Liquid Bitcoin (L-BTC) is a special type of asset on the Liquid sidechain, with a supply that is verifiably backed 1-to-1 with bitcoins (BTC) held by the Liquid Federation on the Bitcoin mainchain.
L-BTC is designed to make the activities of traders and exchanges more efficient than transacting on the Bitcoin mainchain by providing faster settlements and strong confidentiality.
Besides being transacted as an asset on the Liquid Network, L-BTC is also used to pay transaction fees for the transfer of any assets on the network.
A Familiar Transaction Model and Codebase
The Liquid Network is an implementation of the Elements blockchain platform, which itself is based on the Bitcoin codebase. L-BTC (and other Liquid assets) also use the same UTXO transaction model as Bitcoin. Whether you’re a user or developer, sending and receiving L-BTC will feel familiar to you if you have used Bitcoin in the past.
Using something called a two-way peg, BTC can be “transferred” back and forth between the Bitcoin mainchain and the Liquid sidechain.
Transferring BTC from the Bitcoin mainchain to the Liquid sidechain is called a peg-in, and involves sending BTC to a multisig wallet controlled by the Liquid Federation. Once confirmed, an equivalent amount of L-BTC can be claimed by the user that initiated the peg-in. Anyone with a Liquid node can complete a peg-in.
Transferring BTC out of the Liquid sidechain back to the mainchain is called a peg-out, and involves a Liquid Federation member burning L-BTC that they hold. Once confirmed, an equivalent amount of BTC is sent from the Liquid Federation’s multisig wallet to one of the member’s whitelisted addresses. To enhance the security of BTC held on the Liquid Network, only Liquid Federation members can complete a peg-out. Our team is working on future updates to Liquid that would extend the peg-out feature to any user on the network.
At any time, anyone can use a Liquid node to cryptographically verify that the amount of L-BTC held on the Liquid Network is equal to the amount of BTC held in the Liquid Federation multisig wallet.
The Federation Multisig
Bitcoin sent to the Liquid Network are secured in an 11-of-15 multisig wallet, with each of the 15 keys stored on a device called a functionary held by a Liquid Federation member. These functionaries are stored in secure locations geographically distributed around the world.
Each multisig key is stored on a proprietary Hardware Security Module (HSM) within the functionary for extra security.
Whenever a peg-out is initiated by a member, the functionaries:
- Verify that the BTC peg-out transaction is being sent to a whitelisted address.
- Confirm that the L-BTC have been burned by the member.
- Sign a BTC transaction to the member’s whitelisted address.
Once in the member’s wallet, the BTC is free to be transferred elsewhere on the network (e.g. to one of their users’ wallets).
Why 11-of-15 Multisig?
The high key threshold for signing a peg-out transaction ensures that the BTC held on the Liquid Network is secure as long as over two-thirds of the functionaries are acting honestly.
The whitelist—known as the Peg-out Authorization Key (PAK) list—ensures that even if functionaries were compromised, the worst-case scenario is that BTC is sent to a Liquid member’s cold wallet, from which it would be easier to recover than if it went directly to an attacker of the network.
HSMs are the industry standard for securing hot wallets with permanent internet connections. The federation’s HSMs ensure that multiple HSMs must be physically accessed at the same time to even attempt to compromise Liquid’s underlying BTC.
The Timelock and Emergency Keys
In addition to the multisig used to secure the BTC held by the network, a timelock script is also used to provide a backup recovery option in the unlikely event of a system failure.
The timelock ensures that if the network completely stops operating for 7 days, then the funds on the network start to become retrievable using a separate set of emergency backup keys. Liquid's emergency keys are held by Blockstream in secure locations geographically distributed around the world.
Timelocks are reset ahead of expiry through two processes:
- Day-to-day network activity (e.g. Liquid Federation members conducting peg-outs).
- Automatic spends back to the federation for UTXOs with timelocks that are due to expire in 7 days.
Currently, Liquid’s emergency keys are held by Blockstream in secure locations geographically distributed around the world.