What is Taro? Trading Assets and Currencies on Bitcoin

Taro leverages Bitcoin, lightning, and Taproot to enable the peer-to-peer transfer of currencies and assets beyond BTC.

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Are you worried that Bitcoin is too boring to play in the growing digital asset economy? Fret no longer. 

Using Taro, the original blockchain network can support the decentralized exchange of multiple assets – including fiat currencies. Moreover, the protocol works with the lightning network, letting users transact – instantly and for free – with non-BTC-denominated balances. 

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Please read below to learn how the Taro protocol works and what it means for Bitcoin.

What is Taro?

How Taro works. Source: Lightning Labs

Lightning Labs announced Taro – short for “Taproot Asset Representation Overlay” – in April 2022 as a protocol for asset issuance on Bitcoin. 

It will allow app developers to integrate a programmable digital asset ecosystem alongside BTC atop Bitcoin’s open, interoperable monetary network. This could include anything from NFT-like assets (ex., baseball cards) to world currencies, like dollars. 

“This expands the reach of lightning network as a whole,” said Michael Levin – Product Manager at Lightning Labs – regarding Taro in May. “It brings more users to the network, who then drive more volume and liquidity in Bitcoin.”

Lightning Labs’ Chief Technology Officer Olaoluwa Osuntokun has compared Taro to early Bitcoin protocols like Counterparty and Omni. Both were early attempts to bring new assets to Bitcoin, but were rejected by Bitcoiners for bloating the blockchain. 

“[Taro] is like a modern take on [Omni] that makes slightly different tradeoffs,” Osuntokun told CoinDesk in April. “We think its gonna bring a lot more general development activity to Bitcoin.”

How Does Taro Work?

Taro wouldn’t be possible without Taproot – Bitcoin’s most recent upgrade making transactions more lightweight and secure. The upgrade enables a new tree structure letting programmers embed arbitrary asset metadata within existing outputs. 

In other words, Taproot makes Taro asset issuance possible by effectively embedding assets as UTXOs inside existing Bitcoin UTXOs.

Issuing Assets

Taro uses a data structure called Merkle-Sum Sparse Merkle tree (MS-SMT) allowing assets to commit to Taproot script trees. This is a slightly modified version of the classic Merkle tree data structure that helps encode blockchain data more securely and efficiently. 

A Sparse Merkle tree creates a non-inclusion proof for verifying that a user spent a transaction and has forfeited ownership of the asset. Meanwhile, the Merkle sum tree proves that assets within the tree are not growing in supply.

Together, Taro includes the MS-SMT root in the leaf of a Taproot tree. Thus, Taro assets are embedded into Bitcoin transactions in a manner indistinguishable from normal Taproot transactions. 

Transferring Assets

To transfer Taro assets, users must publish new on-chain transactions to reorganize their Merkle trees.

A Taro asset can also be transferred internally between “accounts” within the asset’s Sparse-Merkle tree. Therefore, a Bitcoin transaction could reflect a potentially unlimited number of Taro transactions. To do this, Taro must generate a new MS-SMT for their transactions. 

Furthermore, users may send Taro assets to other Taproot key holders through an “asset split.” First, the sender must update the MS-SMT of their existing Taproot output with new balances. Then, the receiver of the assets will calculate a second MS-SMT committed to a new Taproot output, by splitting the assets received from the previous output.

Transferring Assets on Lightning

To send Taro assets over lightning, the sending and receiving nodes must have Taro-enabled channels for that particular asset.  

However, the intermediary channels routing the payment don’t have to be aware that the sender and receiver are interacting with a Taro asset. 

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Users can also pay or receive lightning invoices using Taro assets. Either party can exchange it for Bitcoin upon transfer. This feature piggybacks on the network effect of the lightning network that has grown in popularity with BTC already, obviating the need to bootstrap an all-new network.

Why is Taro Important for Bitcoin?

• Adoption: With all-new assets – especially fiat currencies – on lightning, there will be a tremendous incentive for people around the world to access the network. This may positively persuade many to use BTC, as an asset, by extension.
• Liquidity: More activity on lightning means more people opening payment channels, making the network more effective at routing payments. Payment routers will benefit from the increased activity with greater profits.
• Fees: If Ethereum’s success is anything to go by, then having a thriving digital economy will translate into higher network fees. Those fees will be used to support miners, leading to a more secure network.
• Scalability: Bitcoin’s digital economy can scale immensely since an unlimited number of Taro transactions may be included in a single Taproot output.
• Programmability: Bitcoin developers can program spending conditions into their Taro assets, just like normal Bitcoin UTXOs. This can make for more creative assets and use cases.
• Auditability: Taro’s tree structure makes asset supply audits possible at both the local wallet level, and across the asset’s entire issued chain.
• Usability: Asset-specific addresses help to mitigate the mistake of sending an asset to an incompatible address.