How colored coins work
A colored coin is a cryptocurrency that includes a promise by an asset issuer to provide a good or service for the owner of the coin. The asset issuer creates colored coins by encoding some of their own cryptocurrency with metadata using a special crypto wallet that knows how to color coins.
The metadata specifies the obligations of the asset issuer to the coin holders. For example, a musician can issue colored coins giving owners the right to attend a concert at a specific date and location. Everyone who has one of the colored coins can then attend.
After creating colored coins, the asset issuer can transfer them to other parties. The transfers are processed as transactions on the cryptocurrency's blockchain network so they offer the same level of security and irreversibility.
Use cases for colored coins
There are many potential use cases for colored coins. Here are a few examples of what can be done with them:
- A company can use colored coins to represent shares, allowing coin holders to trade shares, vote, and earn dividends.
- A community can create its own community cryptocurrency that's secured by the Bitcoin blockchain.
- Subscription services can use colored coins to represent memberships. For example, a streaming company can tie membership to colored coins, making them transferable and secure.
- Colored coins can also serve as ownership records for both real-world and digital assets on the blockchain. A colored coin can be used to manage ownership of a painting, image, or e-book, to name a few examples.
Colored coin examples
Colored coins aren't widely used, but there are a couple of cryptocurrencies that have them. The most notable is IOTA (CRYPTO:MIOTA), which has a version of colored coins called native assets. Native assets are customized tokens that represent real-world assets. Chia (XCH -4.55%) also has colored coins for token issuances of alternate coins, assets, and stablecoins.
Even though colored coins never achieved widespread adoption, developers used the concept to advance blockchain technology. Smart contracts, or self-executing programs that run on a blockchain, can digitize real-world assets, among many other potential applications. Many of the most successful blockchains are capable of running smart contracts.
Non-fungible tokens (NFTs) are another example of blockchain technology that connects back to colored coins since they manage ownership using a blockchain. An NFT is created by encoding a crypto token with ownership data for a digital asset. It can be used to show who owns an image, video, digital avatar, a web domain, or any other digital asset.
Can you invest in colored coins?
You can't invest in colored coins since they're simply a capability of certain blockchains. However, you can invest in cryptocurrencies that have technology related to colored coins.
The best place to start is with smart contract blockchains. Practically anything can be written as a smart contract, so the technology has the same capabilities as colored coins -- and much more. If you want to invest in something similar to colored coins, blockchain networks with smart contract functionality are the closest option.
Ethereum was the first smart contract blockchain. It’s also the largest by a wide margin. Here are a few other smart contract blockchains to consider:
- Cardano (ADA -3.66%)
- Solana (SOL -3.75%)
- Polkadot (DOT -2.30%)
- Avalanche (AVAX -3.43%)
You could also try investing in NFTs, although their value is highly speculative. Each NFT has a record of ownership for a specific digital asset, so they also have some similarities to colored coins. There are several NFT marketplaces you can use to buy and sell NFTs, with OpenSea being the largest.
It's important to mention that all cryptocurrency investments are volatile, and NFTs are particularly risky. If you decide to invest, limit it to a small portion of your overall portfolio, and don't spend any money you can't afford to lose.
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