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Colored coins

Colored coins (also known as colored bitcoins, smartcoins) – a concept similar to Bitcoin-based Smart property, it also can be seen as a form of smart property.

Just like with Bitcoin-based smart property, the idea behind colored coins is to use cryptocurrency blockchain to control ownership of external property. However, in case with colored coins we aren't talking about physical property, but instead about securities (stocks, bonds), private currencies, vouchers, digital goods and so on.

On a basic level it works exactly like normal smart property: property is linked to a certain transaction output (“coin”) in a blockchain. A transfer of this output via a transaction represents transfer of property to a new owner, which can be identified as an owner of a private key corresponding to public key referenced in transaction output.

However, colored coins allows efficient encoding of ownership of multiple units of same property. For example, if one owns 113 identical bonds, they can be represented as a transaction output with 113 satoshi in it. To represent 113 bonds with “normal” smart property one would need 113 individual transaction outputs, which is both more expensive in terms of transaction fees, and also adds to blockchain bloat.

This encoding of quantification is crucial for applications involving securities and currencies, but it means that transactions involving colored coins need to follow certain rules to make sure that transfer of property is unambiguous.

Set of rules which is currently in use is called order-based coloring. The idea behind it is that order of inputs and outputs in transaction can disambiguate the transfer: it unambiguously links inputs to outputs.

Colored coin technology specifications and software is developed by the BitcoinX community. An incomplete specification is available here.


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