So now we have a situation where Alice and Bob have a Lightning channel that contains some sats, but also holds Taproot Assets as that asset data was included in the UTXO that opens the channel.

So now let’s try to visualize what’s happening as Alice and Bob transact with each other and update their channel balance. Here we’ll use two pretty pictures!

Let’s imagine that Alice opened the channel adding 1000 AliceBux to the channel. For their first transaction in the channel, Alice sends Bob 100 AliceBux. As with a normal Lightning channel, this channel update requires both parties to sign a new potential settlement transaction that reflects their new balance. Both Alice and Bob sign a transaction, that could be broadcast to chain, that gives Alice 900 AliceBux and gives Bob 100 AliceBux. If this transaction were broadcast onchain it would essentially be a Taproot Assets on-chain split transaction.

The UTXO holding the 1000 AliceBux would be consumed and two new UTXO’s would be created. One that has the Merkle tree data that holds 900 AliceBux and one that holds the Merkle tree data that hold 100 AliceBux.