that allows the cogs of the economy to churn without too much friction. It flows to sectors of the economy that require more of it, allows new avenues to develop and acts as a system that, ideally, irons out wrinkles. The Bitcoin standard argument rests on the neoclassical assumption that the government controls (or manipulates, as Bitcoiners call it) the money supply and that wrestling away this power would lead to some true form of a monetary system. However, our current financial system is largely run by a network of private actors that The State has little, arguably too little, control over, despite these actors benefitting from The State insuring deposits and acting as the lender of last resort. And yes, of course elite capture of The State makes the nexus between financial institutions and the government culpable for this mess.
But even if we take the Hayekian approach, which focuses on decentralizing control completely and harnessing the collective intelligence of society, countering the current system with these features of Bitcoin falls into the technocratic end of the spectrum because they are prescriptive and create rigidity. Should there be a cap on money supply? What is the appropriate issuance of new money? Should this hold in all situations agnostic of other socioeconomic conditions? Pretending that Satoshi somehow was able to answer all these questions across time and space, to the extent that no one should make any adjustments, seems remarkably technocratic for a community that is talking about the “people’s money” and freedom from the tyranny of experts.
Bitcoin is not democratic and not controlled by the people, despite it offering a low barrier to enter the financial system. Just because it is not centrally governed and the rules can’t be changed by a small minority does not, by definition, mean Bitcoin is some bottom-up form of money. It is not neutral money either because the choice to create a system that has a fixed supply is a subjective and political choice of what money should be, rather than some a priori superior quality. Some proponents might say that, if need be, Bitcoin can be changed through the action of the majority, but as soon as this door is opened, questions of politics, equality and justice flood back in, taking this conversation back to the start of history. This is not to say that these features are not valuable — indeed they are, as I argue later, but for other use-cases.
Therefore, my contentions thus far have been that:
- Understanding the money supply is complicated because of the financial complexity at play.
- The money supply does not necessarily lead to inflation.
- Governments do not control the money supply and that central bank money (reserves) are not the same thing as money.
- Inflationary currencies do not necessarily lead to a loss of purchasing power, and that that depends more on the socioeconomic setup.
- An endogenous, elastic money supply is necessary to adjust to economic changes.
- Bitcoin is not democratic money simply even though its governance is decentralized.
In Part 3, I discuss the history of money and its relationship with the state, analyze other conceptual arguments that underpin the Bitcoin Standard, provide a perspective on the Global South, and present alternative use-cases.
This is a guest post by Taimur Ahmad. 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.
