The Liquid Network is a Bitcoin layer-2 solution that bolsters the network effects of Bitcoin by providing a secure platform for digital asset issuance, bringing new financial instruments and distributed trust models that investors and institutions can leverage.

Liquid does not replace or compete with Bitcoin. Both protocols mutually benefit each other, with Bitcoin providing the underlying security and value for the BTC stored in the Federation’s multisig wallet and with Liquid as a complementary financial layer in a hyperbitcoinized future, onboarding modern financial instruments like securities and bonds.

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Liquid Is Decentralized But Not Fully Permissionless

Liquid is designed to meet the rigorous standards of modern global financial markets while maintaining decentralization through distributed architecture and governance. While it's not fully permissionless like Bitcoin, Liquid is fault-tolerant, censorship-resistant, and has different trade-offs than other second layers like Lightning.

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Liquid Is Secure

Liquid blocks are generated by a geographically and geopolitically-distributed federation of 15 signers (i.e., functionaries) running hardware security modules (HSMs). The round-robin block proposing, combined with the consensus mechanism that drives Liquid, requires 2/3rds + 1 (or 11-of-15) functionaries to approve.

This means several functionaries can be offline, and the network will still create new blocks to progress the chain, bringing a higher degree of resilience. With the activation of Dynamic Federations (DynaFed) last year, Liquid functionaries will be able to join or leave without affecting network operations, enabling even greater resiliency.

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Funds Are Safe

The BTC that backs the L-BTC on the Liquid Network is stored on the Bitcoin blockchain in a multisignature wallet that requires 11-of-15 functionaries to sign, using keys stored on their external HSMs. In addition, each functionary’s HSM can only authorize peg-outs to addresses derived from one of the PAK keys.

Stealing from the Federation's multisig wallet would require compromising 11 separate HSM devices around the world in person while remaining undetected or for 11-of-15 functionary operators to be dishonest and collude.

As of today, the Liquid Network’s functionary source code is free and open-source to the public. The release allows anyone to audit the code that runs the functionaries and to create their own Liquid-like network with similar features, such as Confidential Transactions and asset issuance.

More specifically, with the functionary code, independent parties and users can now review how:

• Unsigned Liquid blocks are produced (in Elements)
• Liquid blocks are distributed and signed
• DynaFed transitions, which update the set of functionaries who operate the network, are coordinated
• Network parameters are added to the block headers to update consensus rules
• UTXOs are swept back to the Federation address when they are close to expiring
• Peg-outs are analyzed and delivered

This fulfills a long standing goal to release the code after the Dynamic Federations (DynaFed) update. DynaFed enables the dynamic addition and removal of functionaries from Liquid, allowing the number of functionaries to be changed more elegantly and securely without needing to fork. If one functionary is unavailable, the network remains unaffected by seamlessly substituting one functionary for another to sign blocks.

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What is a Liquid Functionary?

As a refresher, let's revisit how the Liquid functionaries operate and how Liquid works overall.

Liquid is governed by its federated model of geographically and geopolitically distributed members. Of these 67 members, 15 operate functionaries that run custom-built hardware security modules (HSMs) and specialized software to produce blocks and manage the pegged bitcoin in an 11-of-15 multisignature wallet.

Each functionary has two security components: the hardware and software. The Federation member’s host and the custom-built HSMs at the hardware level. And second, at the software level, the Blocksigner and Watchmen, which communicate with each other inside the HSM.

The Blocksigner software asks Elements for an unsigned block and then distributes it to the other functionaries so each can sign, combine the signatures, and add them to the Liquid Network. The Watchmen software manages the multisignature wallet that handles the pegged bitcoin, delivering peg-outs, and sweeping the controlled UTXOs before they expire.