Bitcoin’s ability to scale is limited by design trade-offs made in the past that optimise for security and decentralisation; as a result of no compromise on those two pillars of the network, scalability on-chain is sacrificed. Today the number of transactions the network can safely secure with every block would not be able to support user growth into the hundreds of millions, let alone the billions.
While the Bitcoin blockchain will remain the source of truth, several projects have been launched that aim to tether itself to Bitcoin in some way but provide another method of value transfer that reduces the need for a final settlement on the main chain.
Popular scaling options include the Lightning Network and, to a lesser extent, Statechains and the Liquid Network. The Liquid Network is a fork of the original Bitcoin code base, which was used to create a sidechain.
Taking a side step
A sidechain is an independent blockchain that runs parallel to another blockchain, allowing for tokens from that blockchain to be used in the sidechain while abiding by a different set of rules, performance requirements, and security mechanisms.
The Liquid can be seen as a layer two solution as this sidechain allows BTC to flow between the Liquid and Bitcoin networks with a two-way peg. The Liquid Network doesn’t have its own token; rather, it’s a ledger with a native asset that is created by committing Bitcoin into a special multi-sig wallet.
Bitcoin used in the Liquid network is referred to as L-BTC, and its verifiably equivalent amount of BTC is managed and secured by the network’s functionaries that also function as block signers.
Liquid is governed by its federation of members, which are geographically and geopolitically dispersed around the world. Since the Liquid Network doesn’t use proof of work, it doesn’t require miners, and in its place, federation members take up responsibility for the security and reliability of the Liquid Network.
What are the functions of a federation member?
The Liquid Federation can consist of a number of companies; to date, there are around 63 members who are dubbed federation members. However, the Network itself comprises 15 validators (“Functionaries”), while regular members can vote on network updates and which member nodes verify the state of the Network and block production.
While anyone can run a Liquid node and monitor the Network, only the 15 Functionaries running full nodes can create new blocks. This position is regularly rotated among Federation members to achieve some measure of decentralisation.
Any Liquid Network Federation member (not necessarily a Functionary) can process peg-in and peg-out transactions (converting BTC to L-BTC). This requires that Federations keep pre-funded wallets on both Bitcoin and Liquid, so users can receive their wrapped or unwrapped assets quickly and without liquidity issues or creating possible double-spend scenarios.
Liquid Members are businesses looking to support the Network and leverage it for operational benefits, services like exchanges or applications built on the Liquid Network. As these businesses naturally benefit from being federation members since their internal operations rely on the Network and its infrastructure.
Functionary operations
When a Liquid Federation member is selected as a functionary, they form a new core management within the group of total members. This subset of the Liquid Federation (currently 15 members) operates specialised servers that sit at the centre of the Network.
Functionaries perform two roles:
- Take turns proposing and signing new blocks on the Liquid sidechain.
- Manage the two-way Bitcoin peg and secure the Bitcoin held on the Network in the federation’s multi-sig wallet.
Network governance
The Liquid Federation members propose and vote for the representatives on the federation’s boards that lead decision-making processes related to the Network’s operation.
- The technology board oversees the prioritisation of new features and develops a technical roadmap for the Network.
- The membership board provides criteria for the onboarding and removal of federation members.
- The oversight board recommends internal rules for the federation’s protocols and policies and oversees the Network’s status.
Peg-out services
Any federation member can be added to the Peg-Out Authorization Key (PAK) list. Once added to the PAK list, the Bitcoin addresses of members are whitelisted, enabling them to perform peg-outs.
Once added to the PAK list, federation members can provide swap services to customers. Liquid users can approach this federation member to convert L-BTC to BTC through the federation members’ peg-out services.
Federation members can perform L-BTC peg-outs themselves, allowing for a high level of convenience and independence or as a method of revenue generation by generating swapping fees.
Liquid Network access for users
Federation members facilitate access to the Network for Liquid users. Members can operate bridge nodes that link between Liquid nodes run by users and the Liquid functionaries.
What Are the Benefits of Being a Liquid Federation Member?
Federation members enjoy several privileges on the Liquid Network.
Contribution to the Network’s Security
The security of the Network is in the best interest of its participants. By joining the federation, members can actively contribute to Liquid’s geographical and geopolitical distribution and, thereby to its resilience.
Contribution to the Network’s Governance
All federation members have voting rights in the board election process and can nominate representatives of their own companies for board seats, allowing every federation member a fair chance for a seat at the table.
Reliable Connection to the Network
Members can maximise the reliability of their connection to the Liquid Network by running bridge nodes that directly connect to functionaries via Tor.
Considerations Before You Liquid your Bitcoin
The Liquid Network offers several benefits, including cheaper transactions, confidential transactions, asset issuance, security tokens, stablecoins, tokenised cryptocurrencies, digital collectables and NFTs, and institutional trading.
It makes for a great walled garden to conduct certain transactions like accumulating Bitcoin cheaply without leaving it on a single exchange and then moving on-chain once you have a UTXO worth moving on-chain.
Liquid also offers additional features and access to applications like Automatic Market Makers, DEFI services or NFT marketplaces if you’re into those sorts of things. The Network is primarily used for transactions that don’t make economic sense on the main chain or for temporary storage as traders exploit arbitrage opportunities or wish to move funds between exchanges faster and cheaper.
It would be something other than a network where you would keep your long-term savings but rather an active account for everyday transactions.
The Liquid Network is an alternative to using custodial services to manage your funds, you will still have a wallet with its own keys, and you can store and send funds as you please within the Network. The Bitcoin backing the Network is held by the various federated members managing the peg-in multi-sig.
You have to trust that federation members will honour your peg-outs, and you can redeem your Bitcoin to an on-chain address. If you feel uncomfortable with this method of consensus, it’s best to steer clear of the Liquid Network and opt for on-chain transactions or the use of the Lightning Network in a non-custodial fashion.
Do your own research.
If you want to learn more about The Bitcoin Liquid Network, use this article as a jumping-off point and don’t trust what we say as the final say. Take the time to research, check out their official resources below or review other articles and videos tackling the topic.
