A statechain is a sequence of holders that succeed each other in owning the same UTXO while it sits in the blockchain untouched. It basically works by making that UTXO be redeemable by two keys: one controlled by the current owner and the other by a Statechain Entity (SE), i.e. a semi-trusted server. Transfers happen by the current owner sending their key to the next and notifying the SE that a transfer took place. The thing that is being transferred is called a statecoin.

Unless the SE colludes with one of the previous owners of the statecoin, it cannot steal the UTXO.

Mercury Layer is an improvement upon the idea that makes it even more appealing: by switching the key shares controlled by the SE and the current/next owner on every transfer, it becomes possible for the SE to delete previous key shares and thus it is impossible for it to retroactively become malicious and steal funds, therefore the system can be operated non-custodially.

Since the UTXO never moves onchain this system offers high scalability promises. It can also be used to transfer Ordinals NFTs, Lightning channels while they are opened, DLC bets and everything that exists at the UTXO level.

Technical Requirements

A new kind of sighash system (akin to APO) is required to operate this system at maximum scalability and reliability, for the current owner of a statecoin to be able to redeem his UTXO without cooperation from the SE, it must receive, at the time of the transfer, a presigned "backup" withdraw transaction that spents the locked UTXO to a Bitcoin address under his control.

To prevent previous owners from using their old backup transactions to steal the UTXO, a mechanism like the one used in Eltoo is employed, such that if a previous owner tries to steal the current owner can always overwrite the steal transaction and claim the funds.

Mercury Layer implements a degraded variant of Statechains that works today, creating backup transactions that start with a huge nLockTime and decrease these with each transfer. This has two drawbacks that don't exist in the full system with covenants:

  1. Backup withdrawals may take a long time, which is bad when an immediate withdraw is needed;
  2. Some users are forced to fall to the chain and pay unnecessary fees at seemingly random times, which may make them value statecoins that are about to expire less than statecoins that will expire long in the future.

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