Blockstream’s new Liquid Network asks us to rethink trust

A few weeks ago Blockstream launched its Liquid Network, a Bitcoin sidechain that “provides fast, secure, and confidential transactions to address the needs of exchanges, brokers, market makers, and financial institutions around the world.”

Liquid, which has sparked both interest and concern, is the first commercial sidechain for Bitcoin. Blockstream wants to provide Liquid users with:

  • Faster trading
  • Enhanced capital efficiency
  • Better privacy
  • Reliability

Founded in 2014, Blockstream is an important player in the Bitcoin and blockchain technology space. The launch of the Liquid Network has been been met with various reactions and questions. What does it mean for the ideal of decentralization and the cypherpunk ideals of early Bitcoin users? How does a centralized intermediary gain our trust?

Blockstream’s motto is “rethinking trust.” Let’s rethink together.

A federated side-chain

As a sidechain, Liquid uses bitcoin as its currency. Specific Liquid features are:

  • “Liquid’s native Liquid Bitcoin (L-BTC) asset is backed by a two-way peg to Bitcoin (BTC) and can be redeemed at any time, providing institutions and end users with a secure and rapid way to transfer bitcoin between members with full settlement in two minutes.
  • Liquid’s Issued Assets brings bitcoin-like features to traditional assets, such as tokenized fiat, digital reward points, and attested assets (e.g. gold coins), removing the need for dedicated blockchains or wallet software.
  • Blockstream’s Confidential Transaction technology ensures that the amount and asset type transferred are known only to the transacting parties, enhancing the privacy of both L-BTC and Issued Asset transactions.”

Liquid uses a two-way peg to get coins on and off the sidechain.

A peg keeps a currency stable with the other, just like central banks usually keep a peg to the US dollar. The two-way peg between L-BTC and bitcoin, used in Liquid, keeps the exchange between the two currencies fixed.

Essentially, this allows for Liquid to develop unique features for the bitcoin currency. Liquid cannot create coins, but produces its own blocks of 1 minute instead of bitcoin’s 10 minute blocks. The transactions are faster, also because they are signed by authorized nodes instead of mining with proof-of-work.

Furthermore, instead of the decentralized model of bitcoin, Liquid uses a federated model, which is essentially private and centralized. The federation acts as an intermediary between the main chain and the sidechain.

An article breaking down sidechains for non-technical users notes that:

“Blockstream is creating a consortium of exchanges to operate as functionaries. If there are 7 exchanges in the consortium, you need 5 of 7 of those exchanges to sign a bitcoin transaction to withdraw from the federated sidechain. Therefore 5 of the 7 exchanges act as a custodian for the entire backing of the sidechain.”

Decentralized centralization for profit

As a federated chain, Liquid seems to take a backstep toward centralization, crushing the cypherpunk dream. At the same time, Blockstream claims to be committed to decentralization. In a recent interview with Blockstream’s Allen Piscitello, the interviewer remarks:

“Blockstream has managed to become a divisive entity in the Bitcoin community, as some members have questioned its legitimacy and its intentions. On one hand, it’s the most upfront, vocal, and involved company in the development of every project which seeks to build layers on top of Bitcoin without compromising the decentralization of the network. On the other and, it seems to be centralizing the talent, the brains, and the resources under a common institutional umbrella, and this type of arrangement is bound to attract criticism.”

The interviewer seems to refer to Blockstream’s employment of many active bitcoin core developers. This means that the most influential developers of Bitcoin are on the payroll of a for-profit company. My point of view is that, once the end-goal becomes profit, intentions can no longer be fully trusted.

Unlike many crypto projects, Blockstream isn’t community funded. It is explicitly a for-profit corporation. One may wonder how developing a P2P decentralized cryptocurrency can generate profits? Since Liquid is on a sidechain, the transaction fees don’t go to the miners but to the developers of the sidechains. “Fee harvesting-layers” redirect power from the miners to the developers, notes a Decentralized Thought video.

“Blockstream makes money on what Bitcoin can’t do, while in control over Bitcoin’s development.”

From this perspective, it can be argued that Liquid sabotages the prospect of improving the Bitcoin network’s main issues of lack of liquidity and slow speed.

Nonetheless, measures are taken to ensure decentralization. Bitcoin for Beginners points out that Liquid Network is:

  • Spread out across parties geography and political jurisdiction
  • Nodes are operated by independent entities (each can only control 1 node)
  • Updates/adding entities need to have consensus from participants first.”

Lightning and Liquid are two of the main solutions for the scaling and speed problems of Bitcoin’s blockchain. Naturally, this attracts institutions such as banks, Wall Street or Visa to get more deeply involved. It gives them access to become intermediaries on the decentralized network and profit as trade passes through them by, for example, running a lightning network node. The sentiment is expressed in this image:

From: CoinSpace Twitter

A question of trust

Liquid Network is designed with a security model different from that of Bitcoin. In this model, you put your trust in the member organizations that makes up the federation. The list of exchanges in the network is:

“23 of the cryptocurrency industry’s biggest players participated in the launch as Liquid members, including Altonomy, Atlantic Financial, Bitbank, Bitfinex, Bitmax, BitMEX, Bitso, BTCBOX, BTSE, Buull Exchange, DGroup, Coinone, Crypto Garage, GOPAX (operated by Streami), Korbit, L2B Global, OKCoin, The Rock Trading, SIX Digital Exchange, Unocoin, Xapo, XBTO, and Zaif.”

On one hand, Piscitello explains:

“And we know going back to the days of Mt. Gox and every year it seems like this happens: if you leave money on an exchange, bad things can happen. And when you’re trusting a single party, there can be insiders that take your funds, there can be bugs that make your funds get lost, there can be hacker that attack it. And so the idea is that you’re moving from a single custodian when you’re holding funds with Liquid, to a group of the functionaries where it would be much harder to attack all of these different entities all around the world, all with their own data centers, all with their servers that we don’t even know where they’re at. So it’s a very challenging problem for someone who’s trying to attack the network. This is why the yardstick for Liquid is: if your alternative is leaving money on a single exchange, Liquid is definitely going to be an improvement for you because now you’re trusting a federation of exchanges.”

On the other hand, many of the exchanges on the list have a dubious past. For example, Zaif was hacked earlier this year with a damage of $60 million in bitcoin in theft. Bitfinex was accused of wash-trading one year ago. BitMex appeared to have been trading against its customers’ will.

Are these really the organization members we want to trust?

It can be fairly said that different security models may suit different kinds of transaction. The design of Liquid Network is meant for businesses who don’t want a lot of auction fees, and can easily transfer between exchanges. Fundamentally, the aim is to allow for liquidity in trading, with rates that don’t differ too much between exchanges. As long as we are not looking at a monopoly over the future progress of the Bitcoin network, I will probably still be able sleep at night.

This development warns that decentralization does not make Bitcoin untouchable, as decentralization idealists may believe. It also shows us that like any organism, Bitcoin adapts to its environment. It will survive and take on new shapes, for better or for worse.

Cover picture from Pexels, picture from CoinSpace Twitter.