What are colored coins and how do they work?
A colored coin is a cryptoasset that has been encoded with distinct information to distinguish it from other assets and identify it with a real-world asset or purchase.
The concept of “coloring” cryptoassets in order to tokenise real-world assets has become popular due to the rise of NFTs. However, to truly understand the NFT boom, you need to know what colored coins are and how they work. This guide explains how eToro CEO Yoni Assia came up with the concept of a colored coin and why these tokens can change the way we define ownership.
What is the origin of colored coins?
The term “colored coin” was created by eToro CEO, Yoni Assia, who co-authored a 2013 whitepaper called Colored Coins with Ethereum creator Vitalik Buterin. In it, Assia and Buterin described the need to update the Bitcoin blockchain so that metadata could be added and, therefore, processed.
Assia and Buterin proposed that it’s possible to “color” a set of Bitcoins to distinguish them from the rest. The Bitcoin blockchain would, therefore, be split into two layers:
- The fundamental layer, which processes transactions using cryptographic technology
- An overlay (aka open asset), where colored coins could be processed
Creating an overlay meant that colored coins wouldn’t alter the source code of Bitcoin. However, the transactions could be processed on the blockchain. Assia and Buterin saw this process of coloring coins as a way of facilitating non-monetary transactions.
To put it another way, colored Bitcoin coins can be used to signify ownership and transference of things other than money, such as shares in a company, tokens in a game, or contracts.
How colored coins work
Within the term “colored coin,” the word “color” is being used to describe the process of making something distinct. An identifiable distinct element is coded into the metadata of a coin, and that’s what makes it colored.
Colored coins are…
A colored coin is a cryptoasset that’s been repurposed to represent something of value by adding extra information to it, called metadata.