Blockstream has released a whitepaper detailing the Strong Federations system, the foundation for the Liquid sidechain project to improve privacy, costs, speed of value transfers and settlement among exchanges and brokerages.
‘An Interoperable Blockchain Solution’
Under the leadership of Adam Back, Blockstream has released a whitepaper dubbed “Strong Federations: An Interoperable Blockchain Solution to Centralized Third Party Risks.” The whitepaper delves into the intricacies of the federated pegs system that can be used to attach sidechains to Bitcoin.
Although Blockstream has talked about the federated peg system before in their first sidechains paper, this new release explores the subject and presents a system that allows all participants to be economically incentivized to operate in the best interest of the network, ensuring that both the generation of new blocks and the withdrawal from the sidechain runs smoothly.
The announcement by Blockstream reads:
With today’s publication of Strong Federations: An Interoperable Blockchain Solution to Centralized Third Party Risks, we share the improvements we have made to the federated peg that was briefly discussed in the original sidechains paper. Strong Federations facilitate movement of any asset among disparate markets, without requiring centralized trust. They provide commercial privacy with support for transactions where asset types and amounts are opaque while preserving the public verifiability inherent to Bitcoin.
The first implementation of a strong federation will be Liquid, a private sidechain that establishes a security profile inherently for rapid transfer and settlement among exchanges and brokerages.
Sidechains?
Sidechains allow Bitcoin to be locked into a peg and to be released on a secondary blockchain as a different asset with new functionalities and features. A popular example of this would be the RSK platform, which will enable users to deploy and interact with smart contracts without needing to invest in an alternative cryptocurrency.
The perfect implementation of sidechains technology would be a fully decentralized peg, in which users could send Bitcoin to a special address to be locked and would then withdraw the secondary asset on the sidechain and vice versa. This is known as a 2-way peg.
Although locking coins on the Bitcoin blockchain and withdrawing them on the sidechain is possible, and has been implemented in systems like Proof-of-Burn, the withdraw process can not be fully decentralized due to limitations in the Bitcoin protocol.
Since sidechains need to work both ways in order to be functional, and Bitcoin cannot provide a withdraw function for the secondary asset to be converted back into Bitcoin (yet), a semi-decentralized alternative for a 2-way peg was found: Federated pegs.
Federated pegs?
Federated pegs work by entrusting the withdraw function to a group of reputable and trustworthy companies, namely exchanges.
The process is simple. Since Bitcoin does not allow funds to be frozen and unfrozen according to the transactions of the secondary blockchain, the user that wants to transfer funds in and out of the sidechain will instead transfer these funds to a special multisig address that is controlled by the federations.
Once the BTC is transferred into the special address, the secondary blockchain will release the funds in a fully decentralized manner without the need of approval by the federations.
Once a user is ready to move coins out of the sidechain and into Bitcoin again, he will simply send his coins to a special address on the sidechain and embed information in the sidechain describing an output on the main blockchain, Bitcoin.
The federated pegs will then create the transaction for the output used. The transaction must be signed by a majority of key holders, which ensures that if one member of the federated peg goes rogue, he does not endanger the entire system.
Blockstream & Liquid
Blockstream’s work began with the “Enabling Blockchain Innovations with Pegged Sidechains” paper that introduced the concept of sidechains to the world of Bitcoin. Since then, Blockstream has focused on developing the sidechain technology into a fully compatible and functional system.
Blockchain has raised $55 millions in Series A funding directed towards the development of the Sidechains project. Since then, the company has had a series of successful developments, including the creation of the Elements Project, an open-source project that allows developers to build and test their sidechain creations like Rootstock (RSK), Gem and the Elements Apha, a fully functional sidechain that is pegged to testnet3 Bitcoin and includes all “production-ready” Elements like Segregated Witness and Confidential Transactions.
However, the first implementation of a strong federation will be Liquid. This is a private sidechain that establishes a security profile inherently for rapid transfer and settlement among exchanges and brokerages.
Through the implementation of the Strong Federations model, Blockstream is looking to improve privacy, costs and speed of value transfers and settlement among these companies. Providing commercial privacy is a major advantage for exchanges using Liquid, who have so far relied on the open-by-default model of the Bitcoin blockchain.
You can read the “Strong Federations: An Interoperable Blockchain Solution to Centralized Third Party Risks” whitepaper here.
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