Taproot Assets: Issuing Assets on Bitcoin

Taproot Assets: Issuing Assets on Bitcoin


August 8, 2023

Critics have always targeted Bitcoin for its lack of support for assets. Lightning Labs, the same company behind LND chose to address this issue. At the end of 2022, the company announced Taproot Assets, a Taproot-powered protocol for issuing assets on the Bitcoin blockchain. The announcement split the community: some feared this would increase regulatory pressure, and others rejoiced that innovation was coming to Bitcoin.

Whether you like it or not, the fact is that assets are coming to Bitcoin. Lightning Labs is not the only company working on this. RGB from LNP/BP association and the BRC-20 standard, built on top of Ordinals are other examples of protocols pushing the limits of what can be achieved with Bitcoin.

In this article, we’ll explore the impact of Taproot Assets on node runners. Let’s dive in.

What is Taproot Assets?

Taproot Assets relies on Bitcoin’s most recent upgrade, Schnoor-Taproot, to issue assets on top of Bitcoin. It leverages Taproot to create a new tree-like structure that allows developers to embed asset data into a UTXO. It also uses Schnorr signatures to make the protocol simpler, scalable, and Lightning compatible. This means that assets issued with this protocol can be deposited into Lightning Network channels, allowing Lightning nodes to offer atomic conversions from Bitcoin to Taproot Assets, benefiting from its network effects and instant, high-volume, low-fee transactions.

Taproot Assets uses a special digital tree structure to quickly and privately access and update transaction information. It also uses another kind of tree to confirm that no extra assets are being created out of thin air. People who use Taproot Assets must take care of the verification and storage costs by keeping the transaction information, or "witness data," either on their personal storage devices or with external storage services called "Universes."

To ensure an asset is legitimate, they trace its entire history to its creation. This is done by receiving a file containing all the transaction information through a communication system called the “gossip layer”. Users can compare this information with their copy of the transaction history and update it with their proofs when they transfer the asset.

The main difference between Taproot transactions and usual Bitcoin transactions is the difference between a secret diary and a public billboard. With Bitcoin, all the instructions (or scripts) that control the coins are fully revealed on the public billboard (the blockchain) for everyone to see. With Taproot, these instructions are kept in a special private structure, like hidden notes in a secret diary, called the 'tapScript branch', which is only shown to specific parties in a transaction.

These hidden instructions don't need to be shown if you use a special spending mechanism called the 'KeySpend' to move the coins. It's like having a secret key to a safe - if you have the key, you don't need to know or show the safe's combination. If the KeySpend path is not an option, only the part of the instructions used is shown on the blockchain, while all other possible instructions stay private.

This allows for more complex instructions without the extra burden of putting more data on the public billboard when using the KeySpend path. It also enables easier checking of the pruned instruction data. In the context of Taproot Assets, it's like being able to attach extra secret notes to a transaction without showing these notes to the public.

Taproot Assets on Lightning

As discussed, Taproot Assets can be deposited and transacted in the Lightning Network. This means that LN users can hold, send and receive payments using other assets besides BTC, such as a stablecoin. These payments can be routed over the Lightning Network without intermediary nodes needing to upgrade or opt-in.

Taproot Assets-enabled channels can be created similarly to how Bitcoin channels are currently created. HTLCs for these Taproot Assets-aware payment channels are nested HTLCs that can be claimed by the recipient by revealing a preimage or by the sender after a timeout, just like a regular HTLC works.

Usually, payment networks face a “chicken and egg” problem. Each time a new asset is created a new payment network is needed. It's like building a new road system to accommodate a specific type of car. Taproot Assets presents a solution: It allows the Lightning Network to accommodate all types of assets in its channels, even finding routes across different assets. In the case of the Lightning Network and Taproot Assets, if all parties along a route are connected regarding liquidity, they can charge transaction fees in BTC or in the respective Taproot Assets being transferred.

Interestingly, even if there's no direct Taproot Assets route, a BTC route can substitute if the first node agrees to forward the Taproot Assets value in satoshis. This allows the LN to function as a platform for exchange between Bitcoin and Taproot Assets over the Lightning Network. 

This feature enables one to receive a Taproot Asset but issue the corresponding invoice to any other Lightning wallet - even to those wallets that have not adopted the Taproot Assets Protocol - which could settle the invoice using BTC. This preserves the Lightning invoice as the universal standard for invoice schemes. An invoice-settled Taproot Assets could be paid by BTC or any other asset, enabling anyone with a Taproot Assets balance to settle any Lightning invoice.

Exchange Rates

The Taproot Assets Protocol gives the ones integrating it the freedom to decide how to manage exchange rates. Like foreign currency exchange, each peer in a channel performing swaps is responsible for determining their exchange rate. They might use popular rates from major digital currency exchanges or develop their own.

When receiving a payment the recipient generates the invoice themselves. This ensures they receive the correct amount in the currency they prefer. Any Taproot Assets-aware Lightning node can potentially act as an edge node. They compete by the fees they collect from transactions and swaps. These include a routing fee, a swap fee, and a spread.

When creating an invoice, the recipient and their peer agree on a rate before it is created. They use this agreed price to create a standard Lightning Network invoice, which includes the routing information and the channel policies, and pass it on to the person paying. 

For instance, when paying an invoice denominated in satoshis with L-USD, Alice has to agree with Bob on the latest exchange rates and fees. She can confirm the payment, passing the required amount of L-USD plus fees, and the recipient will only finalize the transaction if they receive the expected amount of satoshis. Edge nodes have other strategies to prevent misuse of their transaction services, such as closing a channel, reducing the validity of invoices, or increasing spreads. The Taproot Assets Protocol doesn't regulate or set rates. Still, it provides the mechanisms for a functioning market with easy technical entry requirements and tools that allow for automated, instant transactions.

Impact on Lightning Node's

Lightning node runners could benefit from the Taproot Assets protocol. Today, the only payments routed in the Lightning Network are Bitcoin payments. Taproot Assets will bring users that want to transact other assets instantly. This means more payments being routed through the network and, therefore, more fees being collected by routing nodes. Since routing nodes can be agnostic to the protocol, operators won’t need to upgrade their nodes or understand how the protocol works. They need to keep doing what they already do: find out where is demand for liquidity and attend to it.

As the previous section shows, Lightning nodes can also act as asset exchanges. This will be a brand-new use case for nodes on the Lightning Network. The dynamic might be similar to how currency exchanges operate. Nodes can charge fees for swapping between different assets and a spread.

Road to Mainnet

Taproot Assets daemon, LND’s software enabling interaction with the Taproot Assets protocol, is on version v0.2, a beta version not yet ready for real-world use. This version added new features such as the initial Universe API, the ability to send assets to multiple addresses in a single transaction, and batch asset minting.

There’s still work to do to release software ready for real-world use. In its latest community call, hosted on June 1st, LND’s team announced that they are now focusing on making a security audit of their software, adding support for asset burns, multiasset proofs storages in Universes and that they still need to finalize the address format for Taproot Assets.

You can begin building on Lightning today. Voltage's platform is compatible with any open-source tool and has Open API's. Create your first lightning node, or get liquidity with our LSP Flow.

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