What is the Liquid Network?

Liquid Network is Bitcoin’s federated sidechain, serving as a settlement and payments network for cryptocurrency exchanges, market-makers, brokers and other market participants.

The sidechain is built on the Elements codebase and uses Strong Federation technology.

In autumn 2014 Blockstream published a white paper on sidechain technology titled Sidechain Elements.

In June 2015 Blockstream announced the release of open-source code and a test network for Sidechain Elements. The code was designed to let developers experiment with sidechain functionality, initially enabling the creation and transfer of digital assets.

Late in 2015 Blockstream announced its first commercial application, Liquid, based on sidechain technology. Liquid was launched in testing.

In December 2016 the US Patent and Trademark Office (USPTO) published a Blockstream patent application related to sidechains.

In January 2017 Blockstream presented a new project white paper, containing an updated consensus mechanism and trust model, and describing mechanisms that return funds to the parent chain in case of failure.

In May 2017 the first commercial sidechain-based application from Blockstream entered beta.

In July 2018 Blockstream introduced Issued Assets (IA), a tool that lets users create their own tokenised assets on the Liquid sidechain.

In October 2018 Liquid was officially released.

In November 2018 Blockstream publicly launched the block explorer blockstream.info for the Liquid sidechain and the Bitcoin network. The tool allows users to track Bitcoin addresses to which sidechain transactions are linked. Blockstream also released a client for running a full node on Liquid.

Existing blockchains still struggle with scalability.

Theoretically, the simplest remedy is to increase block size, allowing more transactions per block and lower fees. This approach demands additional hardware to run full nodes, excluding resource-constrained nodes and undermining decentralisation. Bitcoin Cash took that route.

Another solution is sharding. It partly abandons parallel processing of all transactions/blocks. The network is divided into sections that can operate independently. Section A interacts with one series of transactions; section B with another.

This can double throughput (with two sections), as nodes no longer process everything simultaneously. By partitioning the blockchain into sections, the number of supported operations can be increased step by step. Each section, or shard, can process transactions on its own. Implementing this model is difficult, and splitting a classical blockchain into hundreds of parts threatens consensus mechanisms.

Yet another solution is the Lightning Network, an off-chain micropayments technology that operates partly independently of Bitcoin’s blockchain. It offers virtually “unlimited” scalability, since miners need not confirm every transaction. However, some properties and integrity of Bitcoin’s blockchain are partly forfeited in this model, though it is a more acceptable compromise for small payments.

Another approach is to create a sidechain pegged to Bitcoin’s blockchain. A sidechain is a second-layer solution, operating partly off-chain relative to Bitcoin’s main chain.

The Liquid sidechain is a separate, private blockchain with a two-way peg to the parent chain.

Transfers use so-called L-BTC tokens. They are pegged 1:1 to bitcoin.

A user on the parent chain first sends coins to a withdrawal address, where they are “locked” by members of a federation to prevent them being spent elsewhere.

The federation is a group of operators acting as an intermediary between the main chain and one of its sidechains. It guarantees interoperability and the ability to switch from the main blockchain to the sidechain at any time.

The federation also ensures that each bitcoin converted to the sidechain corresponds to an equivalent bitcoin frozen in a swap wallet that serves as a bridge. They can be unlocked only once a sufficient number of key-holders attest to the payment’s authenticity.

For additional security this happens after a waiting period. The equivalent amount is then transferred to the sidechain, and the user can spend it. The reverse process applies when sending coins from the sidechain back to the main blockchain.

Operations executed on the secondary chain are not recorded on the main chain, so fees can be much lower or even zero.

Confidential Transactions (CT) make the transferred amount visible only to the transaction’s direct participants or to a third party they designate.

CT allows private “memo” data (for example, refund addresses) to be sent without increasing transaction size by reusing most of the top-level cryptographic protection.

CT are based on the Pedersen commitment scheme—letting a user keep certain data secret while making it binding (immutable) for the future.

Issued Assets are a tool that lets users create their own tokenised assets on the Liquid sidechain.

These assets can represent existing financial instruments (tokenised fiat, cryptoassets, attested assets such as gold coins) or entirely new assets.

Main features of Issued Assets:

• Issue a new asset in any quantity;
• Send multiple assets in a single transaction;
• Privacy via Confidential Transactions;
• Burn an asset;
• Mint additional quantities in future.

These properties can be used to create digital collectibles and loyalty points on the Liquid sidechain, as well as to conduct token sales.

They enable atomic swaps to trade one asset for another without a trusted third party. Because Issued Assets and bitcoin can both be inputs and outputs of a Liquid transaction, swapping bitcoin for an asset—or back—can be done within a single transaction.

A Liquid user can send bitcoins to an address controlled by the Liquid Federation; once the main-chain transaction receives 102 confirmations, the user is credited with L-BTC.

The high confirmation threshold ensures the network remains solvent in the event of a reorganisation of the parent blockchain.

Members of the Liquid federation keep part of their funds in L-BTC, sized to user demand, and can adjust balances as needed. If a user wishes to convert L-BTC back to BTC, a transaction detaches the bitcoins from the L-BTC and members are notified to pay out to a main-chain address. This option is available only to Liquid members.

The Liquid Network federation consists of a group of exchanges, trading venues and other financial institutions. An updated list of official members is available here.

Blockstream does not control the network and acts only as a technology provider to network members. Liquid can continue operating even if Blockstream ceases to exist or members stop supporting the company.

Traders often need to keep funds on an exchange for extended periods so as not to miss trading opportunities. Liquid lets traders move L-BTC to their own wallets while retaining the ability to send those funds back to an exchange within minutes.

Traders can use a multisignature trust model to store their assets, rather than relying on a single exchange.

There are emergency keys that can be used to access the bitcoin held by the network. These keys exist solely for situations where the network is down for an extended period and allow the bitcoins held by Liquid to be returned to the last owner on the Liquid blockchain.

Issued Assets can be moved to other platforms or new blockchains compatible with Liquid, depending on the issuer’s preferences.

In March 2020 researchers at LongHash found that more bitcoin was circulating on Liquid than on the Lightning Network.

That same month the Blockstream team announced a reduction in transaction fees to 0.1 satoshi per byte and an expanded proof range for confidential transactions.

The chief advantage of a sidechain is higher throughput and faster confirmation times.

Liquid Network offers:

• Near-instant transfers between exchanges, market-makers and certain wallets.
• Greater operational efficiency for traders, as sidechains allow significant capital to be moved from one market to another.
• Verifiable auditing: Liquid Network users can verify reserve attestations of various exchange-backed assets;
• Confidential transactions, providing more privacy than Bitcoin. The Liquid sidechain is not vulnerable to transaction-analysis tools.

• If most bitcoin users were to migrate to a sidechain, miners—who also earn from network fees—could be harmed.
• A major drawback of Liquid Network is that it is a private network run by trusted entities. Such a model contradicts the philosophy of decentralisation.
• Sidechains will never match Bitcoin’s security.

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