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Liquid For Bitcoiners: Confidential Transactions

  • November 3, 2021
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  • Category: BitCoin, Blockchain, Cryptocurrency, Investments
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Many Bitcoiners hope to one day be able to send bitcoin on-chain in a private manner: for now, Liquid can help with confidential transactions.

Hardcore Bitcoiners are understandably skeptical about Blockstream’s Liquid sidechain. But as the Bitcoin ecosystem grows, we’re going to need more services backed by Bitcoin that the Bitcoin network itself can’t provide. Liquid is a semi-centralized side chain that — crucially — has no unnecessary shitcoin. This blog series will discuss some of the use cases that are now possible through Specter Hardware and Specter Desktop’s integration with Liquid that might interest Bitcoiners the most.

Confidential Transactions

The possibility of having fully private, on-chain hidden transactions in Bitcoin has been discussed for years. But don’t expect this to come anytime soon — if ever. The Bitcoin ecosystem is wary of experimentation on the Bitcoin base layer. We need to move slowly and be as careful as possible.

Indeed, as Alex Gladstein recounts in his recent article, “The Quest For Digital Cash” for Bitcoin Magazine, cypherpunk Adam Back early on “realized it would be extremely difficult to implement CT [Confidential Transactions on Bitcoin], as the community understandably prioritized security and auditability over privacy.” So Adam Back and Greg Maxwell teamed up to found Blockstream, in large part to implement confidential transactions on a Bitcoin sidechain. That sidechain is called Liquid and has been running since November 2018.

Confidential assets and transactions on Liquid keep the amount and type of assets transferred visible only to participants in the transaction. Yet they still cryptographically guarantee that no more coins can be spent than are actually available.

Confidential Assets whitepaper. Just a few recognizable names in that list. Probably nothing.

So as CoinJoin will continue to be a powerful tool in the privacy-focused Bitcoiner’s arsenal, it’s worth familiarizing yourself with the privacy features of Liquid confidential transactions. You “peg-in” some bitcoin to Liquid and receive an equivalent amount of L-BTC on the Liquid sidechain. Additionally, a growing number of exchanges will let you easily withdraw your bitcoin as L-BTC. You can then send your L-BTC confidentially to any recipient Liquid wallet. These transactions are inexpensive and very fast. The recipient can then deposit the L-BTC into their own Liquid-supported exchange or “peg-out” back to normal on-chain bitcoin.

Give it a try in Specter with a small test amount. See what information can and cannot be traced as you move from Bitcoin to Liquid and across confidential transactions. You’re not gaining perfect privacy here, but certainly improved privacy.

Someday, hopefully soon (hint, hint developers!) we’ll see a CoinJoin implementation that is built on Liquid confidential transactions. Any amount — of any asset! — go into the mix and whatever comes out would have no deterministic traceable link whatsoever. At this point you maybe would have near-perfect privacy at an even lower cost than current on-chain CoinJjoin implementations.

Privacy Best Practices: Coinjoin, Lightning, Liquid

Coinbase and other exchanges know how much bitcoin you bought and on which UTXOs these bitcoin sit. This data is shared with chain surveillance companies that are analyzing on-chain transaction paths, selling their services to malicious players. This data will sooner or later leak out or get hacked and will find its way to a darknet market.

For financial privacy, any working capital operations with bitcoin of a company or an individual should be CoinJoined first and then pushed out for payment operations to Lightning and Liquid. For cold storage, bitcoin should be held in an on-chain wallet and not on the federated sidechain of Liquid. Lightning channels are for facilitating payments, not storing value. Lightning hot wallets have their private keys always online and still need improved hardware backend security. Meanwhile Liquid allows one to move high value amounts of bitcoin with confidential transactions, while keeping keys in air-gapped multisig wallets.

Since the Bitcoin on-chain layer will become very busy and quite expensive to operate on, using Lightning and Liquid will not only be necessary for improved privacy, but also from an economic perspective to optimize for an efficient use of the Bitcoin blockchain. Frequent payment transactions will get pushed out to Lightning and Liquid, while on-chain transactions will happen for high-value hodling, CoinJoin, and settlement purposes.

How To Get Started:

This is a guest post by Moritz Wietersheim. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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