On Coins of Color and Forks of Force

Recently there’s been a heated debate regarding a possible fork to the Bitcoin blockchain. A lot has been written on the various risks and difficulties that a contentious hard fork would create for the ecosystem.

An interesting topic that didn’t yet receive much attention is the subject of bitcoin-based assets, like the ones based on the ColoredCoins protocol, during a fork.

At Colu, we are putting a lot of resources into the development of the open ColoredCoins protocol and platform, and we’d like to share our thoughts and guidance regarding this matter.

The case for clarity

There are a lot of different digital assets on the Bitcoin blockchain, using different protocols like ColoredCoins and others. On ColoredCoins alone, we have projects issuing currency, stocks, property rights, and many other types of assets.

When a cryptocurrency like Bitcoin (which behaves as a bearer asset) forks, it makes sense to expect that its value will split in some way between the two forked coins. Perhaps 30% will go into one, and 70% into the other. Perhaps 0% will go into one side, and 100% into another. Maybe the total value of both coins will be lower than pre-fork, or maybe the total value will be higher. But what we can be sure of, is that when two parties transact on one of the chains, the sender and receiver have the power to decide what they believe the value of that transaction is, and act accordingly.

When a digital asset is involved that is backed by real-word value, like a USD-backed token for example, there’s another complexity. The two parties of the transaction, the sender and receiver, are not the only ones that should agree on its value. There’s a third party, the issuer, that’s involved. The issuer must be willing to eventually accept the transacted assets and give their backed assets in return. In the case of a USD-backed token, the issuer must be willing to accept a payment in that token, as a “withdrawal”, and release real cash in return. This is not a problem when there’s only one chain, but if the blockchain forks, there are now double the tokens, and the issuer can’t respect all of them. So the issuer must decide, and communicate clearly, which of the chains will be considered valid.

If this isn’t made clear prior to the fork, some users might try to transact on the wrong chain after a fork happens, and later discover these transactions aren’t considered valid by the issuer, thus losing value.

The case for stability

We established that digital assets must choose one of the chains, and can’t “let the market decide” like some people claim might be possible with Bitcoin. If that’s the case, which chain should they choose? In general, that’s the issuer’s choice, however, we have some thoughts on that matter. Other Bitcoin companies like BitGo and Bitrated provide reasons why they consider the Bitcoin Unlimited proposal unsafe and unstable, as it currently stands. This is how we believe they affect ColoredCoins issuers:

1. There’s no activation mechanism or grace period for activating the fork. This makes it impractical for issuers to try and plan for supporting Bitcoin Unlimited safely.
2. There’s no wipeout protection, meaning that the chain could eventually, under some circumstances, reorg and rollback completely to the original chain, losing all transactions that ever occurred on the Bitcoin Unlimited fork.
3. The last point is a special case of a larger theme in Bitcoin Unlimited, that non-trivial parts of the chain are at a constant risk of being reorged due to incompatible block size parameters between nodes and/or miners. This is expected behavior with Bitcoin Unlimited. Again, this means that at any point customer funds might be lost.

In addition to that, the Bitcoin Unlimited software has been shown to be unstable, and we believe it needs more development time and better development processes before it’s ready for prime time.

The case for scalability

Users of any sort of “digital assets protocol” on top of Bitcoin, like ColoredCoins, are well aware of rising fees and confirmation times. It is natural to assume that allowing blocks to get larger will relieve some of that stress. However, we believe that we must respect the shared resource that is the Bitcoin blockchain, and do as much as we can to reduce our footprint, instead of pushing for more and more bloat on the system.

We are also confident that “scaling” can’t be achieved by merely raising the block size, and right now the only viable solution we see for true scalability, while keeping Bitcoin’s features of censorship resistance, is by moving transactions off-chain.

This is why we support SegWit, both as an immediate yet cautious increase in block size, and as a first step for solutions like Lightning, which we are already building on.

The case for choice

That being said, ColoredCoins is an open platform. All issuers and users are free to run their own full ColoredCoins node, supported by any Bitcoin-based full node they wish, be it Litecoin, Dogecoin, or Bitcoin Unlimited.

We clearly recommend that issuers choose Bitcoin Core, as we believe it’s the safest option. For this reason, all hosted infrastructure supplied by us will continue to use Bitcoin Core. We also won’t be able to provide support for other forks. However, issuers are free to choose any node software they wish.

Summary and next steps

What’s next for issuers?

Please take the time to research how a Bitcoin hard fork affects you and your customers. You can reach out to the rest of the ColoredCoins community to discuss this. We urge you to make a decision, as “letting the market decide” is in most cases not the right choice for issuers.

We recommend continuing to use Bitcoin Core, but if you choose otherwise be aware that you will have to run your own ColoredCoins node and won’t be able to use our hosted infrastructure.

Please make sure to provide clear guidance to your users as soon as you can.

What’s next for users?

If you’re using an asset issued by someone else, please contact your issuer and ask about their plans in case of a fork. Feel free to attach this post. If you’re not sure, a safe approach immediately after a fork might be to avoid making transactions with your assets until you receive proper guidance from the issuer.

Please feel free to drop by the ColoredCoins Slack team if you have any questions.