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Colored Coins

Introduction

Colored coins refer to a group of similar technologies that use Bitcoin transactions to record the creation, ownership, and transfer of assets external to Bitcoin. "External" refers to assets not directly stored on the Bitcoin blockchain, as opposed to Bitcoin itself, which is an asset inherent to the blockchain.

Colored coins are used to track digital assets and tangible assets held by third parties, and to conduct ownership transactions via colored coins. Digital asset colored coins can represent intangible assets such as stock certificates, licenses, virtual property (game items), or any form of licensed intellectual property (trademarks, copyrights, etc.). Tangible asset colored coins can represent commodities (gold, silver, oil), land titles, and ownership certificates for cars, boats, aircraft, and so on.

The term comes from the idea of "coloring" or marking a nominal amount of Bitcoin, such as a single satoshi, to represent something beyond the value of the Bitcoin itself. As an analogy, consider adding a note to a $1 bill saying "this is a stock certificate of ACME" or "this note is redeemable for 1 ounce of silver," and then trading the $1 bill as a certificate of ownership for that other asset.

Another example: we can mark 100 satoshis of Bitcoin as 100 movie tickets for a particular movie, with each satoshi representing one ticket. This way each satoshi can serve as a substitute for a movie ticket in circulation. Users can either sell their "movie tickets" to others, or send their "movie tickets" to a specific address to redeem real-world movie tickets.

How It Works

The first implementation of colored coins, called Enhanced Padded-Order-Based Coloring or EPOBC, assigned external assets to a single satoshi output. This was a true "colored coin" in the literal sense.

After EPOBC, newer colored coin implementations use OP_RETURN scripts to store metadata about external assets. In a sense, these systems are not true colored coins because no coins are "colored." Instead, transactions using OP_RETURN metadata are used to create and track ownership in an external data store that associates metadata with specific assets.

Today, the two most prominent implementations of colored coins are Colu's Open Assets and Coloured Coins. These two systems use different approaches to colored coins and are not intercompatible. Colored coins created in one system cannot be seen or used in the other.

Use Cases

  • Enterprise Applications: Suppose a company wants to issue 1,000 shares of stock. The company can mark 1,000 satoshis of Bitcoin as corresponding colored coins, with each satoshi representing one share, and use the Bitcoin blockchain to issue and circulate stocks. The same company could also apply colored coins to dividend distribution, board voting, or inter-company trade.

  • Smart Assets: Consider a car rental company that generates colored coins corresponding to each rentable vehicle in its fleet. If a tenant wants to rent a car, the tenant receives the colored coin for the corresponding vehicle and initiates a signature from the wallet address holding the colored coin to rent the car. The user can also choose to return the colored coin or sublease it to someone else after the rental period ends.

  • Digital Collectibles: For real-world collectibles such as music CDs, paintings, antiques, and so on, since the physical items are not convenient to transfer, ownership can be mapped to corresponding colored coins. The circulation of colored coins substitutes for physical circulation. If a user wants to redeem a collectible, they can send the colored coin from their wallet to a specific address to redeem it.

References:

https://wizardforcel.gitbooks.io/masterbitcoin2cn/content/appdx8.html