One theme that kept reoccurring at the New York Department of Financial Services’ hearing on virtual currencies was the idea of colored coins. When Charles Lee, creator of the cryptocurrency Litecoin, first mentioned colored coins in the hearing, Superintendent Benjamin Lawsky seemed completely unaware of the implications. “It’s the fact that you can color a coin to represent something else,” Lee stated.
Colored coins are essentially a way of attaching ownership to a bitcoin transaction, providing a real world link to the somewhat ethereal concept of ownership. The object in question doesn’t really matter. Since bitcoins, and almost all virtual currencies in general are infinitely divisible, you can color a coin (mark ownership of something) for something as little as a DVD or something as big as a house, the object doesn’t really matter.
“You can color a set of coins to represent deeds for example, deeds of houses or cars or anything that you can think of,” Lee said.
“But you are actually sending the deed, youre not just coloring it?” Lawsky questioned, trying to understand the concept of virtual ownership markers.
“No, you are representing that deed with that one coin,” Lee explained. “So if you send that coin to someone else you are basically transferring that deed to that person. So if that person comes to the government and says, ‘I actually own this piece of land because this coin belongs to me,’ they can prove that the coin belongs to them and they actually own that piece of land.” Lee’s explanation was simplistic but effective.
The real implications come into effect when you consider how Initial Public Offerings (IPOs) work. IPOs are a private company’s way of selling shares of the company to the public. Every publicly traded company has gone through this somewhat laborious and expensive process. But the stock offering process can be simplified with colored coins.
“You can have .001 btc represent one google stock for example. If I sent that .001 btc to someone else in addition to sending that bitcoin the stock is also tied to it and whoever owns that .001 btc owns that stock,” Lee said.
Consider Twitter’s IPO, which was pretty textbook. Most companies going through initial offerings look very similar to Twitter’s high profile IPO. The social media darling only had a few underwriters to choose from, going with Goldman Sachs, Morgan Stanley and J.P. Morgan Chase & Co. There are two major issues with this IPO.
Firstly, money was made by a third party that could have been kept by the company. While individual investors made money on Twitter’s successful launch or lost money on Facebook’s botched IPO, the three banks that underwrote both IPOs took home a significant amount of money no matter what. By using colored coins to divvy out shares, bitcoin’s decentralized nature allows the company to offer stocks themselves, thus removes fees and more money is made for the company.
Secondly, the stock market’s entry price is high and not everyone can take advantage of the IPOs. But with colored coins, people could potentially buy single stocks directly from the company, which would reduce fees and make the entry level much lower. Most Wall St. banks only deal in blue chip stocks and investors must have thousands of dollars to initially invest.
Additionally, IPOs are very expensive and can be cost prohibitive to smaller companies. But colored coins offer a way for mom and pop companies to fundraise money while providing something back to investors. Think Kickstarter crowdsourcing but instead of a t-shirt or keychain FOB, stocks can be given to investors instead.
However, currently colored coins are only conceptual, but developers are working on implementation. The future may still be unclear on the landscape of colored coins, but the concept was intriguing to NYDFS panel.