What is Discreet Log Contracts (DLCs)? Explained

In 2020, DeFi has attracted considerable attention with the emergence of hundreds of projects on Ethereum combining blockchain technology and open financial instruments, from collateralized stablecoins to derivatives products. While DeFi products are most easily implemented on a smart contract platform such as Ethereum, Bitcoin is not excluded from the implications these decentralized finance products have for the legacy cryptocurrency’s network. For more information, you can go bitsoftware360.com

Sidechains, such as RSK, have the potential to provide advanced smart contract capabilities similar to those provided by Ethereum. This could enable the development of a wide variety of sophisticated financial products on Bitcoin-based networks. Interesting ideas have been proposed to expand bitcoin’s functionality and enable more complex financial applications. One of these proposals is called discreet log contracts, which has grown in popularity over the last few years. In this article, we’ll explore what discreet log contracts are:

What are Discreet Log Contracts?

Discreet Log Contracts (DLCs) are reliable agreement protocols between two or more parties that allow money to be exchanged based on the outcome of an event. This outcome is determined by one or more external entities known as ‘oracles’, who publish information about said event outside of the contract terms, so no further details need to be shared with them. Once the event has taken place, the winning party can use this commitment from an oracle to claim their funds.

The transactions behind Discreet Log Contracts (DLCs) can be made indistinguishable from ordinary Bitcoin transactions, or they may take place within a Lightning Network channel. This makes DLCs more private and cost-efficient than other known methods of executing Oracle-based contracts. Furthermore, compared to earlier Oracle approaches, DLCs are arguably more secure since an incorrectly stated result is evidence enough for fraud detection.

Working of Discreet Log Contracts (DLCs)

In Tadge Dryja’s whitepaper, the basics of a DLC (Discreet Log Contract) are clearly outlined. A DLC is essentially an agreement between two parties which has monetary value tied to it. During the creation process, three entities participate; those making the exchange and a third party known as an oracle who supplies necessary data for successful negotiation. Depending on this information provided by the oracle, funds will be distributed as per conditions stated in the contract.

Blockchain technology enables parties acting in a DLC to remain anonymous, even if the oracle is unable to obtain such data. This ensures greater privacy and security while keeping operations decentralized. Schnorr firms play an important role in making DLCs operate, and with the integration of Taproot and GraftRoot technologies, they can help enhance their overall performance. In other words, these two technologies are great complements to how DLCs function.

Lightning Network and Discreet Log Contract

Discreet Log Contracts (DLC) provide an interesting function, but scalability is a potential issue. Fortunately, Tadge Dryja has created DLCs that can be executed on the Lightning Network with great success. By using dedicated Lightning Network channels for each transaction, thousands of transactions can be completed quickly and easily when the channel limit is reached. Once this happens, all accounts involved are automatically closed and blocks are issued to the Bitcoin blockchain network.

By using DLCs, it is possible to conduct thousands or even hundreds of thousands of operations without any negative effect on the Bitcoin blockchain. Even though this process would no longer be native, its positive benefits outweigh this limitation. It’s possible to integrate DLCs with systems that are compatible with the Lightning Network, such as RSK Lumino Network, which would significantly improve this second layer Bitcoin protocol. Moreover, this system can be adapted for other types of networks and protocols like HTML and Schnorr signatures.