The first online colored coins wallet, Coinprism, went live this week, kicking off public experimentation with the exchange system that aspires to take Bitcoin trading to the next level.



Never heard of colored coins?



As if Bitcoin weren’t useful enough already, crypto-currency developers have come up with the colored coins system to trade not only money, but literally anything else you want while piggybacking on Bitcoin’s security mechanism.



Here’s how they work.







Instead of representing money like Bitcoins do, colored coins represent property. The owner of the coins decides and defines for others what they represent. A colored coin can be a car, for example. Colored coins can be stock shares in a startup company you want to found.



Colored coins act as a voucher or an IOU for some real-world asset. They can be purchased (with bitcoins, for example), or traded for other colored coins.



One Redditor explained it this way: “Let's say I want to grow an apple tree. I need money for fertilizer, insecticide, and water. I can supply the seed, the land, and the labor. So to raise money for this venture I sell applecoins expecting to get a yield of 1000 apples in a season (we have fast growing trees). I sell 100 colored coins to cover those costs and will give each colored coin owner 5% of the yield rounded down to the nearest whole apple and then will offer a discount on apple pie to the applecoin holders as well. To redeem the colored coins for the apples, you must send them back to me.”



This YouTube video helps explain the process.



The colored coins are not purely created out of thin air in the digital world – they are financially backed by bitcoins. Users must own bitcoins to create colored coins, as well as manage and send them to other people.



However, the two are not directly linked in value. After putting a minimum threshold of bitcoins (600 Satoshis, or 0.000006 BTC) into their colored coins wallet, the user can issue any number of colored coins, defined as whatever they want. Coinprism is, so far, the only company operating a colored coins wallet, though ChromaWallet (still in development) is not far behind.



The issue of trust, then, is still central to the colored coins operation. Buyers have to trust that the owner of the colored coins is good for redeeming them as promised (always a tricky question). However, there are a number of safeguards available to ensure deals with colored coins are on the straight and narrow – drawing up legal contracts for buyers of colored coin stock shares, for instance.



If your project fails or you change your mind, you can convert your colored coins back to bitcoins.



Colored coins’ linkage to Bitcoin holds implications for both.



The colored coin system piggybacks on the Bitcoin blockchain, meaning it enjoys all the same security benefits. Exactly how the systems are connected is too technical to explain in detail here, but anyone interested can check out the protocol here.



Since the colored coin transactions are verified through the same process as bitcoins, they are also limited by the Bitcoin verification speed of (currently) about 10 minutes per confirmation.



Colored coin use will also increase the number of small bitcoin transactions as people trade them for colored coins, increasing the strain on the Bitcoin system with higher trade volume.



However, the confirmation speed can be increased as Bitcoin gets bigger to accommodate higher traffic. Colored coins are also good for Bitcoin business: they’ll increase the demand for bitcoins (since you have to have bitcoins to send and manage colored coins).



So far, people have responded to colored coins with a mixture of seriousness and delighted mockery.



Canadian company Vapetropolis, which describes itself as an online retailer of vaporization products for smoking weed, is already holding a 30-day colored coins IPO.



On the other hand, one enterprising individual has used the new technology to create Penis colored coins. “The currency of my pants has arrived!” he wrote on Reddit, offering directions to “receive Penises” in colored coins for a suggested donation of other users’ various colored coins.



The public response is a vivid illustration of the idea behind Coinprism, the first operating colored coins wallet: you put clean white light into the prism, and all kinds of colors come out the other side.