Original title: Layered Bitcoin
Written by Saurabh Deshpande
Compiled by: Chris, Techub News
Throughout history, money has served three key functions in society: a store of wealth, a medium of exchange, and a unit of measure. While the form of money is constantly changing, its functions remain largely the same. There are two schools of thought about money, those that support credit or soft money and those that support hard money. Like today’s fiat currency system, credit money is always a liability of some kind.
When you hold dollars or rupees, these currencies are effectively liabilities of the government. This means that the value and ability to use the currency is dependent on the economic health and creditworthiness of the government. If the government is unable to meet its obligations or faces an economic crisis (such as default), then the purchasing power of the currency will be severely affected. In other words, the currency may lose value, making it impossible for you to buy essential goods and services with it.
Hard money refers to money that is not dependent on the credit of a government. That is, its value does not depend on the economic condition or creditworthiness of the government. Precious metals (such as gold), as representatives of hard money, do not decrease in value due to government defaults. On the contrary, their value may increase because precious metals are seen as having stability. This is because precious metals are considered to be reliable stores of value in times of economic uncertainty.
Bitcoin is the first successful implementation of non-sovereign currency in digital form. “Non-sovereign” here means that Bitcoin does not rely on the credit or support of any national government. In 2009, Satoshi Nakamoto released Bitcoin, when the world had just experienced a global financial crisis caused by bad loans and unilateral interest rate decisions. The strong dollar has depreciated by more than 95% in its lifetime. Ray Dalio, in his article “ Paradigm Shifts ”, discusses the central banks’ reduction of interest rates in various crises and the impact of these measures on the respective economies.
Source – Paradigm Shifts
The chart shows that interest rates have been gradually falling in developed countries since the 1980s. At the same time, the monetary base, the amount of money in circulation, has been rising relative to gross domestic product (GDP). Despite the rapid growth in the money supply, actual total economic output has not kept pace. When the money supply increases too quickly, it usually pushes prices up, leading to inflation, higher living costs, increased debt burdens, and greater income inequality. The high inflation environment we are currently in is a result of the policies adopted by central banks.
Precious metals like gold become more valuable when there is inflation and uncertainty in the economic environment. Unlike fiat currencies, there is less government intervention in the supply of gold. This means that the supply of gold is not frequently affected by government policies. In addition, the supply of gold is more stable and is not as susceptible to policy adjustments as fiat currencies, making it more predictable. This high predictability allows gold to maintain its value over decades and become a store of wealth.
Bitcoin was created as peer-to-peer electronic cash. Over the years, it has deviated (or at least expanded) from its original electronic cash goals and evolved into digital gold.
In 2018, I heard an interesting point of view: blockchains are like islands. Because blockchain technology is relatively independent of external systems and environments, they are like closed islands. Each island has its own priorities and technical and social characteristics. Bitcoin Island always prioritizes security and decentralization, without considering speed and programmability.
The concept of decentralization is very broad and complex, and its specific meaning can vary depending on the context. Balaji Srinivasan proposed a method to evaluate the decentralization of blockchains . He suggested breaking down the blockchain into multiple subsystems and evaluating the degree of decentralization of these subsystems separately. The specific subsystems include: mining, clients, developers, exchanges, nodes, and ownership. He proposed to derive the overall degree of decentralization by measuring the Gini coefficient and Nakamoto coefficient of these subsystems.
Bitcoin supporter Jonathan Bier believes that the degree of decentralization can be judged by evaluating the difficulty of users verifying transactions. Bitcoin limits the block size to ensure that ordinary users can participate in transaction verification, thereby supporting decentralization. At the same time, to achieve the universal programmability of the blockchain, developers need to carry out detailed planning and design.
First, the language or system they use should be Turing complete. "Turing complete" means that a system has the ability to perform any calculation that can be expressed by an algorithm, as long as there is enough time and memory. This means that the system can simulate any computer program and has the ability to perform complex computing tasks.
Secondly, Gas metering needs to be optimal. Gas metering refers to the mechanism of how to measure and calculate resource consumption. In blockchain, this is mainly used to control and limit the resources consumed by each block and each operation (such as handling fees or Gas) to ensure the stability and fairness of the network.
Ethereum's Solidity is a Turing-complete language, which means it can perform any computation given enough time and memory. However, Ethereum's operations are subject to Gas limits, meaning that each operation and smart contract execution has a certain amount of gas fees. This design is intended to prevent over-consumption of resources and network congestion.
Bitcoin's scripting language is intentionally limited to ensure greater security. It is a low-level, stack-based language that avoids complex functions by design, primarily to reduce potential security risks. But this design also brings some flaws, such as unfixed bugs that have existed since the time of Satoshi, and the lack of some key operators, making the scripting language limited in practical applications.
Blockchains such as Ethereum and Solana have developed into interconnected ecosystems, and the interaction between them can bring more opportunities and advantages. For example, users can transfer assets or utilize various services between different blockchains, forming an interconnected blockchain network. However, Bitcoin Island adheres to its core goal, which is security, and has not introduced features or changes in its infrastructure that can make migration to other blockchains easier. Bitcoin Island only allows users to hold, transfer or trade Bitcoin, mainly for inscriptions and runes, which limits the user experience because Bitcoin Island does not provide broader blockchain interoperability features.
BTC is mostly stored in vaults due to limited use. Meanwhile, assets like ETH have abundant opportunities to enjoy yield and passive income in the form of staking, re-staking, lending, etc. Other blockchains have undergone rapid modernization as they develop new infrastructure, while Bitcoin remains old but strong.
Don’t get me wrong, Bitcoin’s conservative approach ensures its security and decentralization. More features usually bring complexity and increase the attack surface.
The Bitcoin island remains strong but isolated. Other blockchains are connected to each other via many bridges.
The separated islands reminded me of the history of my hometown, Mumbai. Once known as Bombay, Mumbai was originally made up of seven separate islands. The merging of these islands began in the 1680s and continued over the centuries. Today, as I walk through the bustling metropolis, there are few traces of these former divisions. The city feels seamlessly unified, its fragmented past all but forgotten.
This shift in Mumbai raises an interesting question: Will we see a similar evolution in the Bitcoin ecosystem? Some teams are working on this.
The evolution of the seven islands of Mumbai. Source – Reddit
This post is about how some development teams are working to provide more ways for Bitcoin holders to use it. It starts with explaining why we need better infrastructure, then explores the different approaches teams are taking to expand BTC use cases. Finally, I’ll mention that the ultimate vision involves not only technical consensus, but also social consensus.
This transformation is happening now as the team is building different auxiliary islands for Bitcoin Island and finding solutions to modernize Bitcoin Island. The permanent reform of Bitcoin Island can only happen after a social revolution among the islanders and they agree to change their rules so that bridges to other islands can be used as confidently as the infrastructure within the island.
Why do we need better infrastructure?
Mature blockchains, such as Ethereum, Solana, and even the upcoming Monad, are built with developers in mind. They serve as platforms for developers to create applications, providing a comprehensive ecosystem with a variety of learning resources, tools, frameworks, and features. In contrast, Bitcoin was built incrementally in practice, lacks a well-thought-out API, and has almost no clear development documentation.
There are three key reasons to improve network infrastructure: improving user experience, facilitating financialization, and scaling payments.
Better user experience will boost activity and bring in more fees
The Ordinals protocol is a way to leverage Bitcoin UTXO and view a single Satoshi (the smallest unit of BTC) in a different way, which has led to innovations such as inscriptions (NFTs on Bitcoin). The enthusiasm around Ordinals and inscriptions has led to the evolution of alternative standards such as BRC-20 and runes . These inscriptions and runes have breathed new life into Bitcoin, increasing the total daily transaction volume of Bitcoin by 70% compared to when only BTC transfers were being made.
These new ways to transact in Bitcoin have helped increase fees by about 40%. However, these new methods often spark heated debate within the Bitcoin community. One side believes that Bitcoin should focus on improving its core function as a decentralized payment system. They believe that expansion beyond this scope may jeopardize the security, simplicity and effectiveness of Bitcoin as a sound currency.
The other side advocates for a more flexible approach that expands Bitcoin’s functionality to include non-payment uses. They argue that such an evolution is necessary for Bitcoin to remain competitive and relevant in the rapidly evolving blockchain ecosystem.
According to Token Terminal, Bitcoin miners have earned about $109 million from fees in the past 30 days. During the same period, applications like Uniswap and Lido Finance earned $90 million and $104 million, respectively. With the latest halving in April 2024, miners' block rewards were reduced by 50%. After the halving, the block reward was reduced from 6.5 bitcoins per block to 3.125 bitcoins. Therefore, the monthly miner subsidy was reduced by 13,500 bitcoins (3.125*144*30), which is equivalent to $891 million at $66,000 per bitcoin. Therefore, monthly fees only account for about 12% of the subsidy loss.
Recent developments like Runes are encouraging, but we need more. What are the challenges? Bitcoin’s UX is far inferior to Solana or Ethereum L2s like Arbitrum. Exchanges on Solana take seconds and cost just a few cents. However, if you want to trade Runes on Bitcoin, you’ll need to pay a few dollars in fees and wait for a block to confirm the transaction.
Additionally, when you buy a rune, you have to buy the full amount listed, and the buyer cannot modify the amount to be purchased. Another disadvantage is that runes are not exchangeable for each other, unlike how we can exchange USDC for MKR on Ethereum. Traders must first sell one rune for Bitcoin and then buy the other rune they want. This extra step in the middle makes for a very poor user experience.
In addition, Bitcoin cannot be used directly as collateral or for lending. Users must extract Bitcoin from the Bitcoin native chain and transfer it to other chains before they can use financial applications on these chains. This process increases operational complexity and affects the overall user experience.
Enhancing the financialization of BTC
First, at $66,000 per Bitcoin, Bitcoin’s current market cap is close to $1.3 trillion. Like gold, Bitcoin is an external currency, meaning governments cannot manipulate its supply. While the exact size of the gold loan market is unknown, some reports estimate it to be around $100 billion. Therefore, a big reason to build applications on Bitcoin is to use Bitcoin as collateral to borrow stablecoins. A strong lending market would enable Bitcoin holders to earn yield on their Bitcoin.
Taking staking as an example, other native assets such as ETH and SOL have inherent uses in staking to ensure network security; about 27% of circulating ETH is staked in staking protocols, with an annual return of about 4%. Another about 4% of ETH is staked in re-staking protocols, and 67% of circulating SOL is staked. In addition, both ETH and SOL are widely used as collateral assets in their respective DeFi ecosystems.
Wrapped BTC (or WBTC) is the most widely used version of BTC in different DeFi ecosystems, with a market capitalization of about $10 billion, accounting for less than 1% of the total BTC in circulation. This shows the huge potential of BTC financialization.
Assuming BTC usage in staking or DeFi reaches similar levels as Ethereum, around 30%, this amount would be $390 billion. For comparison, the total locked value of all other chains in all DeFi is currently $101 billion. BTC could become the most productive liquid asset, but this potential is currently constrained by intentional technical limitations.
Expand BTC Payment
Bitcoin's base layer is not designed to be a high-throughput system. If Bitcoin is to become the settlement layer of the Internet, we need faster transaction speeds. As Mohamed Fauda mentioned, the current maximum size of a Bitcoin block is 4MB, which means that the Bitcoin network can only process 4MB of data in a 10-minute period. Based on this limit, the transaction throughput of the Bitcoin network is approximately 6.66 KB (kilobytes) per second. This processing speed may not be enough to meet the requirements for large-scale transaction needs, so it is necessary to increase processing power or introduce new technologies to increase the transaction speed of the Bitcoin network.
The Bitcoin network does not perform well when handling high volumes of transactions. For example, during the minting or rune release of Quantum Cats, users may experience a suboptimal experience. This poor user experience not only affects those attempting to perform minting operations, but also other users sending and receiving Bitcoin on the network. In short, the current processing capacity of the Bitcoin network is insufficient to effectively handle high volume transactions, which affects the transaction experience for all users.
Although the Lightning Network is a solution for scaling the Bitcoin network, its actual adoption has been less than ideal. Currently, the network’s total capacity or liquidity is around 5,000 BTC, a figure that represents the total amount of Bitcoin locked in all Lightning channels. This capacity limits the network’s liquidity and the amount of Bitcoin that can move through it, which in turn affects the LN’s ability to handle high-frequency transactions and large-scale payments.
Let’s say Joel needs to raise $1 million to pay coffee plantation workers in India, and decides to use the Lightning Network to accept donations. To do this, Joel can’t just fire up an LN wallet and wait for donations. He needs to ensure there is enough inbound liquidity to accept this huge amount of money. Inbound liquidity refers to the amount of Bitcoin locked by the counterparty in the Lightning channel, which is used to support the inflow of funds from the counterparty to Joel.
For another example, Sid is one of Joel’s counterparties who has locked $10,000 worth of Bitcoin in a lightning channel. If Joel wants to accept a $1 million donation, he needs other counterparties like Sid who have locked up a total of $1 million to ensure that he can receive this large donation. Because inbound liquidity is limited by the funds locked by each party in the channel, this limits the transaction amount that the network can support, thus posing a challenge to the Lightning Network’s ability to scale.
In short, inbound liquidity determines the maximum transaction amount that the Lightning Network can handle, and this liquidity is always limited by the opportunity cost of capital, that is, the Bitcoin invested in the channel cannot be used for other purposes.
Challenges of Bitcoin Development
Bitcoin is not only a technical system, but also deeply rooted in culture and social consensus. Bitcoin's supply cap is a hard-coded rule that the maximum supply is fixed at 21 million BTC. This hard limit is regarded as one of the core values of Bitcoin, and any change to this cap requires broad social consensus and technical support.
Technical efforts to make codebase modifications can become futile due to a lack of social consensus. The last major contentious fork of Bitcoin occurred during the Block Wars in 2017. At that time, the Bitcoin network split into two different blockchains:
Bitcoin (BTC) : In this fork, the Bitcoin network implemented the SegWit (Segregated Witness) protocol, which is intended to improve transaction processing capacity and scalability.
Bitcoin Cash (BCH) : This is another blockchain that split from the original blockchain and chose to increase the block size to improve transaction throughput.
In this fork, most miners chose to continue mining on the Bitcoin chain.
Stability is essential for an asset to be considered a currency or store of value. The main reason why fiat currencies lose purchasing power over time is that central banks often use their power to increase the money supply. The unpredictability of unilateral actions by central banks can cause certain currencies to become unstable and weaken.
Bitcoin's culture tends to resist frequent changes. The Bitcoin community is cautious about any changes that may affect its stability, and even technical improvements such as Taproot, although not controversial, took years from conception to implementation. This cautious attitude reflects Bitcoin's emphasis on maintaining the stability of its currency and value storage functions.
Implementing the above changes is more than just changing Bitcoin. The Bitcoin base layer needs to be as simple as possible. Simplicity is critical to reducing attack vectors and improving stability. The idea is to perform complex things like lending and minting stablecoins using BTC as collateral outside of the base layer, just like Ethereum’s L2.
L2 for Bitcoin?
What is L2 and what should it do?
Provide sufficient data for the first layer to verify and resolve disputes, if any.
Beyond the base layer, there should be no additional security measures.
Allowing users to unilaterally withdraw their assets to the base layer or layer one.
Since Bitcoin’s current opcodes are limited and cannot meet the requirements for verifying any proof, any chain claiming to be a Bitcoin layer 2 network cannot truly be called L2.
Another important aspect of L2 is that its security assumptions should be consistent with Bitcoin’s security assumptions. Every blockchain has some basic security assumptions, such as:
Most mining nodes are honest
Nodes can independently verify blocks and reject invalid blocks
Forks are resolved on the longest branch of the chain, and so on.
When designing and implementing L2 solutions, the security assumptions of their base layers cannot be extended. For example, if the second layer has a centralized block production sequencer, users need to be able to challenge block production at a low cost. The first layer (such as Bitcoin or Ethereum) should ensure that users can withdraw their funds from the second layer through the first layer's mechanisms as long as their funds have not been spent. Currently, even Ethereum's L2 solutions fail to fully implement these mechanisms.
If we strictly follow the characteristics of L2, then some solutions that are considered to be Ethereum L2, such as Arbitrum, cannot be considered as true L2. Since Bitcoin's opcodes cannot currently verify any proof, any chain that claims to be Bitcoin L2 does not actually meet the true L2 definition. The Lightning Network may be the only solution that meets the L2 definition. For the convenience of discussion, this article will collectively refer to these solutions as the Bitcoin extension layer.
The Current State of Bitcoin’s Scaling Layer
In general, there are two main ways to use Bitcoin:
Use cross-chain bridges : Since Bitcoin itself has limited application scenarios, users can transfer Bitcoin to other blockchains through cross-chain bridges so that they can use Bitcoin for more applications on those blockchains. This method allows users to take advantage of the rich functions and application scenarios of other blockchains outside the Bitcoin network.
Create an environment or chain : Develop a new environment or blockchain in which investors can use Bitcoin applications. This means developing a dedicated blockchain or platform that can support Bitcoin and allow users to perform various applications and operations on the platform, thereby expanding the scope of Bitcoin use.
In order to enable Bitcoin to support more application scenarios and functions, these new layers may introduce more security assumptions or mechanisms than the Bitcoin base layer. When using these new layers, users hope that these additional security assumptions and mechanisms can minimize the impact on the security and integrity of Bitcoin. By studying Ethereum's expansion strategies and methods, we can provide valuable experience and reference for understanding and designing Bitcoin's expansion solutions.
After several years of development, Ethereum has realized that rollups are the key way to scale. Currently, we still don’t know which method is the best way to scale and make Bitcoin more programmable.
Whether storing data or choosing a cross-chain bridge design, projects are making trade-offs between decentralization, security, speed, and user experience. The answers to the following questions form the design space for projects or companies building extended Bitcoin layers:
How to implement a cross-chain bridge from Bitcoin to a new chain?
How is the data stored (data availability)?
How to use Bitcoin Layer 1 for settlement?
Are any changes expected in Bitcoin’s base layer to achieve its full vision?
Which execution environment to choose?
Does the extended Bitcoin layer facilitate the use of Bitcoin for purposes such as gas and staking?
When expanding the functionality and use cases of Bitcoin, various teams have made different trade-offs and decisions in terms of security, usability, performance, etc. Each team may adopt different strategies in these aspects in order to find the most appropriate way to meet the needs of users while maximizing the security and reliability of Bitcoin.
Cross-chain mechanism
Bitcoin on the Bitcoin chain cannot be directly transferred to other chains, so an infrastructure is needed to achieve this cross-chain transfer. A typical cross-chain mechanism is to lock the user's Bitcoin on the Bitcoin network and mint an equal amount of synthetic tokens on the target chain to represent these Bitcoins.
What is the typical locking mechanism? When a user wishes to transfer their Bitcoin from the Bitcoin network to a different chain, they send Bitcoin to a specific address on Bitcoin. This address is controlled by the bridge operator. When the bridge operator detects the arrival of Bitcoin, they mint an equal amount of synthetic tokens on the target chain and send it to the address specified by the user.
The risk of this mechanism is that if the cross-chain operator loses Bitcoin on the Bitcoin network, the tokens minted on the target chain will become worthless. We witnessed this risk after the FTX collapse. SolBTC, a wrapped version of Bitcoin operated by FTX/Alameda, became worthless because FTX no longer honored redemptions after filing for bankruptcy.
Therefore, all operations performed by users on the target chain are completely dependent on how the cross-chain operator manages and protects the user's bitcoin on the Bitcoin network. According to how Bitcoin is managed, cross-chain mechanisms can be divided into three types.
Trustless cross-chain
This cross-chain mechanism is only possible if L1 can verify the proof submitted by L2. For Bitcoin, this mechanism is currently not feasible because Bitcoin cannot understand anything happening outside of it.
Trust-minimized cross-chain relying on economic security
Another way for Bitcoin to cross-chain is for multiple public parties to handle the locking and unlocking process of Bitcoin. These public parties protect users' Bitcoin on the Bitcoin network and mint and destroy synthetic Bitcoin tokens on other chains. Threshold Network's tBTC is an example of this mechanism. In the tBTC system, multiple public parties (i.e. nodes) jointly protect users' Bitcoin and mint tBTC tokens on other blockchains such as Ethereum. When users need to redeem Bitcoin, these nodes destroy the corresponding tBTC and unlock the Bitcoin on the Bitcoin network.
This means that before an operator can perform any action on a user’s Bitcoin, the majority of operators running Threshold Network nodes must agree. Rather than relying on a centralized intermediary, tBTC randomly selects a group of operators running Threshold Network nodes to protect the Bitcoin deposited by users.
Who can become a node operator on the Threshold Network? The network has a governance token, T. While T is used for governance, a minimum of 40,000 T is required to become a node operator. As of June 25, 2024, there are 139 active nodes on the network.
The tBTC Beta Stakers program aims to gradually decentralize the node network through delegated staking. Beta stakers can delegate their stakes to five professional node operators: Boar, DELIGHT, InfStones, P2P, and Staked. Beta stakers are expected to run nodes for at least 12 months and actively participate during this period, such as responding to network upgrades within 24 hours of notification.
Whenever a user requests to mint tBTC, a new deposit address is generated on the Bitcoin network. This address is controlled by a node on the Threshold Network and is dedicated to the user's request. Users can mint tBTC on multiple networks, including Ethereum, Arbitrum, Optimism, Mezo, and Solana.
The user needs to provide two addresses when making a request: a recovery address on Bitcoin (used to return Bitcoin if there is a problem in the minting process), and an address on the target chain (the address where the user wants to receive tBTC). Once the request is made, the user needs to deposit Bitcoin into the generated address and wait for the guardian to confirm the deposit. After confirmation, the minter will send tBTC to the user's address on the target chain.
Currently, there are approximately 3,500 bitcoins locked in the Threshold Network, valued at over $200 million.
Given the capabilities of Bitcoin opcodes, trust-minimized cross-chain is currently the best way to achieve cross-chain. The specific implementation of trust-minimized cross-chain may vary depending on the design of multisig. Threshold Network's tBTC, Stack's upcoming sBTC implementation, and Botanix's spiderchain are all examples of trust-minimized cross-chain.
Custody cross-chain
In this design, a centralized provider locks the user's bitcoin in an address managed by a custodian. BitGo's WBTC is the most widely used method for transferring bitcoin across chains to other chains, with more than 150,000 BTC having been transferred across chains via WBTC. The current distribution of WBTC is as follows.
BitVM
In addition to the three existing bridge types, Robin Linus released the BitVM white paper at the end of 2023. BitVM proposes a new way to implement Turing complete smart contracts on Bitcoin. If a system can perform any calculation given enough time, it is called Turing complete. As mentioned earlier, Bitcoin is Turing incomplete by design, and BitVM proposes a way to overcome this problem without changing the existing opcodes, and proposes a so-called trustless bridge mechanism.
BitVM uses an optimistically verified approach to zero-knowledge proofs. Under this mechanism, the transaction execution is assumed to be correct by default, provided that no one objects to it. This approach relies on at least one validator monitoring the system. If there is an error in the transaction execution, the validator has the responsibility to stand up and question it, thereby ensuring the correctness and security of the system. This mechanism ensures that complex calculations can be efficiently processed and verified on the Bitcoin network while maintaining decentralization and security.
As long as no one challenges the zero-knowledge proof (ZK proof), everything works fine. If there is a dispute about the zero-knowledge proof, the system will start a mechanism to resolve the dispute through on-chain interaction. This interaction usually increases the transaction volume on the chain because every challenge and response needs to be recorded on the blockchain. This mechanism ensures that even in the case of disputes, the system can resolve the problem in a transparent and verifiable way on the chain, thereby ensuring the correctness of the transaction and the security of the system.
In early versions of BitVM, there were significant problems with liquidity management. When a user requested a withdrawal from the bridge, the system could only complete part of the withdrawal, and the remaining part needed to be provided by the bridge operator with liquidity. Afterwards, the operator would be compensated from the bridge system. As the amount locked in the bridge increases, the operator must reserve more liquidity funds to ensure that all users' withdrawal needs can be met. This puts a lot of pressure on the operators because they need to prepare enough funds in advance to deal with withdrawal requests. The need to maintain a high level of liquidity results in a design that performs poorly in capital efficiency, that is, more funds are required to ensure the normal operation of the system, and these funds may not be actually used most of the time, thereby reducing the efficiency of capital utilization.
Assume that the bridge operator needs to always maintain 10% of the bridge's total locked value (TVL) as liquidity. For example, if the bridge TVL is $10 billion, the operator needs to always maintain $1 billion in liquidity reserves. As the bridge system attracts more liquidity, the operator needs to maintain more Bitcoin inventory to ensure that all withdrawal requests can be processed.
Tyler White and Rijndael wrote an article explaining in detail the problems with BitVM, including the challenges of liquidity management.
Execution Layer
In order to improve the practicality of Bitcoin, it is crucial to design a blockchain that can provide the best user experience. Developers need to consider multiple factors when designing this blockchain to ensure that users can use Bitcoin conveniently and safely.
Execution Environment: Should an EVM-compatible chain be used? EVM compatibility has many advantages, such as:
Tools accumulated over the years, such as wallets and bridges to other EVM chains, are available to developers directly.
Users are already very familiar with this UX.
Ethereum’s L2 has benefited from EVM compatibility. EVM-compatible L2s like Arbitrum and Optimism can quickly attract users and applications already on Ethereum. However, L2s that are not EVM-compatible like Starknet face greater adoption difficulties.
However, the EVM also has its disadvantages. Since the EVM needs to execute transactions serially, parallel processing is not possible. Newer execution environments, such as the Solana Virtual Machine (SVM) and the upcoming Monad, support parallel processing.
Data availability: Similar to Ethereum, some Rollup solutions have emerged in the Bitcoin space. Rollups come in different forms depending on where and how the data is stored. Some store state differences (the difference between two states of the chain after executing a batch of transactions) and validity proofs on L1. Some store compressed transaction data on L1, and some store only validity proofs on L1, while storing transaction data on a separate layer.
Some chains like Stacks use Bitcoin as a checkpointing mechanism. Stacks' block time is much shorter than Bitcoin's. Stacks publishes the data between its blocks on every Bitcoin block.
The execution layer can publish transaction data on Bitcoin in the form of inscriptions. Recall the Bitcoin network's 6.66 kbps bandwidth. If we assume that the size of a compressed transaction is 10 bytes (usually around 20 bytes), a Bitcoin block can theoretically contain about 600 compressed transactions. However, this maximum is almost impossible to achieve, because 4 MB blocks are very rare, and it is even rarer that the entire 4 MB space is available for inscriptions.
The block size depends on the mix of SegWit and non-SegWit transactions. SegWit (Segregated Witness) separates the transaction data from the witness data. The idea is that not all data stored in a block is equally important. Instead of limiting the block size to the traditional 1 MB, SegWit proposes a new limit of 4 million weight units. So if a block is all non-SegWit transactions, the limit will be 1 MB. But if it is all SegWit transactions, it can go up to 4 MB.
Multiple teams have different strategies and approaches on how to leverage Bitcoin’s liquidity. Each team faces their own technical and design challenges and makes different choices within those challenges. This article will briefly describe how these teams work, what stage of development they are in, and the progress they have made so far.
By studying the work of these teams, we can better understand the direction of expansion and innovation in the Bitcoin ecosystem and how to more effectively utilize Bitcoin's huge liquidity.
Babylon
Babylon is focused on expanding the use of Bitcoin as a collateral asset. Unlike other second-layer solutions, Babylon proposes a new approach called remote staking Bitcoin. This approach is different from the traditional method of locking Bitcoin on the Bitcoin network to mint a synthetic version. Babylon's remote staking mechanism introduces the following mechanisms:
When a user decides to stake their BTC, they create a special UTXO that is designed to be usable only under certain conditions. First, it can only be used after the staking period ends, which means that during the staking period, these bitcoins cannot be transferred or used. Second, the user can terminate the stake and destroy this UTXO with a special signature (EOTS), thereby unlocking the bitcoins. This mechanism ensures the security and immutability of the stake, while also providing users with some flexibility to terminate the stake when needed.
When users stake their Bitcoin and complete the corresponding transactions, they will receive an EOTS. This EOTS allows users to participate in validating blocks on the PoS blockchain within the Cosmos ecosystem. By validating blocks, users can earn additional income.
If users abide by the rules of the protocol during the staking period and do not commit any breach of contract (such as attempting to withdraw the staked bitcoins in advance), they can unlock their bitcoins at the end of the staking period. At this point, users can choose to unlock their bitcoins or submit an unstaking transaction on the Bitcoin network to officially end the staking and recover their bitcoins.
If dishonest behavior is detected, the user's EOTS will be exposed to the public. Babylon's monitor ensures that there is at least one honest operator. This program suite acts as a relayer for data between Bitcoin and Babylon. The submitter program submits the Babylon checkpoint to the Bitcoin network using OP_RETURN. The reporter program scans the Babylon checkpoint and reports it back to Babylon. If anomalies are detected, anyone (called a slasher) can use the public EOTS key and submit a Bitcoin transaction to obtain the malicious user's stake.
A common question is why users can't just use their keys to get their stake back themselves. The answer could be that when miners see this transaction, if someone else initiates the same transaction, the miner will choose the one with the higher fee. For example, if the stake amount is 5 BTC, the slasher can share 4.99 of it with the miner and make a profit. In this case, the miner keeps most of the profit instead of the slasher. However, the malicious user will lose most of the stake anyway, either to the slasher or the miner.
Babylon's remote staking method for Bitcoin allows users to use Bitcoin to participate in block verification on other PoS chains during the staking period by creating a UTXO that can only be spent once. However, the complexity of this mechanism is that not all PoS chains have successfully implemented the slashing mechanism (i.e., a penalty mechanism that reduces the stake of a validator when it is dishonest). In addition, although Babylon's remote staking method can be used to protect other PoS chains, if other uses of Bitcoin (such as lending) are to be realized, BTC still needs to be transferred to these applications through a bridging mechanism.
Build on Bitcoin (BOB)
BOB is an Optimistic Rollup-based solution that aims to combine the Bitcoin and Ethereum ecosystems. Optimistic Rollup is a technology that expands Ethereum by rolling up transactions before submitting them to the Ethereum mainnet to achieve higher transaction speeds and lower fees. BOB plans to gradually achieve its goal of aligning with Bitcoin through a four-phase gradual release, providing users with a more flexible and efficient blockchain application experience.
Phase 1 - OP Rollup. At this stage, it is purely an Ethereum Rollup. Fraud proofs are not yet live on the mainnet. Fraud proofs are a mechanism that allows anyone to question the validity of transactions included in a Rollup batch.
Phase 2 – Ethereum Rollup with Bitcoin Security. In this phase, BOB will utilize Bitcoin’s merged mining. Merged mining allows miners to secure (or mine) multiple chains at the same time as Bitcoin.
Phase 3 - Optimistic Bitcoin Rollup via BitVM. BitVM is not live yet. When it is online after improving upon the current version, BOB will start using BitVM for settlement on Bitcoin.
Phase 4 – ZK Rollup on Bitcoin. After Bitcoin accepts opcodes that allow verification of ZK proofs, BOB will settle on Bitcoin using ZK proofs.
As of June 17, 2024, BOB's TVL is approximately $60 million, of which Sovryn DEX contributes approximately $20 million.
Botanix
The Botanix team has brought an important innovation: Spiderchain. Spiderchain is a coordinating node for a rolling multi-signature mechanism on Botanix. Let's explain it in detail. An L2 requires a bridge and a chain to execute transactions. The coordinating node is responsible for protecting user funds on Bitcoin and minting and destroying synthetic Bitcoins on the EVM layer. The coordinator runs Bitcoin and Spiderchain EVM (Botanix) nodes.
Assume there are N coordinators on the network. Each Bitcoin block randomly selects M (<N) coordinators to protect incoming Bitcoins. Each spooch, new keys are generated along with a new set of coordinators. During the bridging process, the newest Bitcoins are selected first to ensure that older and established coordinators control older coins.
Botanix's chain is EVM-compatible and secured by a PoS consensus mechanism. In addition to securing Bitcoin on Bitcoin and facilitating the minting and redemption of synthetic Bitcoins by participating in a rolling multi-signature network, coordinators also participate in the block construction of the EVM chain. They publish the root hash (a compact version) of Botanix EVM transactions as an inscription on Bitcoin.
It is important to note that simply publishing data on Bitcoin does not mean settlement. The difference here is that the data published in the form of inscriptions by external chains like Botanix is stored in places that are not verified by Bitcoin nodes (miners). The Bitcoin protocol is completely unaware of this data. Therefore, it is impossible to determine whether the transaction data published in the inscription is correct.
As of June 2024, Botanix EVM and Spiderchain are still in the testnet stage.
Citrea
Citrea is building a ZK Rollup on top of Bitcoin. On top of Bitcoin means that it intends to use Bitcoin as a data availability layer. Citrea believes that the most secure and incentive-aligned way to scale the Bitcoin blockchain is to shard execution through on-chain verifiability and data. Sharding execution means dividing the execution task into smaller parts, and in this way, the efficiency and security of the overall system can be improved.
Citrea then aggregates these shards, or batches of transactions, and publishes the difference in state between two batches of transactions on Bitcoin along with a proof called a proof of validity. However, the problem currently is that Bitcoin does not have the ability to verify these proofs. Therefore, Citrea’s final form will have to wait until Bitcoin has opcodes that allow it to verify ZK proofs.
In the meantime, it will use the BitVM implementation as a temporary solution to handle proofs and bridge Bitcoin in and out of Rollup. Naturally, Citrea also inherits the shortcomings of BitVM mentioned in the previous section. In the future, as BitVM improves, Citrea will improve its bridging capabilities.
Source: Citrea
As of June 2024, Citrea is in the testnet stage.
Mezo
Mezo calls itself Bitcoin’s economic layer, not Bitcoin’s L2. It uses Thereshold Network’s tBTC bridge to bring Bitcoin in and out of the EVM chain.
Mezo is built by the team that developed products such as tBTC, Fold, Keep and Taho. This team has been working on the development of Bitcoin-related applications for many years. Mezo's goal is simple: to expand the use cases of Bitcoin. It achieves this goal through the following three mechanisms:
Allow Mezo users to secure the network and earn returns by staking Bitcoin.
Allows users to pay gas fees in Bitcoin, which will be distributed to veBTC and veMEZO stakers.
Build an end-to-end BitcoinFi experience.
So, what is BitcoinFi and the economic layer? Most new chains, including EVM-compatible chains, rely on existing user experiences, such as the same wallets and bridge tools. Improving the user experience is almost never a priority. Mezo designed the entire user experience from scratch, which is very rare. It includes the following:
A native stablecoin (mUSD) backed by BTC, without the need for users to bridge from other chains.
A long-tail lending protocol secured by BTC.
Fully integrated boarding and alighting access is provided by Fold.
Integrated wallet experience provided by Taho.
Combining all of these applications, Mezo creates a unique end-to-end BitcoinFi experience.
Mezo is based on the Cosmos SDK and uses Comet BFT as the consensus mechanism.
CometBFT is software for safely and consistently replicating applications across multiple machines. By safe, we mean that CometBFT works as long as less than a third of the machines fail in any way. By consistent, we mean that every non-faulty machine sees the same transaction log and computes the same state. Safe and consistent replication is a fundamental problem in distributed systems; it plays a key role in fault tolerance in a wide range of applications, from currencies to elections to infrastructure orchestration. — Source: CometBTF documentation
CometBFT consists of two components: a consensus engine and a general API. The consensus engine is based on Tendermint core and is responsible for block production, verification, and finality. Tendermint is one of the earliest proof-of-stake consensus designs and provides BFT consensus , which means that even if up to one-third of the nodes in the network are malicious, the consensus mechanism can still work properly and reach consensus. This fault tolerance makes the network more secure and stable.
ABCI allows the consensus engine (responsible for reaching consensus and validating blocks) and the application logic (responsible for processing transactions and executing smart contracts) to run in different environments. This separation makes the system more modular, and individual components can be developed, tested, and upgraded independently. This flexibility not only improves development efficiency, but also increases the maintainability and scalability of the system. Developers do not have to be limited to the same programming language as the consensus engine, which reduces the learning curve for development and can leverage existing technology stacks and tools. Because different programming languages and tools can be used, more types of applications can be developed and run on this platform, attracting more developers and projects to participate. Mezo was initially only compatible with the Ethereum Virtual Machine (EVM) runtime, which means it is able to run Ethereum-based smart contracts and applications.
Mezo is designed so that as it becomes more popular, Bitcoin holders may benefit directly or indirectly. Specifically:
Direct income : Bitcoin holders can stake their Bitcoin on Mezo to earn staking income. This means that their Bitcoin is not only an asset they hold, but they can also earn additional returns through staking.
Indirect benefits : Even if Bitcoin holders choose to continue holding Bitcoin on the Bitcoin network, they can benefit from it. This is because when more Bitcoin is taken out of circulation and used to pay fees on Mezo, the total amount of Bitcoin in circulation in the market decreases. This reduction in circulation may lead to an increase in the value of Bitcoin, thereby indirectly benefiting holders.
Mezo has a dual staking model, as shown in the figure below. Validators on the network can stake Bitcoin and MEZO (the native token of the Mezo network). By staking Bitcoin and MEZO, validators receive veBTC and veMezo respectively. "ve" stands for validator escrow, and these tokens are usually locked in smart contracts. Validator escrow token holders have governance rights, and network rewards and fee income are shared with them.
The longer the asset is locked, the more ve tokens are issued. veBTC stakers earn Bitcoin, and veMEZO stakers earn MEZO rewards. Part of the MEZO rewards can be burned to increase the Bitcoin inventory.
Yield is one of the core elements of Mezo, as the fees paid by users are distributed to validators who stake Bitcoin. Mezo plans to further expand the application scope of Bitcoin staking through the liquidity staking provided by its sister project Acre. When users deposit Bitcoin into Acre, they will receive a liquid staking token stBTC in return. The deposited Bitcoin will be used for cross-chain and DeFi applications. The income generated through these activities will be accumulated in stBTC, which can be exchanged for Bitcoin 1:1.
Source — Acre Blog
Despite Bitcoin’s market cap exceeding $1 trillion, it plays little role in the lending market. The following chart shows the distribution of WBTC in the lending market. The data shows that from July 2023 to June 2024, the amount of WBTC used in the top three lending applications decreased from about 50,000 to about 23,000. The decline in the total amount of WBTC in lending applications can be attributed to the 48% drop in WBTC supply, from 285,000 WBTC in May 2022 to just over 150,000 WBTC now. This decline is mainly due to the market’s awareness of the risks of centralized parties in the aftermath of the Luna, 3AC, and Alameda incidents.
In the first phase of Mezo's initial launch, it has begun accepting Bitcoin deposits and offers three different lock-up periods: two months, six months, and nine months. Deposits earn points in the form of HODL points, with 1,000 points generated per BTC per day, and the longer the lock-up period, the higher the multiplier. Users can also deposit other assets such as USDe, USDC, and USDT to increase the returns on BTC deposits. As of July 2024, Mezo's total locked volume (TVL) reached $135 million.
In addition to rewarding holders, Mezo will also share some of its fees with the Bitcoin Core protocol.
Stacks
Stacks recently underwent a Nakamoto upgrade to address the chain forks and slow transactions that existed before the upgrade. Stacks uses a consensus mechanism called Proof of Transfer (PoX).
Under this mechanism, Bitcoin miners who are interested in generating blocks on Stacks need to send some Bitcoin. Suppose miner Alice is randomly selected to generate a block on Stacks. The Bitcoin sent by miner Alice is distributed to those users who stake (lock/stake) Stacks' native token STX. This means that users who stake STX will receive Bitcoin as a return. Interestingly, this return is provided in the form of Bitcoin, rather than in the form of the chain's native token like most blockchains. This approach may attract more users because Bitcoin is considered a more stable and widely recognized cryptocurrency.
Then once Bitcoin miner Alice is selected, she can keep generating Stacks blocks until the next Bitcoin block is mined. When Alice generates Stacks blocks, they are sent to the signers for verification. When more than 70% of the signers accept these Stacks blocks, they will be accepted by the Stacks network and added to the blockchain. Assuming Alice generates 10 Stacks blocks before the next Bitcoin block is mined, once the next Bitcoin block is mined, new miners (such as Bob) will have the opportunity to compete to generate the next batch of Stacks blocks.
Bob will add the hash of the first block generated by Alice on Stacks to the block submission transaction he submits to the Bitcoin blockchain. Stackers (stakers) will detect this transaction submitted by Bob. They then create a term change transaction on Stacks that includes the hash of the last block generated by Alice (i.e., block 10).
Although the development of the Bitcoin layer is still in its early stages, we can compare these chains in the following aspects:
Chain design : The basic design of each chain, including consensus mechanisms, smart contract capabilities, and scaling solutions. For example, some chains may focus on security and decentralization, while others may focus more on high throughput and low latency.
Bridge design : How the design of the bridge between chains enables the transfer and interoperability of cross-chain assets. The bridge mechanism includes how to transfer Bitcoin to other blockchains without sacrificing security and ensure the reliability of cross-chain transactions.
Total locked value : The total locked value is the total value of assets locked or staked in the protocol by users.
In addition to the teams mentioned above, many other teams are also building extension layers for Bitcoin. These teams include Alpen, Bison, BitLayer, Rootstock, SatoshiVM, and Soveryn, among others. Readers can find a full list here.
The relationship between L2 and L1
L2s help L1s in two ways: scaling and reducing costs. They provide users with a cheaper way to transact without sacrificing too much security (or even no security loss for L2s with non-custodial, trustless bridges and no additional security assumptions).
Take Ethereum L2 as an example. According to Token Terminal, in the second week of June 2024, 7.1 million transactions were conducted on Ethereum, with revenue of $10.6 million. The cost per transaction for users was about $1.5. At the same time, five L2s - Arbitrum, Base, Blast, Optimism, and Polygon - conducted more than 70 million transactions with a total fee of $2.75 million. The fee per transaction was about $0.03.
We can debate the quality of these transactions, including whether they are bots, but Ethereum itself cannot support that many transactions.
However, when using L2 layer solutions, L1 no longer interacts directly with users. This disadvantage is similar to the situation in traditional business models: those companies that are closer to end users usually capture more value. Amazon is a good example because it has a huge distribution network, which gives it an advantage in its relationship with suppliers and manufacturers.
Dollar Shave Club uses a subscription model to sell razors directly to consumers. This model bypasses traditional retail channels such as stores and wholesalers, thereby saving costs in these intermediaries. Without middlemen to make a profit, Dollar Shave Club is able to sell razors to consumers at a lower price while retaining more profit and value, rather than sharing it with other links in the traditional supply chain.
Typically, adding an intermediary layer weakens the direct connection between enterprises and end customers, which is seen as a disadvantage in traditional business because enterprises want to directly reach customers, maintain customer relationships and obtain more value. However, in the blockchain field, by introducing L2 solutions, L1 has not lost its connection with users. Instead, they adopt a business-to-business (B2B) model, entrusting certain user interactions and transaction processing to L2. This model brings the benefits of expansion and cost reduction. But the question is, will doing so allow L2 to capture most of the value? And, will L2 pass on enough fees to L1 to ensure that L1 still gets the benefits and resources it deserves to maintain its network operations.
Ethereum has widely adopted L2 solutions over the past three years, which allows us to draw conclusions by analyzing the impact of these solutions on the Ethereum ecosystem. Predatory means whether L2 extracts too much value from Ethereum, thereby weakening the value and role of Ethereum itself. To determine this, there are two ways to start:
1: Assess the impact of L2 by observing the changes in Ethereum's share of revenue in its ecosystem. The chart shows the comparison of Ethereum's revenue with the five leading L2 solutions. The data shows that Ethereum has always accounted for more than 90% of the revenue of the entire ecosystem. This means that even with the existence of L2, Ethereum still maintains most of its revenue, and L2 has not caused a significant negative impact on Ethereum's economy.
2: Another way is to look at market cap or price. Value capture is usually reflected in the price of an asset. By analyzing the total market cap of ETH (Ethereum's native token) in the entire Ethereum ecosystem, we can see whether Ethereum is affected by L2. Currently, ETH accounts for more than 95% of the total market cap of the entire Ethereum ecosystem, even taking into account the market cap of the top 10 L2s. This shows that even with the existence of L2, Ethereum's market cap still accounts for the vast majority, and L2 has not significantly affected the overall value of Ethereum.
Ethereum itself cannot support that many transactions, but it still captures more than 90% of the ecosystem value, which shows that L2 is the right step to scale Ethereum. As long as L2 settles on L1, healthy competition between L2 for L1 block space is good for the health of the base layer.
What's next?
Assume that Bitcoin and other chains are different islands. In order to create a true L2, these islands need to be connected by bridges, but the prerequisite is that the residents of Bitcoin Island need to reach a consensus. Currently, some projects hope to become Bitcoin's L2 and are working hard to build infrastructure as a temporary solution.
When these L2 islands are ready, it’s just a matter of waiting for Bitcoin Island residents to agree that they need to bridge to other islands. Instead of trying to find more complex bridge methods before reaching internal consensus, focus on using infrastructure that has been proven to work and has been battle-tested.
