Stacks — Advancing to the Next Stage Through Nakamoto Release

Disclaimer: The contents of this report reflect the opinions of the author and are provided for informational purposes only. It is not written with the intent to recommend the purchase or sale of tokens or the use of protocols. Nothing contained in this report is investment advice and should not be construed as such.

1. New Possibilities of the Bitcoin Network

In early 2023, the introduction of Ordinals to the Bitcoin network sparked a vibrant discussion about new approaches to utilizing network block space. By May of the same year, a surge in demand for BRC-20 led to the network's temporary inability to process blocks, prompting Binance, the world's largest central exchange, to temporarily suspend Bitcoin withdrawals.

The term "Ordinals," originating from the word ordinal which means “a number indicating position in a series,” refers to a protocol developed in January 2023 by Casey Rodarmor. Using Bitcoin's script, Rodarmor enabled the arbitrary attachment of data to satoshis, the smallest unit of Bitcoin. This innovation allows the storage of text, images, audio, video, and code directly on the Bitcoin blockchain, leading to the proliferation of PFP NFT collections commonly found on Ethereum within the Bitcoin ecosystem (Click here for more details).

A year after the advent of Ordinals, three NFT collections issued on the Bitcoin network have ranked in the top ten by market capitalization (NodeMonkes, Runestone, Bitcoin Puppets), showcasing its potential as a bona fide smart contract platform.

1.1 Bitcoin L2 and Stacks

Consequently, numerous projects claiming to be Bitcoin-based Layer 2 (L2) solutions have emerged. As of April 15, the writing date, projects classified under "Bitcoin Sidechains" on DefiLlama number 11, collectively nearing a Total Value Locked (TVL) of $900M. There is ongoing debate about whether these projects effectively function as L2s using Bitcoin as Layer 1 (L1), but the rapid increase in TVL and the surge of new projects indicate growing market interest in the Bitcoin narrative.

Among these, the growth shown by Stacks is particularly noteworthy. Launched in 2017, Stacks has been consistently striving since 2021 to implement smart contracts on the Bitcoin network. In the following sections, we will explore Stacks' trajectory and the significant upcoming upgrade known as the "Nakamoto Release."

2. Blockstack, the beginning of Stacks

In 2017, completing his PhD, Muneeb Ali released the original whitepaper for Stacks (formerly known as Blockstack at that time) and successfully raised $52 million through a token sale on CoinList. Before this, the early team had previously built protocols and applications directly on the Bitcoin L1. The project name was Onename, which enabled decentralized names and profile pages on Bitcoin network. This experience led to the design of Stacks in 2017, as the team shifted their focus to creating a more robust platform.

Blockstack pointed out that the existing Internet adopts a centralized data storage and management method, and used blockchain technology to implement a decentralized network where users have sovereignty over their data. Therefore, they wanted to create a blockchain layer that allows developers to easily develop dApps, similar to Ethereum.

Meanwhile, the sale of Stacks (STX), the token of the Blockstack ecosystem, was approved by the SEC under Regulation A+ in 2019, and the company succeeded in raising $23 million. This was the first token sale to be approved by the SEC, so the company's efforts to issue a token within the regulatory framework garnered market attention.

From 2018 to 2020, the Stacks team dedicated themselves to building out the robust infrastructure that would power the project. Stacks was designed to function as a programming layer for Bitcoin, operating as a blockchain with cross-chain consensus, seamlessly integrating with the Bitcoin network. The team also developed Clarity, a safe and secure programming language specifically tailored for the Stacks ecosystem. Throughout this period, Stacks garnered support from prominent investors, including Union Square Ventures, Harvard Endowment, Winklevoss Capital, Naval Ravikant, and other notable figures in the industry.

3. Stacks 2.0

"I view Bitcoin as the best, most decentralized money layer," Ali told Decrypt at the Messari Mainnet conference in New York last week, adding that 1% of all Bitcoin in circulation is now issued as wrapped Bitcoin (wBTC) on Ethereum. "That clearly means that there's demand for using Bitcoin in smart contracts... Instead of trying to bring Bitcoin in a wrapped fashion to some smart contract chain, why don't you bring the smart contract functionality directly to Bitcoin?" — Bitcoin DeFi? It's a Thing, Says Stacks Founder Muneeb Ali, Decrypt

In January 2021, Blockstack launched the Stacks 2.0 mainnet, reinventing itself as the Stacks network. As seen in the interview with Muneeb Ali, Stacks 2.0 was conceived with the goal of integrating smart contract functionalities into the Bitcoin network without altering Bitcoin itself. The design of the chain was aimed at inheriting the decentralization and security of the Bitcoin network while enhancing its scalability by adding smart contract capabilities.

3.1. Proof of Transfer (PoX)

The consensus mechanism of Stacks, known as Proof of Transfer (PoX), is a core innovation aimed at inheriting the security of the Bitcoin network and can be seen as an extension of Proof of Burn (PoB). PoB is a consensus mechanism in a Proof of Work (PoW) environment where miners burn the cryptocurrency of that network to participate in the mining competition.

Unlike PoB where miners burn Bitcoin, in the PoX model, miners transfer their Bitcoin to STX holders participating in the Stacking process. Miners operate Stacks nodes and use the Bitcoin network as the anchor chain for block creation and mining. The PoX mechanism works as follows:

• Registration: Miners transmit consensus data to the network to register as mining candidates.
• Commitment: Registered miners enter the mining competition by transferring Bitcoin to a pool of STX token holders.
• Election: A miner is selected to create a new block on the Stacks blockchain using a Verifiable Random Function (VRF).
• Assembly: The selected miner generates a block and receives STX tokens as a reward.

The elected miner, through the election process, not only records hashes of all new transactions on the Stacks chain onto the Bitcoin block but also helps maintain the security of both the Bitcoin network and the Stacks chain by following the PoX model. This method establishes an incentive system between miners on the Bitcoin network and Stakers on the Stacks chain. “Stacking” is similar to “staking” in Proof of Stake (PoS) networks but differs in that STX is locked up to receive rewards in the anchor chain’s token, BTC. The detailed roles of miners and stackers are as follows:

[Miners]

1. Miners transfer BTC to stackers to receive transaction fees accumulated on the Stacks block and block rewards.
2. The amount of BTC they transfer determines their probability of winning in the mining competition, a process that incorporates VRF.
3. Elected miners have the right to generate new blocks on the Stacks chain and stream microblocks.
4. Elected miners receive STX and transaction fees as block rewards.

[Stackers]

1. Stackers lock up their STX for a designated cycle.
2. They can choose to stack independently or pool their STX with other stackers, proportional to the amount of STX locked.
3. Stackers provide a BTC address to receive BTC rewards, with the probability of receiving rewards proportional to the amount of STX stacked.
4. After the set lockup cycle, the stacked STX is unlocked.

3.2. Bitcoin L2?

Stacks 2.0’s launch and the introduction of the PoX mechanism signify its function as a smart contract platform for the Bitcoin network. However, categorizing it strictly as an L2 on the Bitcoin network is challenging due to several nuances:

• Stacks 2.0 has its own token and a separate security budget from the Bitcoin network.
  • Security budget refers to the resources allocated to maintain network integrity, including mining rewards, operational costs, and network fees.
• Unlike Ethereum and other ecosystems' L2s, asset transfers do not occur under the verification of L1 security guards.

Because of these reasons, it is difficult to classify Stacks 2.0 in the same category as traditional L2s. Furthermore, transactions on the Stacks chain ultimately settle on the Bitcoin network, which does not cleanly fit the sidechain category either. Muneeb Ali, co-founder of Stacks, referred to the Stacks chain as “Layer 1.5” in a 2021 Decrypt interview.

The Bitcoin network did not start as a smart contract platform, so attempts to introduce or enhance scalability through smart contracts do not occur as they do with Ethereum and EVM chains. According to the Spartan Group's December 2023 report "BITCOIN LAYERS — Tapestry of a Trustless Financial Era", the distinction of Bitcoin L2 can be more clearly understood.

The Bitcoin L2 Trilemma introduced in the report is defined by the following components:

1. Open Network: Adopts an open network model, not a federation.
2. No New Token: Does not introduce a new token.
3. Full VM/Global State: Applies a “global state” method instead of limited off-chain contracts.

Stacks, while introducing a new token (STX), violating condition 2, meets conditions 1 and 3, positioning it as a Bitcoin L2 solution. In contrast, the Lightning Network meets conditions 1 and 2 but adopts a "Local Consensus" method where transactions are recorded only within a P2P network, thus not fulfilling condition 3.

This was the way Stacks had connectivity to the Bitcoin network prior to the Nakamoto release, and with the Nakamoto release, they're moving closer to the ideal Bitcoin L2.

4. Toward Stacks 3.0, the Nakamoto Release

4.1. Existing Issues with the Stacks Chain

The unique structure of the Stacks chain, while enabling it to function as a smart contract platform for the Bitcoin network, has also introduced systemic problems. These issues include:

• Security Model
  • Unlike the Bitcoin network, which has a substantial security budget, the Stacks chain operates on a separate budget defined by the BTC paid by Stacks miners. This dependence on miners' budgets increases the security risk.
• Performance and Scalability
  • The Proof of Transfer (PoX) mechanism and other connectivity structures between the Stacks chain and the Bitcoin network enhance decentralization and security but impose limitations on chain performance and scalability.
  • The miner election process, tying new block creation to the slow block generation cycle of Bitcoin, introduces high transaction confirmation latency, affecting user experience and complicating dApp onboarding.
• Miner Extractable Value (MEV) Issues
  • Bitcoin miners, holding a significant portion of the Bitcoin hashrate, could potentially censor the commitment transactions of other Stacks miners (BTC transactions participating in the STX mining competition), allowing them to deterministically secure Stacks rewards and transaction fees.

4.2. Main Objectives and Design Changes

4.2.1. Main Objectives

The Nakamoto Release, a major upgrade scheduled for this year, aims to address the aforementioned issues of the Stacks chain, enhancing chain performance and security. The key changes include:

• Fast Block Times
  • Transaction confirmation times within blocks are reduced from minutes to seconds by decoupling the miner election process from block generation, allowing miners to produce multiple blocks before the next election.
• Achieving Transaction Security through Bitcoin Finality
  • Stacks transactions achieve security through the hashing power of the Bitcoin network, meaning transactions settle on the Bitcoin blockchain, ensuring immutability from the most secure network.
• Improved Resistance to MEV
  • The BTC bidding mechanism for STX rewards is refined to mitigate MEV issues during the miner election process, changing the miner election algorithm to prevent Bitcoin miners from having an undue advantage.

4.2.2. Changes in Block Generation Mechanism and Stacker Roles

Under the previous system, blocks generated on the Stacks chain were directly tied to Bitcoin blocks, leading to slow block generation and transaction confirmation times.

Post-Nakamoto Release, the introduction of a "Tenure-based block production" mechanism resolves these issues by allowing elected miners to produce multiple Stacks blocks during a single Bitcoin block cycle. This mechanism significantly reduces block generation and confirmation times to approximately 5 seconds, dramatically enhancing the scalability of the Stacks chain.

In this new system, stackers are responsible for validating each block produced during a miner's tenure, shifting from merely locking up STX tokens to actively verifying, storing, signing, and broadcasting each block. This new role significantly changes the dynamics between miners and stackers, as outlined below:

1. Miners transmit BTC to stackers and participate in the mining election process.
2. Upon miner election, a "tenure change" transaction grants the new miner a tenure.
3. Miners produce blocks in seconds and must collect signatures from stackers during the validation process.
4. Validating a block requires signatures from over 70% of stackers.

4.2.3. Chain Structure Changes and Achieving Bitcoin Finality

Stackers, now serving as signers, ensure the continuity of the blockchain by signing only the most recent valid block during the tenure change or mining election process, preventing arbitrary forks by miners.

Additionally, during their tenure, miners must include the indexed block hash, containing the hash of the first Stacks block recorded in the previous tenure, in their "commit" transactions. This indexed hash is then recorded on the Bitcoin blockchain, continuously updating the history of the Stacks blockchain across tenures.

Ultimately, this structure means that transactions submitted during the Nth tenure are recorded on the Bitcoin blockchain in the N+2 tenure, making it as difficult to reverse a Stacks transaction as it is to reverse a Bitcoin block. This system aligns with traditional L2 characteristics, offering fast transaction approvals while inheriting the security of the Bitcoin network.

4.2.4. Addressing the Bitcoin MEV Issue

Prior to the Nakamoto Release, MEV issues arose as Bitcoin miners like F2Pool could censor commitment transactions from other Stacks miners, manipulating their own BTC bids to secure block rewards and transaction fees. This not only reduced the BTC rewards for stackers but also diminished the reliability of the mining process.

The Nakamoto Release introduces criteria to enhance fairness in the mining process:

• Miner Participation in Recent Blocks
  • To qualify for miner election during a tenure change, participation in the mining election process in at least 10 recent blocks is required, fostering a stable mining community and discouraging cherry-picking of chain rewards.
• Median of Past Bids Method
  • The probability of a miner being selected is based on the median of all BTC bid amounts recorded in the last 10 blocks, preventing miners from securing block rewards through abnormal bids.
• Absolute Bid Total
  • The selection process considers the absolute total of bids, not just variable bid amounts, ensuring that the mining election proceeds on a stable economic basis.

These measures aim to enhance the transparency and trustworthiness of the Stacks blockchain's mining process by mitigating MEV issues through the introduction of these criteria.

4.3. Nakamoto Release Launch Plan

Following the publication of the white paper on sBTC and Nakamoto Release at the end of 2022, the Stacks Foundation and its development team have spent a considerable amount of time preparing for the Nakamoto Release. As shown in the image, by February 2024, the features of the Nakamoto Release were finalized and integrated into the testnet (named Argon under Nakamoto Milestone 0.3). Since then, the rollout of the Nakamoto Release updates has been actively progressing.

The Nakamoto Release comprises a two-phase process, each involving a hard fork. These phases are termed Instantiation and Activation, respectively, representing a plan derived from the intention to minimize disruptions in the chain environment by allowing for a final adjustment period to fix bugs before full feature activation.

4.3.1. Original Launch Plan

• Phase 1: Instantiation
  • Although most of the code for the Nakamoto Release, including the upgraded proof-of-transfer mechanism pox-4, is applied, the features are not yet activated.
  • Signers and partners are given at least two staking cycles to register with the pox-4 contract. During this period, the registered signers are monitored to ensure they are validating blocks correctly before moving to the Activation phase.
• Phase 2: Activation
  • This phase involves activating the signer-based system, fast blocks, and Bitcoin finality with the application of the Nakamoto Release update and the activation of Nakamoto rules.
  • "Nakamoto rules" refer to the overall logic that distinguishes the pre- and post-Nakamoto Release.

4.3.2. Revised Launch Schedule After Plan Adjustment

The first phase upgrade, Instantiation, commenced on April 22. Assuming no significant bugs are found and Instantiation concludes smoothly, the second phase upgrade was initially scheduled to start in mid-May. However, following the progression of the first phase, improvements related to the Signer Resiliency/Recovery system were identified, and the Stacks Foundation announced a revision to the original plan on May 1. The main contents are as follows:

• The original Nakamoto Release plan included only a basic signer recovery system to begin the Activation phase.
• The need for an advanced signer recovery system was recognized after the onboarding of signers during Instantiation. The upgrade to this system is now planned for completion by the end of 2024, after the Activation of the Nakamoto Release.
• An additional eight weeks of development time are required before the Nakamoto Release Activation phase, with the completion of the signer recovery system code scheduled for July 15 and the Nakamoto Release Activation set for August 28.
• The new work and timeline will offer some key benefits such as better miner resiliency to signing timeout and bad responses from Signers, better handling around Signer responsiveness and key loss scenarios, improvements to how Miners produce and handle tenure extensions, and network anti-entropy and flash block handling.

The revised plan involves an eight-week code development period, concluding on July 15, with the Activation phase of the Nakamoto Release, initially scheduled for mid-May, now starting approximately three months later, on August 28. Fortunately, the sBTC upgrade, originally planned for the third quarter, is still set to proceed on schedule four weeks after the start of the Activation phase.

5. sBTC: The Final Puzzle Piece for Stacks' L2 Transition

The full activation of the Nakamoto Release expected in May is crucial for the significant performance improvement of the Stacks chain and the achievement of Bitcoin finality for Stacks blocks. However, to truly function as a Bitcoin network L2, the Nakamoto Release alone is insufficient.

Post-Nakamoto Release, Stacks will resemble a sovereign rollup environment. Yet, to truly function as a Bitcoin smart contract platform and L2, it is essential to be able to integrate and utilize Bitcoin's native asset, BTC, directly on-chain. Muneeb Ali, founder of Stacks, highlighted the difficulty of moving BTC in and out of layers without altering Bitcoin's L1, suggesting that a decentralized and open group of signers applying a peg mechanism to BTC—namely, sBTC—would be the closest approach to a trustless bridge.

sBTC connects BTC assets between the Bitcoin network and the Stacks chain based on two primary features:

• 1:1 Redeemability: As long as the Stacks chain is operational, sBTC and BTC can always be exchanged at a 1:1 ratio.
• Open Membership: Anyone can participate in the sBTC protocol, and no centralized entity controls the custody of BTC.

Unlike existing Stacks chain BTC-related assets like xBTC or aBTC, which required central management or multi-sig during the bridging process, sBTC utilizes the Proof of Transfer mechanism's stackers as a signer group to facilitate near-trustless BTC bridging.

The sBTC update and implementation are scheduled for Q3 2024. The Nakamoto Release and the sBTC update are critical milestones for Stacks in achieving its ambitious goal of transforming into a complete Bitcoin network smart contract platform. Observing the progress of the Stacks chain as it aims to become a true Bitcoin L2 and a smart contract platform utilizing dormant BTC is highly recommended.

<References>

• Stacks docs
• Stacks: A Bitcoin Layer for Smart Contracts
• sBTC: Design of a Trustless Two-way Peg for Bitcoin
• Jeff Benson and Daniel Roberts, Bitcoin DeFi? It’s a Thing, Says Stacks Founder Muneeb Ali, Decrypt
• Katelyn Peters, Blockstack (Stacks): What it is, How it Works, FAQ, Investopedia
• muneeb.btc tweet
• light tweet
• Stacks, A Showcase For Stacks Nakamoto Release Transactions
• Stacks, What’s Next for Stacks After Nakamoto Upgrade
• The Spartan Group, Bitcoin Layers: Tapestry of a Trustless Financial Era
• Mitchell Cuevas, Nakamoto Activation: 8 Weeks of Additional Development Time Expected, Stacks Foundation