How will Liquid build BTC ecological decentralized finance?

Preface

“Bitcoin – the global reserve currency for settling financial assets

Liquid – the backbone of the future global financial system” – Blockstream

The birth of Bitcoin is the beginning of decentralized finance, which has brought a series of revolutions to the traditional financial system. However, while Bitcoin itself is impressively secure and decentralized, it also faces its own set of challenges, such as its scalability and ability to handle large numbers of on-chain transactions, which is where Liquid Network comes in reason. Liquid Network is not only a side chain of Bitcoin, but also an innovative technical solution designed to improve the speed, privacy and scalability of Bitcoin, while also giving users more financial autonomy. This article will provide an in-depth exploration of Liquid Network, including its core functions, technical operations and security, current development status, and future prospects.

Core functions

Liquid Network is not only a side chain of Bitcoin, but also a decentralized financial tool with multiple core functions. This part will discuss in detail the core functions of Liquid Network, including fast settlement, privacy, digital asset issuance, and the relationship with Bitcoin anchoring.

1 Quick Settlement

A distinctive feature of Liquid Network is its fast settlement capabilities. This is critical for high-frequency trading and rapidly changing market conditions in financial markets. Specifically, Liquid Network has the following two characteristics:

• Unchanged block time: Liquid Network's block time is one minute, which means that transactions can be packaged and confirmed faster compared to the longer block time of the Bitcoin main chain. This makes Liquid Network very suitable for transaction scenarios that require rapid settlement.
• Two-block transaction finality: Liquid Network requires only two blocks to confirm a transaction, compared to the six-block transaction finality of the Bitcoin main chain. This reduces the risk of double spending and enables users to conduct transactions faster.

Liquid Network's fast settlement function is essential for high-frequency trading in financial markets. Traders can take advantage of Liquid Network's one-minute block times to execute orders faster, enabling more efficient arbitrage and trading strategies. This advantage makes financial markets more competitive and traders can respond more quickly to market fluctuations.

2 Privacy

Privacy is another key feature of Liquid Network. In traditional Bitcoin transactions, all transaction amounts and asset types are publicly visible. In contrast, Liquid Network provides higher privacy protection, which is reflected in the following aspects:

• Confidential Transactions: Liquid Network uses confidential transaction technology to make the amount and asset type of transactions invisible to third parties. This helps protect users' financial privacy. The Liquid network protocol has been carefully designed to ensure that the type and amount of an asset are invisible to anyone except the sender and recipient. This powerful privacy feature is achieved through Confidential Transactions, an advanced cryptography protocol developed by Blockstream. This is of great importance to traders. Taking the Bitcoin blockchain as an example, if they need to move large amounts of money, traditional blockchain analysis tools may detect this activity, causing the market to react before traders have a chance to execute the transaction, affecting the asset. price. But due to the high level of confidentiality of Liquid transactions, traders can safely transfer funds without worrying about their trading intentions being revealed. This provides users with greater transaction freedom and security.
• Protection of asset types: Liquid Network will not publicly disclose the asset types involved in transactions. This means users can trade multiple digital assets on Liquid Network without having to worry about their asset type being revealed. This is particularly important for financial institutions, investors and traders. Liquid Network’s privacy significantly reduces the risk at the forefront of large transactions in financial markets. Liquid Network’s privacy features ensure that the transaction amounts of large transactions are not visible to third parties. This means that other market participants cannot obtain information about the trade before it is executed. Large-volume trading parties can trade more confidently without worrying about information leakage.
• KYC: Liquid Network, like any network involving finance, KYC procedures are a topic of great concern to users. In Liquid Network, the built-in KYC procedure is not mandatory. This means anyone can use Bitcoin Core and Elements full nodes to lock Bitcoin onto Liquid Network without KYC verification. This policy also reflects the principles of decentralization and anonymity within the Bitcoin ecosystem. However, depending on the service provider and usage on Liquid Network, users may be required to submit KYC information in order to meet local regulatory requirements. For peg-out operations, that is, retrieving BTC from Liquid Network to the Bitcoin main chain, some platforms may require users to submit KYC information. This is due to the need to ensure the legality of the transaction and compliance with international security laws. At the same time, this is also to protect the investment rights and interests of token holders and provide them with appropriate protection measures. Although KYC is required in these specific cases, users can still trade certain assets anonymously on Liquid Network. Liquid Network provides users with the freedom to choose to participate in KYC while protecting the privacy of their transactions. This balance makes Liquid Network an innovative solution in the financial and digital asset space, designed to improve transaction efficiency, maintain privacy and compliance.

3 Digital Asset Issuance

Liquid Network allows individuals, institutions, and companies to issue a variety of digital assets, including stablecoins, security tokens, and other financial instruments. This function provides more possibilities for financial innovation in the BTC ecosystem, enabling users to convert various assets into digital forms and conduct transactions. Like other assets on Liquid Network, issued digital assets can also enjoy fast transaction confirmation and high privacy. Currently, Liquid Network already supports many different types of asset issuance. Here are some examples of the different asset types that can be issued on Liquid Network:

1. Stable currency: Liquid Network provides an ideal platform, and Tether’s USDT stable currency has been issued on the Liquid Network network. The value of these stablecoins is pegged to the corresponding fiat currency (such as the U.S. dollar), making them ideal for cross-border payments, cross-chain transactions, and leveraged trading. The issuance of stablecoins can be completed through a simple asset locking and certification process.

2. Security tokens: Liquid Network supports the issuance of security tokens, which represent various financial instruments such as stocks, bonds, and other securities. For example, the Blockstream Mining Note and the El Salvador Bitcoin Bond are both security tokens issued on the Liquid Network. These tokens can be traded more easily with the same efficient settlement and privacy as Liquid Bitcoin.

3. Digital collectibles: For the game and digital collectibles market, Liquid Network provides a convenient way to tokenize virtual assets. For example, online combat game Lightnite and MMO space strategy game Infinite Fleet have both chosen to tokenize their in-game items on the Liquid Network.

4. Other assets: Liquid Network also supports the issuance of various other assets, such as reward points, vouchers, etc. These assets can be customized for different use cases and needs.

4 Bitcoin anchoring relationship

Liquid Bitcoin: L-BTC, is a special asset on Liquid Network. It is special in that its supply corresponds one-to-one with Bitcoin (BTC). This means that every time someone transfers BTC to Liquid Network, a corresponding amount of L-BTC will be created. Similarly, when someone withdraws BTC from Liquid Network, the corresponding amount of L-BTC will be destroyed. This one-to-one relationship ensures that L-BTC is equal in value to Bitcoin.

L-BTC exists to provide greater transaction speed and privacy on the Liquid Network. Traders and users can move bitcoins onto the Liquid Network for faster, more private transactions. In addition, L-BTC is also used to pay various transaction fees on Liquid Network.

Bitcoin’s two-way anchoring: Bitcoin’s two-way anchoring means that BTC can be “transferred” between the Bitcoin main chain and the Liquid side chain. Transferring BTC from the Bitcoin main chain to the Liquid sidechain is called “depositing” and involves sending BTC to a multi-signature wallet controlled by the Liquid Federation. Once confirmed, the user who initiated the deposit can claim an equal amount of L-BTC. Anyone with a Liquid node can complete the deposit.

Transferring BTC from a Liquid sidechain to the mainchain is called a "withdrawal" and involves Liquid Federation members destroying their L-BTC holdings. Once confirmed, Bitcoin Federation's multisig wallet will send an equal amount of BTC to one of the member's whitelisted addresses. In order to enhance the security of BTC held on the Liquid network, currently only members of the Liquid Federation can complete withdrawals.

In general, Liquid Network provides a diversified asset issuance platform, enabling issuers to bring various assets into the Liquid Network ecosystem, using its efficient settlement speed and privacy features to provide financial and digital asset fields Brings new opportunities and innovations. Not only can traditional financial instruments be tokenized, but new frontiers of digital collectibles and virtual assets can also be explored. Liquid Network provides a flexible, efficient and secure solution for asset digitization.

Technical Operations

Liquid Network's technical operation is quite unique, and its core features include Liquid Federation and block signatures.

Liquid Federation

The Liquid Network is collectively managed by a group of members called the Liquid Federation. These members include major exchanges, trading desks, wallet providers, payment processing services, financial institutions and other important companies in the Bitcoin space. These members are distributed globally, making Liquid Network decentralized. However, it needs to be emphasized that each member of the Liquid Network does not have a single control. Instead, they collaborate through multi-signature smart contracts to ensure the stability and security of the Liquid Network.

Block signature

Functionaries equipment

In Liquid Network, the generation of blocks does not rely on proof of work (Proof-of-Work), but is completed by 15 special hardware unit Functionaries in the Liquid Federation taking turns to sign. In a cycle, these 15 Functionaries take turns proposing blocks. Only when 11 of these Functionaries validate and sign a block will it be added to the chain. These hardware units are distributed around the world and form the "heart" of the Liquid Network, responsible for signing transactions, generating blocks, and protecting the BTC locked in the Liquid Network. Functionaries can be said to be the core of the Liquid network. They play a vital role, providing network connections, generating blocks, and ensuring the two-way anchoring of Bitcoin.

Hardware Security Module (HSM)

The HSM on each hardware device Functionary is used to protect one of the 15 keys used to sign Liquid network blocks as well as federated multi-signature wallets. HSM prevents chain reorganization larger than one block. It does this by tracking the block height of the last signed block as well as the hash of the previous block. HSM only signs blocks in two situations:

• If the previous block is the same, then the block heights must be equal.
• If the previous block is different, then the block height must be higher than the height of the previous block last signed.

HSM will never sign a block that is lower than the last signed height. In addition, the HSM also verifies and signs the withdrawal transaction, but ensures that certain conditions are met before signing, for example, the transaction output must be returned to a federated or whitelisted address.

To sum up, the security of Liquid Network is guaranteed by its joint management model (Liquid Federation) and multi-signature smart contracts. The wide distribution of Liquid Federation members increases the Liquid Network's resistance to attack. Additionally, transaction data in the Liquid Network is protected by Confidential Transactions, making it difficult to monitor or trace.

Liquid Network Status and Prospect

Liquid Network has seen significant growth since its launch in late 2018. Liquid Network’s network capacity, a key measure of its adoption, has remained constant at around 3,500 BTC for the 2022-2023 year, showing that more and more users and entities are choosing to lock Bitcoin to Liquid Network.

The number of L-BTC currently in circulation

BTC second-layer network interoperability: Due to high transaction fees caused by Bitcoin network congestion, the market demand for second-layer solutions continues to increase. The Blockstream green team is integrating various btc second-layer networks to enable users to manage the BTC main chain, Liquid and Lighting on the same platform. With the continuous development of the BTC ecology, the seamless integration of Liquid as the core financial asset layer 2 of the BTC ecology and Lighting as the general bridge of the BTC ecology will support more types of decentralized financial services. This will expand the scope of application of Liquid Network, allowing it to play a role in more areas.