Sceptical Friend is in the pub telling me about a Bitcoin enthusiast he had encountered earlier in the week. “He kept on praising the advent of coloured coins. I had no idea what he was talking about, but nodded enthusiastically, which seemed to keep him happy. What is a coloured coin anyway?”
I think for a while, and reply to Sceptical friend with the best explanation I can:
“Coloured coins are a generalisation of the technology used by Bitcoin such that it can be used not just for the transfer of currency, but for transfer of anything. Take for example a share in a company. Currently, in order to purchase a publicly-listed share, you’d have to call up a broker who has access to the stock exchange, who would then have to buy your share on the exchange and deliver it to you as required. For the privilege of that transfer, the stock exchange charges the broker a fee, and in turn the broker passes that fee on to you. If it were a decentralised transfer system, like the one currently in use by Bitcoin, then there would be no centralised exchange, no exchange membership fees, and more than likely no broker. Transferring ownership of the share would, like any Bitcoin transfer currently, involve the exchange of cryptographic keys. The value of the share could still go up or down, just like it did before. As another example, look at the house you recently bought. You had to pay a conveyancing solicitor to oversee the transfer of the property title deeds. If it had used the same technology as Bitcoin uses, the transfer of title would have been as instant as making a purchase using Bitcoin, would have been direct between buyer and seller, and would have cut out any middle man. If we call the coins that are used to represent company shares ‘red’ coins and the coins used to represent your property ‘green’ coins, you’ll begin to understand why the concept of coloured coins is so appealing”.
“Clever. Why aren’t they in regular use?” queries Sceptical Friend.
“Well trying to tie them in with existing Bitcoin technology isn’t so obvious. If they are integrated into the exact same data protocol, it could clog up existing infrastructure and slow down Bitcoin processing in general. Creating a parallel protocol is the likely solution, but it requires enough people to adhere to the idea for a particular set of coloured coins to reach a critical mass. In either case, the rewards mechanism for mining coloured coins as opposed to mining Bitcoin would need some tweaking: what colour of coins would miners be rewarded in? After all, you wouldn’t want a miner owning a part share of your house. I suppose as with all things Bitcoin, it just requires a degree of education and accessibility for enough people that we haven’t yet reached. But it is reassuring to know that when we do get to that point, the technology is there to support its implementation.”
“Interesting. Of all the Bitcoin ideas you’ve explained to me, this one resonates with me the most. I can see the application, and I would be an adopter. Let me know when coloured coins are a reality, and in the meantime, I’ll just have to stick to traditional methods of exchange. Speaking of which – fancy a game?” Sceptical Friend reaches around and picks up a game of tiddlywinks off the shelf. Coloured coins of a sort, I suppose.