Bitcoin's birth as a groundbreaking technology has had a profound impact on the entire financial industry and even the future model and structure of the world economy. Bitcoin solves the problems of the traditional financial industry's reliance on centralized intermediaries, inefficient cross-border transactions, high transaction costs, and insufficient trust mechanisms. However, the original Bitcoin public chain has the limitations of slow transaction confirmations, no support for smart contracts, and limited scalability. In order to solve these problems, the sidechain technology, Layer2 solution came into being. Today, with this article, we will introduce what a sidechain is. As well as Bitcoin's first sidechain project, Liquid (because the term "Layer2" is widely used in the blockchain space, the Liquid project's official website currently describes itself as Bitcoin Layer2, but by strict definition Liquid is a sidechain). (We will discuss the difference between sidechains and Layer2 in a subsequent article in this series).
1. Introduction to Sidechain Technology
1.1. Background of the emergence of sidechain technology
With the rapid development and popularity of Bitcoin, its advantages in decentralization, transparency, and security have gradually emerged. However, the Bitcoin main chain also faces some challenges, such as long transaction confirmation times, poor network scalability, and functional limitations. In particular, during peak trading hours, Bitcoin transaction confirmations may need to wait for tens of minutes or even longer, which is less than ideal in application scenarios that require rapid settlement. In addition, the Bitcoin network itself does not support smart contracts, limiting its application in emerging fields such as decentralized applications (DApps) and decentralized finance (DeFi).
To address these challenges and improve the functionality and scalability of the Bitcoin network, sidechain technology has emerged.
1.2. What is sidechain technology
Sidechain technology is a blockchain extension solution that allows digital assets to be transferred between the main chain (e.g., the Bitcoin blockchain) and a subsidiary chain (sidechain). With sidechains, users can take advantage of new features on the sidechain, such as smart contracts, fast transaction confirmation, and multi-asset support, while maintaining the security of the main chain. The core mechanism that enables this cross-chain asset transfer is Two-Way Anchoring (Two-Way Peg).
1.2.1. Two-way anchoring mechanism
The two-way anchoring mechanism is the key innovation of sidechain technology, which allows digital assets to be freely transferred between the main chain and sidechains without affecting the total amount of assets. This mechanism usually involves the following steps:
1) Asset Locking: When a user wishes to transfer bitcoins from the main chain to the side chain, they first need to lock those bitcoins in a special address on the main chain. This address is usually managed by the sidechain's federated organization or smart contract, ensuring that these locked bitcoins cannot be used until they are unlocked.
2) Generate Sidechain Assets: After Bitcoin is locked, the sidechain generates an equivalent amount of replacement assets (e.g., L-BTC in the Liquid sidechain) and distributes them to users. These alternative assets can be used on the sidechain to support a variety of operations such as trading, smart contract execution, etc.
3) Asset Unlocking and Transferring Back: When a user wishes to transfer an asset from the sidechain back to the main chain, the user needs to destroy or lock the replacement asset on the sidechain, after which the original bitcoins on the main chain will be unlocked and returned to the user. This process ensures that the total amount of assets between the main chain and the sidechain is always balanced.
1.2.2. Advantages of two-way anchoring
1) Security: The bi-directional anchoring mechanism ensures the balance of assets between the main chain and side chains by locking and unlocking, reducing the risk of double payments or asset theft. Since the assets on the main chain are frozen during the operation of the side chain, it can ensure that the operation of the side chain will not affect the security of the main chain.
2) Flexibility: Bi-directional anchoring allows users the freedom to move assets between the main and side chains when needed. This flexibility allows users to take advantage of the high performance and new features of the sidechain while still being able to return to the main Bitcoin chain to hold and use their assets.
3) Decentralization: While some sidechains may rely on federated organizations to manage the anchoring process, the overall decentralized nature is maintained. Users do not need to rely on any single centralized entity to secure their assets.
1.3. What problems are solved by sidechain technology
Sidechain technology aims to solve some of the problems inherent in the Bitcoin main chain, including the following:
1) Increased Transaction Speed: Sidechains typically have shorter block generation times, which can significantly reduce transaction confirmation times. This allows the Bitcoin network to better cope with the demands of high-frequency transactions.
2) Extended Functionality: Sidechains are able to introduce features that are not possible on the Bitcoin main chain, such as smart contracts, multi-asset support, and private transactions. This allows Bitcoin to be more than just a payment system, but also a platform for a wider range of decentralized applications.
3) Enhanced scalability: By transferring some transactions or functions to run on the side chain, the load of the main chain can be effectively reduced, thus enhancing the scalability of the entire network.
4) Maintaining Security: Sidechains can still utilize the arithmetic or consensus mechanisms of the Bitcoin main chain through merge mining or other security mechanisms, ensuring the security and decentralized nature of the sidechain.
1.4. Bitcoin's current sidechain ecosystem
Currently, the Bitcoin sidechain ecosystem is dominated by the following projects: Liquid Network, RSK (Rootstock), Drivechain, Sidechain Elements, Liquid Taro. These sidechain projects each focus on different functions and application scenarios, such as fast transactions, smart contracts, and privacy protection. Next, this article will introduce the Liquid project in detail.
2. Liquid Project Description
2.1. Background on the emergence of the Liquid project
The Liquid project was started by Blockstream in 2015 and officially launched in 2018. The background of its creation stems from the Bitcoin network's shortcomings in scalability, transaction speed, and privacy protection. As the volume of Bitcoin transactions increased, transaction confirmation times became longer and network congestion became a growing problem. In addition, financial institutions and exchanges are increasingly demanding faster and more private transactions. As a result, Liquid was created as a sidechain project designed specifically for financial institutions and exchanges to address these limitations of the Bitcoin main chain.
2.2. How Liquid Network Works
The Liquid Network is a Bitcoin-based sidechain network that connects to the Bitcoin main chain through a bi-directional anchoring mechanism. How it works can be summarized in the following key points:
1) Two-Way Anchoring: Users can convert Bitcoin into L-BTC (Liquid Bitcoin) within the Liquid Network by locking Bitcoin into a special address on the main chain. These L-BTC can be traded quickly on the Liquid Network and can be transferred back to the Bitcoin main chain at any time.
2) Block Time: The Liquid Network's block generation time is 1 minute, which significantly improves the speed of transaction confirmations and better meets the demands of high-frequency transactions than the 10-minute time required by the Bitcoin main chain.
3) Confidential Transactions: Liquid Network utilizes confidential transaction technology, which enhances the privacy of transactions by hiding the amount of the transaction so that only the parties involved in the transaction can see the exact amount.
4) Multi-Asset Support: In addition to Bitcoin, Liquid Network allows users to issue and trade other digital assets such as stablecoins, securities and tokens.
2.3. Liquid Network Economics
Liquid Network's economic model is centered around the following:
1) Transaction Fees: Liquid Network's transaction fees are relatively low and are used primarily to incentivize nodes in the network (i.e., federated organizations) and to cover transaction validation costs. Low transaction fees are an important factor in attracting financial institutions and users of high-frequency trading.
2) Federated Organizations: The Liquid Network is managed by a federation of organizations, which typically include well-known exchanges and financial institutions. They are responsible for the operation and maintenance of the network and decide by consensus on block generation and other key matters as needed.
3) Use of L-BTC: L-BTC is a core asset in the Liquid Network that is anchored one-to-one to Bitcoin, allowing users to make fast transactions and payments with L-BTC on the Liquid Network, while enjoying the privacy and fast confirmations provided by the network.
2.4. Liquid Network's current ecological status
The Liquid Network is currently being used in a number of applications, mainly in the areas of fast bitcoin trading, asset distribution, and decentralized finance (DeFi), which will be described in more detail in Chapter Three.
2.5. Liquid Network Future Development Plans
Liquid Network's plans for future growth include the following:
1) Expanding Network Participants: Liquid plans to attract more exchanges, financial institutions and node participants to further decentralize its network and enhance its security and reliability.
2) Expanded Functionality: The Liquid Network plans to introduce additional features such as more advanced privacy technology, smart contract support, and cross-chain interoperability to enhance the attractiveness and utility of the network.
3) Global Outreach: Liquid Network is working to expand its global reach and attract more international users and organizations to its platform in order to promote the adoption of Bitcoin on a global scale.
4) DeFi and Asset Management: Liquid will continue to explore applications in the areas of decentralized finance and asset management to drive further development of the Bitcoin ecosystem.
3. The Liquid Network ecosystem and its services
Liquid Network, a sidechain project for Bitcoin, has developed and offered some popular services, focusing on fast transactions, asset issuance, privacy protection, and more. Here are some of Liquid's current popular services:
3.1. Fast Bitcoin Trading (L-BTC)
Liquid Network's core service is to provide fast Bitcoin transactions, L-BTC is a one-to-one anchored asset with Bitcoin, users can transfer Bitcoin from the main chain to the Liquid Network through the two-way anchoring mechanism, Liquid Network block confirmation time is 1 minute, compared to the Bitcoin main chain's 10-minute block time, the use of L-BTC to conduct transactions can dramatically L-BTC can significantly shorten the transaction confirmation time compared to the 10-minute block time of the Bitcoin main chain. At the same time, L-BTC has lower transaction fees, making it ideal for frequent traders.
Liquid Network offers fast bitcoin and digital asset transfers between multiple well-known exchanges. This feature allows exchanges to quickly transfer assets between different trading platforms, reducing delays in transferring funds between platforms and increasing liquidity.
3.2. Confidential Transactions (CT)
Liquid Network offers an enhanced privacy transaction service that hides transaction amounts through confidential transaction technology. Even if the transaction takes place on a public blockchain, the exact amount of the transaction is not visible to third parties and is only known to the parties involved in the transaction.
3.3. Asset issuance and management
Liquid Network supports users to issue and manage a wide range of digital assets (similar to Ether ERC20) on the network, including securities, stablecoins, tokens, and more. This feature makes Liquid a flexible asset management platform, especially in the financial sector, allowing users to easily issue and transfer a wide range of financial instruments.
3.4. Decentralized trading of digital assets
Liquid Network's decentralized trading service allows users to securely trade assets peer-to-peer within the network. While this area is currently under development, Liquid Network has begun to support some basic Decentralized Finance (DeFi) functionality such as decentralized exchanges and contract trading.
3.5. Liquid Securities
Liquid Securities is a service focused on security tokenization that allows companies to issue and manage security tokens on the Liquid Network.The Liquid Securities platform supports compliance requirements to ensure that the security tokenization process complies with relevant laws and regulations. Companies can easily issue security tokens and trade them securely on the Liquid Network.
3.6. Blockstream AMP (Asset Management Platform)
Blockstream AMP is a Liquid Network-based asset management platform that allows businesses and institutions to create, issue and manage various types of digital assets.The AMP platform offers a rich set of features such as rights management, compliance control, asset transfers, and more, making it ideal for financial institutions and corporations.
4. How to use Liquid Services
To use the Liquid service, users first download a wallet that supports the Liquid Network, such as Blockstream Green or Aqua Wallet. users convert their bitcoins to L-BTC through a two-way anchoring mechanism, which locks the bitcoins away from the main chain and gives them the equivalent value of L-BTC on the Liquid Network. L-BTC can be used for fast, low-cost transactions within the network and enjoy the privacy of confidential transactions. L-BTC can be used for fast, low-fee transactions within the network and enjoy the privacy of confidential transactions.
Users can also issue and manage digital assets, such as securities, tokens, etc., on the Liquid network, utilizing platforms such as Blockstream AMP for compliance management and asset transfers. Additionally, users can trade L-BTC on Liquid-enabled exchanges or transfer them back to the Bitcoin main chain.
The Liquid network enables users to trade bitcoin and digital assets quickly and securely, making it ideal for high-frequency trading, privacy needs, and digital asset management scenarios.
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