COLORED COINS

Back when Bitcoin was still new, community members were fond of pushing the boundaries of what could be done with its protocol beyond sending and receiving BTC. New use cases were pursued as developers explored the limitations of what was possible with the rules set by Satoshi’s code. One of the more intriguing experiments to emerge in 2012 concerned extending Bitcoin's utility by “colouring” small denominations of bitcoin to represent real-world assets like stocks, bonds, and property. And thus Colored Coins was born.

Bitcoin is fungible by design, meaning that each unit of the currency is interchangeable with any other unit of the same value. But what if someone were to alter that by marking specific coins out as being unique? This was the idea that the developers of Colored Coins stumbled across after realising that the protocol’s Bitcoin Script language enabled metadata to be encoded into transactions. It effectively provided a way for certain transactions to be marked as different from all the others.

The first concept of what was to become Colored Coins appeared in a blog post by Yoni Assia, CEO of eToro, on March 27, 2012. Titled “bitcoin 2.X (aka Colored Bitcoin) – initial specs,” the post proposed using a “genesis transaction” to create a new asset class on the Bitcoin network. Because the entire history of every bitcoin is recorded on the blockchain, it would be possible to trace the lineage of specific coins and distinguish them from ordinary bitcoins. These coloured coins would represent a separate asset whose value was independent of BTC's market price, deriving its worth instead from the community or asset it represented.

Mathematician Meni Rosenfeld, then-president of the Israeli Bitcoin Association, then took this idea and ran with it. His whitepaper "Overview of Colored Coins," published in December 2012, transformed the idea into a more rigorous technical framework. To preserve an asset's “colour” when its underlying UTXO is spent in a transaction with multiple inputs and outputs, he proposed a scheme called Order-Based Coloring in which the inputs and outputs were sorted in a specific, matching order by color. This deterministic rule would allow specialised software to trace the flow of colour from inputs to outputs, preventing it from being lost or mixed.

Colouring in the Bitcoin Blockchain

Momentum behind the idea grew, culminating in a more detailed 2013 whitepaper co-authored by a group of early Bitcoin pioneers including Assia, Rosenfeld, Amos Meiri, and a young Vitalik Buterin. This theoretical work moved into reality on November 11, 2013 when the first coloured coin was issued in Bitcoin block 269,000.

While this milestone provided a practical demonstration of Colored Coins, it failed to spark a wave of assets being issued on the Bitcoin blockchain. One of the reasons behind this was the number of competing protocols. Different parties had different approaches to implementing Colored Coins, and with no clear winner, the nascent sector fragmented at a critical point in its life cycle.

As Colored Coins co-founder Amos Meiri recalls, “What I think Vitalik realized that others didn't was that in order to execute all of the dreams we had with Colored Coins there should be a new blockchain – Ethereum. At the time I was sure there should be one blockchain and only layers being built on so I decided to keep on working on Bitcoin.”

The early methods for colouring coins were clever but also flawed since they required every user to run the same “colour-aware” software to interpret the transactions correctly. Any deviation, such as using a standard Bitcoin wallet to handle a coloured UTXO, risked violating the colouring rules and permanently destroying the asset's value, reverting it back to its base satoshi value. This fragility posed a massive user experience and security challenge. Another issue, Meiri notes, was block space since “Colored Coins was a hack. For it to really work, Bitcoin’s core code should have been changed.”

Despite the intellectual fervour and technical innovation, the Colored Coins movement never achieved mainstream adoption on the Bitcoin network. A combination of technical hurdles, user experience challenges, and the rise of more suitable platforms relegated it to a fascinating but ultimately niche chapter in blockchain history. Nevertheless, its impact was profound, laying the groundwork for the forthcoming field of asset tokenisation and the multi-billion dollar NFT market that would follow.