Liquid Network

The Liquid Network is a layer two (side-chain) developed by Blockstream, which is built as a peg-in and out system tethered to the Bitcoin’s mainchain. Liquid has a native token in L-BTC or Liquid Bitcoin, which is created by locking bitcoin into a multi-sig wallet managed by a federation of different members.

This helps Liquid from double spending bitcoin since L-BTC is issued and destroyed based on the amount of bitcoin held by the federation multi-sig wallet. Liquid is aimed primarily at traders and exchanges to allow faster settlement in 2 minutes, rather than 10 minutes on Bitcoin’s mainchain, while providing more privacy through the help of confidential transactions.

Non-native digital assets can be added to the Liquid Network, such as stablecoins, NFTs and STOs and allow developers to create a permissionaless swaps and atomic swaps between assets on the chain. Liquid’s primary use case is for arb trading between compatible exchanges to ensure they can transfer funds fast. 

The Liquid Network is a “sidechain” built using the Bitcoin blockchain and is essentially a fork of the bitcoin code base with the mining aspect removed from the consensus. Instead of having public participants mining to secure blocks, Liquid opts for large-scale institutions to act as federation members, with many of the members being exchanges that support Liquid network transfers.

Blockstream launched the network and provided technical support and development along with several other companies.

Liquid runs independently of bitcoin, but it tethers itself to bitcoin through the peg-in system. That’s why many see Liquid as a layer-2 network that interacts with the main chain via a “two-way peg.” Assets on a sidechain are pegged 1:1 to the value of the native assets they represent, allowing anyone to use their tokens and coins on another blockchain.

Liquid has its own blockchain, with its own data set and size; it has additional features that bitcoin does not support and a different consensus mechanism, but like Bitcoin, Liquids consensus rules are written in code and enforced by Liquid nodes.

The federation multi-sig

Bitcoin sent to the Liquid Network is secured in an 11-of-15 multi-sig wallet, with each of the 15 keys stored on a device called a functionary held by a Liquid Federation member. These functionaries are stored in secure locations geographically distributed around the world.
Each multi-sig key is stored on a proprietary Hardware Security Module (HSM) within the functionary for extra security.

Whenever a peg-out is initiated by a member, the functionaries:

  • Verify that the BTC peg-out transaction is being sent to a whitelisted address.
  • Confirm that the L-BTC have been burned by the member.
  • Sign a BTC transaction to the member’s whitelisted address.

Once in the member’s wallet, the BTC is free to be transferred elsewhere on the network (e.g. to one of their users’ wallets).

Running a liquid node

Running a full node within the Liquid Network is open to anyone. The connection is established through so-called bridge nodes that are run by functionaries and participant members. With a Liquid full node, anybody can self-validate the Liquid sidechain transactions and access additional features.

Users running a full node can independently perform a peg-in to the network, perform confidential transactions, and issue tokenized assets on Liquid.

However, getting out is a different story, with node runners having to approach either so-called Liquid functionaries or participant members to submit a peg-out.

To use the liquid network, you need to get liquid BTC (L-BTC) either from a third party or by running your own Liquid node via a process called “peg-in”. 

Bitcoin from the main chain is pegged 1:1 with L-BTC but in order to “peg-out” i.e. convert your L-BTC back to Bitcoin on the mainchain, you can only do this via one of the Liquid Federation members or through a 3rd party that supports exchanging L-BTC to BTC.

It’s very important to be aware that you need to have a way to convert L-BTC to BTC before you peg-in so bear that in mind if you want to get involved with the Liquid Network.

Through confidential transactions, traders can make large buy or sell orders without publicly broadcasting their intentions, so they can’t be front-run by other market actors.

The Liquid network is a separate network, and once you move value into this network, new rules apply, which give you access to several advantages should you be happy with the trade-offs in consensus. 

The advantages that attract users to the Liquid network are:

Faster transactions

Liquid Network does not mine blocks but instead uses Signed Blocks, which reduces the time it takes to validate and process transactions. New blocks are confirmed in around two minutes by the various federation members, unlike the 10 minutes it takes to add a block to the Bitcoin blockchain through the mining process.

Greater privacy

The main chain of bitcoin is a public ledger that provides transparency since anyone can map transactions to individual addresses and even check wallet balances and audit the full supply. Since the Liquid network is only based on bitcoin that can be pegged into the network, the need to audit the amount of every transaction within its chain is not needed; this affords users greater privacy.

Liquid Network implements Confidential Transactions to conceal key transaction information from outsiders; while you can check transaction fees and the send and receive address as you would on bitcoin, the total amount is hidden. 

Reduced transaction fees

While Liquid provides faster clearing times and higher throughput, it also offers users lower fees paid on transactions. Liquid takes a different approach to consensus (block signing) and increases transaction speed, so users don’t have to pay extra to process transactions quickly. 

Low Liquid Network fees are ideal for retail and institutional investors wanting to trade BTC without the restrictions of the main chain or to bypass certain high fee days on the bitcoin base chain.

Issuance of non-native assets

Liquid Network facilitates the issuance of digital assets, which would be impossible to do on Bitcoin, given the latter’s limited functionality. Users can issue, buy, and exchange the following assets on Liquid. These assets can range from utility tokens such as in-game currency, security tokens, stablecoins, and digital collectables (NFTs).

The ability to create other assets on Liquid also brings new features to the chain, like the option of paying for your chain fees with USDT with the help of Liquid Taxi.

Trustless atomic swaps

Atomic swaps allow people to swap assets without relying on an exchange or another trusted intermediary. Liquid users can conduct trustless, peer-to-peer Atomic Swaps using the open-source Liquid Swap tool. An example of this would be users who swap tokenized versions of BTC (L-BTC) and USDT (L-USDT) on the Liquid Network. 

 

In bitcoin, there are no solutions without trade-offs; while the Liquid Network offers some great features to retail and institutional traders, it should be considered temporary storage to consolidate funds and optimise your UTXO sets on the base chain.

The Liquid Network is not ideal for long-term holding and should be used to move back to the base chain to avoid risks.

Centralisation risk

The Liquid Network is run by a federated system; there are 15 Functionaries who are responsible for adding new transactions and maintaining the ledger. While this system reduces confirmation time, it is highly centralised and subject to the control of a few parties.

Liquid’s closed system can be shut down at any time and relies on just 15 computer hubs, which increases the risk of censorship and malicious attacks; it is also subject to state attack should some of the federation members not be sufficiently dispersed geographically.

Redemption risk

When using the Liquid network, you are at the mercy of the federation members. They could collude to steal funds or fail to honour your peg-out requests, leaving you stranded.

Limited support

The Liquid Network is also limited by the number of wallets that support the Liquid chain, so you have less optionality versus that of other L2 options like the Lightning Network.

If you want to learn more about the Liquid network, we suggest checking out the following resources to start your journey.

  1. blockstream.com/liquid
  2. liquid.net

 

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