MetaCoins that are built using Bitcoin’s blockchain are said to be on-chain – whilst those with their own blockchain are said to be off-chain.
The basic idea of MetaCoins is to add additional functionality to the Bitcoin protocol such as distributed exchanges, CFD’s, digital assets and various forms of contracts.
MetaCoins that use the Bitcoin blockchain benefit from the high level of security in the system due to its high network hashing power with the downside that they have to use space and memory in Bitcoin’s blockchain. This has caused a problem between on blockchain meta coins, such as counterparty and MasterCoin, and pure Bitcoin enthusiasts.
For a long time people were encoding various values into the blockchain which would then sit in the UXTO – or unspent transaction pool (basically a way of quickly checking whether a transaction will be valid if the pool contains it) – making it less and less inefficient to access.
The Bitcoin team came up with a compromise to allow developers to use the security of the blockchain as well as reducing the burden on the network and bloating of the blockchain & UXTO.
They did this by adding the OP_RETURN function which allows a 40 byte field where data can be stored as a transaction in the blockchain but not stored in the UXTO – or list of unconfirmed transactions.
As such a Bitcoin can be given colour – but what is colour? Colour is just an attribute so for example in terms of asset ownership – “the right to own something” - as well as further applications. The coin doesn’t have colour and using the term colour is actually an extension taken from physics to define differences between various particles – it’s just a naming system.
So now that a particular bitcoin can be given a colour (or be said to prove ownership of a car) as defined in the 40 byte op_return metadata field – and stored in the block chain – the bitcoin associated with that transaction can be transferred with the holder retaining ownership of the underlying asset – as proven by its inclusion in the blockchain and initial genesis of being made into a coloured coin.
Coloured Coin Wallets would need to keep track of where the coloured Bitcoins have moved to. This would be particularly useful for say a Company issuing shares. The owner of the share could remain anonymous and the need for custodians would be removed – so reducing costs whilst throwing up issues of suitability of investment and regulatory oversight. However a Company could pay dividends in this manner by tracking the addresses and percentages of the total number of coloured shares that a particular address holds.
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