Cryptocurrencies, or digital currencies, have most often than not been synonymous with monetary transactions. But coloring coins (not literally) was the first experiment to associate cryptocurrencies with non-monetary use cases. Although colored coins aren't widespread nowadays, many crypto enthusiasts believe they paved the way for innovations like smart contracts and NFTs (non-fungible tokens).
Colored coins have inspired many high-profile crypto projects and technologies, and some developers are still exploring the potential benefits of colored coins across the Web3 ecosystem. If you’re interested in digging into the history of cryptocurrency, knowing all about what colored coins are is a must.
Colored coins are cryptocurrencies that have unique metadata associated with them. This metadata marks a colored coin as distinct from other cryptos. While the crypto used to make a colored coin has the same fiat value on the open crypto market, it contains special features thanks to the addition of this metadata.
When developers create Bitcoin (BTC) colored coins, the underlying Bitcoin is worth the same as any other Bitcoin. However, colored bitcoins have additional non-monetary benefits thanks to their metadata. Typically, the metadata in a colored coin grants holders access to special perks or ownership rights.
Historical records suggest Meni Rosenfeld of the Israeli Bitcoin Foundation published the first colored coins white paper in 2012. A year later, Ethereum's co-founder Vitalik Buterin and eToro's Yoni Assia published another paper detailing colored coins.
Initially, blockchain developers were only interested in using Bitcoin's blockchain to code colored transactions. To this day, colored coins are most associated with Bitcoin, but they can exist on other blockchains like Bitcoin Cash, Litecoin, and Dogecoin.
In the early 2010s, blockchain developers used specific inputs and outputs when coloring a BTC transaction, but today, they rely on the blockchain's OP_RETURN Script. Coders can link roughly 80 bytes of data to a specific BTC transaction and signal this information to nodes via OP_RETURN. Typically, when developers color a cryptocurrency, they use small amounts of digital assets. For example, Bitcoin colored coins can be just a few hundred Satoshis. (For context, one Satoshi equals 0.00000001 BTC, or about $0.0002 if one BTC is worth $20,000.)
An issuer can send their colored coin on the blockchain like any other crypto transaction, but they need a crypto wallet designed to decipher colored messages.
Unlike layer-2 solutions like the Bitcoin Lightning Network, colored coins usually aren't used to send monetary value between crypto users. Instead, these coins are meant to grant holders the unique benefits and features associated with the metadata. Therefore, the market value of a colored coin isn't as significant as a non-colored cryptocurrency.
Colored coins helped introduce blockchain technology’s uses beyond peer-to-peer (P2P) payments and alternative investments. Here are some other benefits of colored coins:
Colored coins have unleashed a wealth of opportunities for blockchain developers, but there have been a few negative features associated with these cryptocurrencies. Also, as new blockchain technologies gain prominence, colored coins have lost some appeal. Here are some of the most prominent disadvantages of colored coins:
The applications of colored coins are endless, but most involve granting holders access to unique features, events, or even real-world properties. A few potential use cases of colored coins include:
Most often, when crypto enthusiasts talk about coloring coins, they're referring to Bitcoin, which is primarily because of BTC’s dominance in the crypto market. Also, when developers began formulating the colored coin technology, there weren't as many cryptos to choose from. However, it's possible to color any crypto asset with specific metadata.
Most people in the crypto community view colored coins as the precursor to NFTs. In many respects, colored coins and NFTs have the same features, serve similar purposes, and represent unique ownership privileges on a blockchain.
But there's a noteworthy distinction in how these cryptocurrencies operate. Unlike colored coins, NFTs rely on autonomous smart contracts to validate ownership on top of a blockchain. In contrast, developers who create and send colored coins transfer a cryptocurrency like Bitcoin that already has a market value on its native blockchain.
While NFTs are connected to whatever smart contract blockchain they're on, they are distinct from the chain's native crypto asset. For example, a Bored Ape NFT on Ethereum uses an Ethereum token standard called ERC-721, which isn't the same as Ethereum's native currency ETH. A colored coin, however, makes use of a native crypto asset like BTC or ETH.
Colored coins don't receive as much attention as NFTs, but they played a vital role in the history of crypto. It's unlikely blockchain developers would have thought to create NFTs or smart contracts without the foundations of colored coin technology. Also, since colored coins are often linked to real-world assets, many suspect they may have inspired the creation of fiat-pegged stablecoins and security tokens.
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