From isolated islands of value to mutual exchange, a review of the development history of Bitcoin's "layering"

Original title: Layered Bitcoin

Original author: SAURABH DESHPANDE, Decentralised.Co

Original translation: TechFlow

Throughout history, money has fulfilled three key functions in society: it serves as a store of value (wealth), a medium of exchange, and a unit of account. While the form of money is constantly changing, its functions remain essentially the same. Broadly speaking, there have always been two schools of thought, one that supports credit money or soft money and the other that supports hard money. Credit money, like today's fiat currency system, is always a liability of some kind.

The dollars or rupees you hold are a debt of the government. If the government defaults, your money will not be able to buy basic goods and services.

On the other hand, hard money is not a debt of the government. For example, precious metals like gold will not depreciate even if the government defaults. Instead, its value will increase due to its perceived stability.

Bitcoin is the first successfully implemented non-sovereign hard currency. Satoshi Nakamoto released Bitcoin in 2009, when the world had just experienced a global financial crisis caused by bad lending practices and unilateral interest rate decisions. The strong dollar has depreciated by more than 95% during its lifetime. In his article Paradigm Shifts, macroeconomics guru Ray Dalio writes about how central banks reduce interest rates in response to various crises and the impact this has on their respective economies.

Source – Paradigm Shifts

The chart shows how interest rates have fallen in developed countries since the 1980s. At the same time, the monetary base has grown as a percentage of GDP. Therefore, total output has not grown at the same rate as the money supply. When the money supply increases rapidly, it can lead to higher inflation, higher cost of living, increased debt burdens, and greater income inequality, regardless of the rate of household income growth. The high inflation environment we are currently in is a result of the policies adopted by central banks.

In such situations, the role of precious metals like gold becomes more significant. Government interference in the supply of gold is minimal. With less government influence, the supply of gold is more predictable than fiat currencies. This high predictability allows gold to retain its value over decades and serve as a store of wealth.

Bitcoin was born as peer-to-peer electronic cash. Over the years, like many innovations, it strayed (or at least expanded) from its original electronic cash goals and evolved into digital gold.

In 2018, I came across an interesting analogy comparing cities to blockchains. Because blockchains are isolated from the outside world, they are more like closed islands. Each island has its own priorities and technical and social characteristics. Bitcoin Island always prioritizes security and decentralization over other aspects such as speed and programmability.

Decentralization is a broad and nuanced term. Balaji Srinivasan proposed measuring decentralization by breaking down a blockchain into its subsystems, such as mining, clients, developers, exchanges, nodes, and ownership. He proposed that the overall degree of decentralization could be derived by measuring the Gini1 and Nakamoto2 coefficients of the subsystems.

According to many Bitcoin supporters such as Jonathan Bier, we can see decentralization in terms of how difficult it is for users to verify transactions themselves. The difficulty of verifying transactions is the reason why Bitcoin blocks are small (up to 4 MB). In order for a blockchain to provide general programmability (not just on paper but in practice), developers must plan a few things.

First, the language or system they use should be Turing complete. "Turing complete" means that the system is able to perform any computation that can be expressed by an algorithm given enough time and memory.

Second, gas metering needs to be optimal. Gas metering refers to how the system is designed to measure the cost of resources (for example, the maximum gas consumption per block and the gas consumed by different operations). Ethereum's Solidity is a Turing-complete language, but it is generally limited by gas. Bitcoin's scripting language is intentionally limited to ensure greater security. Furthermore, as Matt mentioned, it is a low-level, stack-based language that is riddled with unfixed bugs since the days of Satoshi, and lacks key operators that prevent it from being very useful.

Blockchains like Ethereum and Solana have evolved to interconnect, forming interactions from which they could benefit. However, while Bitcoin Island has steadfastly adhered to its security goals, it has not incorporated any changes in its infrastructure that would allow for easier movement to other blockchains. Bitcoin Island only allows residents to hold, transfer, or trade their BTC for inscriptions and runes, which provides a poor user experience.

Due to its limited use, BTC is primarily held in vaults. Meanwhile, assets like ETH have abundant opportunities to enjoy yield and passive income in the form of staking, re-staking, lending, and more. Other blockchains have undergone rapid modernization as they have developed 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, increasing the surface of attack.

Bitcoin islands remain strong but isolated. Other blockchains are connected to each other through stronger bridges.

The separated islands reminded me of the history of my hometown, Mumbai. Once known as Bombay, it was originally made up of seven different islands. The fusion of these islands began in the 1680s and continued for centuries. Today, as I walk through this busy metropolis, there are few traces of the former separation. The city feels seamlessly unified, its past divisions all but forgotten.

This transformation in Mumbai raises an interesting question: Will we also witness a similar evolution in the Bitcoin space? Some teams are working on this.

The Evolution of the Seven Mumbai Islands. Source – Reddit

This post is about how some teams are offering Bitcoin holders different ways to use their wealth, rather than just holding it. I will lay the foundation by explaining why we need better infrastructure, and then dive into the different approaches teams are taking to expand BTC use cases. Finally, I mention that the ultimate vision is not only about technical consensus, but also about social consensus.

This transformation is happening as teams are building different auxiliary islands for Bitcoin Island and looking for solutions to modernize Bitcoin Island. The permanent reform of Bitcoin Island can only happen after a social revolution among the islanders and agree to change their rules, so that bridges to other islands can be used as confidently as the infrastructure within the island.

Why is better infrastructure needed?

Mature blockchains like Ethereum, Solana, and the upcoming Monad are built with developers in mind. They are designed as platforms for developers to build applications. These chains offer comprehensive ecosystems that support developers through a variety of learning resources, tools, frameworks, and features. Satoshi did not have these in mind when developing Bitcoin. Bitcoin does not have a well-thought-out API and there is almost no clear documentation to learn Bitcoin development

There are three key reasons to continuously improve network infrastructure - better user experience (UX), more financialization, and scale payments.

Better UX will increase activity leading to more fees

The Ordinals protocol is a way to leverage Bitcoin UTXOs 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. Inscriptions and Runes have given Bitcoin a boost in activity. The total number of daily transactions has increased by 70% compared to BTC transfers alone.

These new ways to transact in Bitcoin have helped increase fees by about 40%. However, these new ways have sparked a heated debate within the Bitcoin community. One school of thought believes that Bitcoin should focus on strengthening its core function as a decentralized payment system. They believe that expansion beyond this scope may compromise Bitcoin's security, simplicity, and effectiveness as sound money.

On the other hand, advocates for a more flexible approach argue for expanding Bitcoin's functionality to cover non-payment use cases. They believe that this evolution is necessary for Bitcoin to remain competitive and relevant in the rapidly evolving blockchain ecosystem.

Is this enough? Not entirely. According to Token Terminal data, Bitcoin miners have earned about $109 million in 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, the block subsidy received by miners has been reduced by 50%. After the latest halving, the block reward (subsidy) has been reduced from 6.5 BTC per block to 3.125 BTC. This has reduced the monthly subsidy for miners by 13,500 BTC (3.12514430). At $66,000 per token, that’s about $891 million, so 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? The user experience on Bitcoin is far inferior to Solana or an Ethereum L2 like Arbitrum. Exchanges on Solana take only seconds and the fees are just a few cents. However, if you want to trade Runes on Bitcoin, you need to pay a few dollars in fees and wait for a block to confirm the transaction.

In addition, when you buy Runes, you have to buy the full amount listed. Buyers cannot modify the amount of Runes they want to buy. Another drawback 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 BTC and then buy the other Rune they want. The extra step in the middle adds unnecessary friction in the user experience.

The user experience of trading Runes is far from ideal. There is no way to use BTC as collateral or to make loans. You have to take BTC out of Bitcoin L1 and put it on other chains to use in financial applications.

Increasing Financialization of BTC

First, Bitcoin’s market cap is approaching $1.3 trillion, at $66,000 per BTC. Just like gold, Bitcoin is an external currency, meaning governments cannot manipulate the supply of Bitcoin. While the exact size of the gold loan market is not available, some reports estimate it at $100 billion. Therefore, one of the most important reasons to build applications on Bitcoin is to use native BTC as collateral to borrow stablecoins. Strong lending markets will allow Bitcoin holders to earn yield on their BTC

Take staking as an example, other native assets like 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 yield 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 circulating BTC. This shows the huge potential of BTC financialization.

Assuming that BTC's usage level in staking or DeFi is similar to Ethereum, reaching about 30%, this amount will reach $390 billion. For comparison, the total locked value of all other chains in all DeFi is currently $101 billion. BTC has the potential to become the most productive liquid asset, but this potential is currently constrained by intentional technical limitations.

Scaling BTC Payments

The Bitcoin base layer is not designed for high throughput. If Bitcoin is to become the settlement layer of the internet, we need faster transaction speeds. As Mohamed Fauda said, there is a limit to the number of transactions that can be issued in this way. At a maximum block size of 4MB, Bitcoin can support 6.66 kbps (4 MB / 10 minutes) of data.

The Bitcoin network is currently unable to handle high traffic. Users experience poor experiences during anticipated events such as the minting of Quantum Cats and the release of runes. The poor user experience affects not only those trying to mint inscriptions, but also those sending and receiving BTC.

The Lightning Network (LN), as the leading BTC scaling network, has poor adoption. The network capacity or liquidity is around 5000 BTC. This is the amount of BTC locked in all Lightning channels. This affects the liquidity of the network and the amount of BTC that can move through it.

Why is this important? Let’s understand with an example. Joel is raising $1 million to pay coffee plantation workers in India and he decides to use LN to accept donations. He can’t just spin up an LN wallet and accept donations. He needs to have $1 million in inbound liquidity. Inbound liquidity is the amount of BTC locked in the channel by your counterparties. Sid is one of Joel’s counterparties who has $10,000 locked. Joel needs more counterparties like Sid who have a total of $1 million locked in order to accept $1 million worth of donations. This is a major challenge for network scaling because inbound liquidity will always be limited by the opportunity cost of capital.

Challenges of Bitcoin Development

Bitcoin is as much a cultural phenomenon as a technical one. Social consensus is the last line of defense. For example, the 21 million supply hard cap can be modified by forking the code to increase the tail emission by 1%. But for this change to take effect, all miners must mine on this fork, which is unlikely to happen. This is because the hard-coded cap has been one of the main value drivers of BTC. If this cap is broken, the value may be perceived to fall. Miners are unlikely to mine on a fork that may lose value.

The technical effort required to change the codebase will be rendered useless due to the lack of social consensus. The last contentious fork of Bitcoin was during the Block Wars in 2017. The network split into two, Bitcoin implemented SegWit (explained later) and Bitcoin Cash, which increased the block size. At the time, most of the computing power chose to stay on BTC.

For something to be considered money or a store of value, it can’t change often The main reason fiat currencies lose purchasing power over time is that central banks often use their power to increase supply. The unpredictability of this unilateral action by central banks makes some currencies permanently weaker. Bitcoin culture is resistant to change. Even something as non-controversial as Taproot took years from conception to implementation.

Implementing the above changes is more than just changing Bitcoin. The Bitcoin base layer needs to be as simple as possible. Simplicity is essential to reduce attack vectors and increase 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 does.

L2 for Bitcoin?

What is L2? It should:

· Provide sufficient data for Layer 1 to verify and resolve disputes (if any).

· Should not have additional security assumptions beyond the base layer.

· Allow users to unilaterally withdraw their assets to the base layer or Layer 1.

Since Bitcoin’s opcodes currently limit its ability to verify any proof, these conditions cannot be met. Therefore, any chain claiming to be Bitcoin L2 cannot be called a true 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, etc.

The second layer or L2 should not extend the security assumptions of the base layer it is built on. For example, if the second layer has a centralized sorter that monopolizes block production, users need to be able to challenge block production at low cost. The first layer should be able to instruct the L2 to release user funds as long as the user's funds have not been spent. Currently, these mechanisms do not even exist in Ethereum's L2.

If we strictly follow the above L2 characteristics, even some consensus Ethereum L2s, such as Arbitrum, are not true L2s. Since Bitcoin's current opcodes limit its ability to verify any proof, any chain claiming to be Bitcoin L2 cannot be called a true L2. Lightning Network is probably the only solution that meets the definition of L2. As a general term, this article refers to these solutions as Bitcoin extension layers.

The Current State of Bitcoin Extension Layers

In general, there are two main paths to using BTC: 1) using cross-chain bridges, as Bitcoin itself has limited applications, and 2) creating an environment or chain where investors can reside with applications that use BTC.

In order to enable more use cases and expansion, new layers may make additional security assumptions on top of Bitcoin. Users who wish to use their BTC will tend to accept the least security compromises. Ethereum's expansion roadmap is a good reference for understanding how the Ethereum expansion design space has evolved.

After several years of development, Ethereum has recognized that rollups are a key way for it to scale. Currently, we still don’t know which method is the best way to scale and make BTC more programmable.

Whether storing data or choosing a cross-chain bridge design, projects make trade-offs between decentralization, security, speed, and user experience. The answers to the following questions constitute 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 to store data (data availability)?

· How to use Bitcoin’s first layer for settlement?

· Are any changes to Bitcoin’s base layer expected to achieve its full vision?

· Which execution environment to choose?

· Does the extended Bitcoin layer facilitate BTC for uses such as gas and staking?

Teams are making different types of trade-offs to provide better functionality and expansion for BTC holders.

Bridge Mechanism

BTC on Bitcoin cannot be directly transferred to other chains, so an infrastructure is needed to enable such cross-chain transfers. A typical bridge mechanism is to lock the user's BTC on the Bitcoin network and mint an equal amount of synthetic tokens on the target chain to represent these BTC.

What is a typical locking mechanism? When a user wants to transfer their BTC from the Bitcoin network to other chains, they send BTC to a specific address on Bitcoin. This address is controlled by the bridge operator. When the bridge operator detects the arrival of BTC, they mint an equal amount of synthetic tokens on the target chain and send them to the address specified by the user.

The risk of this mechanism is that if the bridge operator loses BTC on the Bitcoin network, the tokens minted on the target chain will become worthless. We witnessed this risk after the collapse of FTX. SolBTC, a wrapped version of BTC operated by FTX/Alameda, became worthless as 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 bridge operator manages and protects the user's BTC on the Bitcoin network. Different bridge mechanisms can be divided into three types based on how BTC is managed.

Trustless Bridging

This bridging mechanism is only possible if the first layer (L1) can verify the proof submitted by the second layer (L2). This mechanism is not currently feasible for Bitcoin because Bitcoin cannot understand anything that happens outside of it.

Trust-Minimized Bridging Relying on Economic Security

Another option for BTC bridging is for multiple public parties to handle the locking and unlocking of BTC. These public parties secure the user's BTC on the Bitcoin network and mint and destroy synthetic BTC tokens on other chains. Threshold Network's tBTC is an example of such a mechanism that relies on an honest majority.

This means that the majority of operators running Threshold Network nodes need to agree before the operator can perform any action on the user's BTC. Instead of relying on centralized intermediaries, tBTC randomly selects a group of operators who run Threshold Network nodes to protect the BTC 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, at least 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. Beta stakers can delegate their stake 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. For example, they need to be highly responsive to network upgrades, ideally upgrading their nodes 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 dedicated to the user and is controlled by a node on the Threshold Network. Users can request to mint tBTC on networks such as Ethereum, Arbitrum, Optimism, Mezo, and Solana.

Users need to provide two addresses - a recovery address on Bitcoin (to which BTC will be returned if there is a problem during the minting process) and an address on the target chain (where the user hopes to receive tBTC). Once the request is made, the user must deposit BTC into the generated address and wait for the guardian to confirm their deposit. Once confirmed, the minter will send tBTC to the user's address on the target chain.

Currently, Threshold Network has approximately 3,500 BTC locked, valued at over $200 million.

Given the capabilities of Bitcoin opcodes, trust-minimized bridges are currently arguably the best bridge implementation. The specific implementation of trust-minimized bridges may vary depending on the design of the multisig. Threshold Network's tBTC, Stack's upcoming sBTC implementation, and Botanix's spiderchain are all examples of trust-minimized bridges.

Custody Bridges

In this design, a centralized provider locks a user's BTC in an address managed by a custodian. BitGo's WBTC is the most widely used method for bridging BTC to other chains, with over 150,000 BTC already bridged 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.

The core idea of BitVM is to optimistically verify zero-knowledge proofs (ZK proofs) on Bitcoin. As long as there is no objection to the transaction execution, it is assumed to be correct. This system usually assumes that there is at least one honest verifier. If the execution is incorrect, at least one honest verifier should raise a question.

So, as long as the zero-knowledge proof is not challenged, everything works fine. If there is any objection, the challenger and prover will enter a challenge-response or binary game on-chain. The specific definition of the binary game is beyond the scope of this article, but a link is provided for interested readers. The result of the binary game is an increase in the transaction load on the chain.

Liquidity management was another significant flaw in early versions of BitVM. When a user withdraws funds from the bridge, the system completes a portion of the withdrawal and the bridge operator must provide liquidity in advance. The operator is later compensated from the bridge. As the amount locked in the bridge increases, the operator must maintain more liquidity to honor withdrawals. This puts pressure on the operator and makes the design highly capital inefficient.

Assume that on average the operator needs to keep 10% of the bridge’s total locked value (TVL) in liquidity at all times. If the bridge TVL is $10 billion, the operator needs to keep $1 billion in liquidity at all times. As the bridge attracts more liquidity, the operator needs to keep more BTC in inventory. Tyler White and Rijndael wrote an excellent article that explains the BitVM problem in detail.

Execution Layer

To increase the utility of BTC, designing a chain that provides the best user experience (UX) is key. Developers need to consider multiple factors when designing this chain.

· Execution Environment - Should an Ethereum Virtual Machine (EVM) compatible chain be used? EVM compatibility has many advantages, such as:

· Developers can use the tools that have been accumulated over the years, such as wallets and bridges to other EVM chains.

· Users are already very familiar with this UX.

· Ethereum’s Layer 2 (L2) networks have benefited from EVM compatibility. EVM-compatible L2s like Arbitrum and Optimism have quickly attracted users and applications already on Ethereum. L2s that are not EVM-compatible, like Starknet, face greater adoption challenges.

· However, the EVM also has its disadvantages. Since the EVM requires transactions to be executed 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, a number of 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 such as Stacks use Bitcoin as a checkpointing mechanism. Stacks has a much shorter block time than Bitcoin. Stacks publishes its inter-block data 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 compressed transactions are 10 bytes in size (usually around 20 bytes), a Bitcoin block can theoretically contain about 600 compressed transactions. However, this maximum is almost impossible to achieve, as 4 MB blocks are very rare, and it is even rarer that the entire 4 MB space is available for inscriptions.

· Block size depends on the mix of SegWit and non-SegWit transactions. SegWit (Segregated Witness) separates transaction data from witness data. The idea is that not all data stored in a block is equally important. Instead of limiting block size to the traditional 1 MB, SegWit proposes a new limit of 4 MB. 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 are building layers on top of Bitcoin to take advantage of BTC’s massive liquidity. This article looks at six different teams that are making different tradeoffs and have interesting designs. We briefly describe how they work, their stages of development, and their progress to date.

Babylon

Babylon is focused on expanding the use of BTC as a collateral asset. It proposes a new approach different from other Bitcoin layers (the so-called L2) called remote staking of BTC. Instead of locking BTC on the Bitcoin network to mint synthetic versions, this approach introduces the following mechanism:

1. Users lock their BTC in a self-custodial vault by creating a UTXO that can only be spent once. This UTXO can only be spent after the predetermined staking period ends or after the user burns the staked UTXO through their special EOTS (extractable one-time signature).

2. After confirming the staking transaction, users can use their EOTS to verify blocks on the PoS chain in the Cosmos ecosystem to earn rewards.

3. If the user behaves honestly, they can unlock their BTC at the end of the staking period or submit a transaction to unstake it to the Bitcoin network.

4. If dishonest behavior is detected, the user's EOTS will be made public. Babylon's monitor ensures that there is at least one honest operator. This suite of programs acts as a relayer for data between Bitcoin and Babylon. The submitter program submits Babylon checkpoints to the Bitcoin network using OP_RETURN. The reporter program scans Babylon checkpoints and reports them back to Babylon. If an anomaly is detected, anyone (called a slasher) can use the public EOTS key and submit a Bitcoin transaction to obtain the malicious user's stake.

5. A common question is why users can't use the key themselves to get back their stake. The answer may be that when miners see this transaction, if someone initiates the same transaction, the miner will choose the transaction with a higher fee. For example, if the stake amount is 5 BTC, the slasher can share 4.99 BTC 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, whether to the slasher or the miner.

While Babylon offers an interesting way to extend the usefulness of BTC, its mechanics are fairly complex. For example, slashing mechanisms have not yet been successfully implemented on many PoS chains, despite some having been online for years. Additionally, while Babylon can leverage remote staking to make BTC usable for securing other PoS chains, it requires a bridge to enable other BTC use cases, such as lending.

Build on Bitcoin (BOB)

Better known as BOB, Build on Bitcoin is an Optimism-based rollup set to settle on Ethereum as of June 2024. It claims to be an Ethereum L2 aligned with Bitcoin. BOB will be launched in four phases:

· Phase 1 – OP Stack Rollup. In this phase, it is purely an Ethereum rollup. Fraud proofs are not yet live on mainnet. Fraud proofs are a mechanism that allows anyone to question the validity of a transaction included in a rollup batch.

· Phase 2 – Ethereum Rollup with Bitcoin Security. In this phase, BOB will leverage 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 goes live after improving upon the current version, BOB will start using BitVM to settle on Bitcoin.

· Phase 4 – Zk Rollup on Bitcoin. BOB will use Zk proofs to settle on Bitcoin after Bitcoin accepts opcodes that allow verification of Zk proofs.

As of June 17, 2024, BOB’s TVL is approximately $60 million, with Sovryn DEX contributing approximately $20 million.

Botanix

The Botanix team has brought an important innovation: Spiderchain. What is Spiderchain? It is a coordinating node for a rolling multi-signature mechanism on Botanix. Let's explain it in detail. As we mentioned before, 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 BTC on the EVM layer. The coordinator runs the Bitcoin and Spiderchain EVM (Botanix) nodes.

Assume there are N coordinators on the network. Each Bitcoin block randomly selects M ( <n) coordinators to secure incoming btc. each epoch, new keys are generated along with a set of coordinators. during the bridging process, newest btc is selected first ensure that older and established control coins.< p>

Botanix's chain is EVM-compatible and secured by a PoS consensus mechanism. In addition to securing BTC on Bitcoin and facilitating the minting and redemption of synthetic BTC by participating in a rolling multi-signature network, coordinators participate in block construction of the EVM chain. They publish the root hash (a compact version) of the Botanix EVM transaction as an inscription on Bitcoin.

It is important to note that simply publishing data on Bitcoin does not imply settlement. The difference here is that the data published by external chains like Botanix in the form of inscriptions 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.

Botanix EVM and Spiderchain are still in the testnet stage as of June 2024.

Citrea

Citrea is building a Zk rollup on top of Bitcoin. By “on top of Bitcoin” it means that it intends to use Bitcoin as a data availability layer. Citrea says that the most secure and incentive-aligned way to scale the Bitcoin block is to shard execution with on-chain verifiability and data. Sharding execution means dividing the execution task into smaller parts.

Citrea then aggregates these shards or transaction batches and publishes the difference in state between two transaction batches on Bitcoin along with a proof called a proof of validity. But the problem at the moment is that Bitcoin does not have the ability to verify these proofs. 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 process proofs and bridge BTC in and out of Rollups. 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 testnet stage.

Mezo

Mezo claims to be an economic layer for Bitcoin, not L2 for Bitcoin. It uses Threshold Network's tBTC bridge to bring BTC in and out of the EVM chain Mezo.

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 BTC. It achieves this goal through the following three mechanisms:

1. Allow Mezo users to secure the network and earn income by staking BTC.

2. Allow users to pay gas fees with BTC, which will be distributed to veBTC and veMEZO stakers.

3. Build an end-to-end BitcoinFi experience.

So, what is BitcoinFi and the economic layer? Most new chains, including EVM 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, which users do not need to bridge from other chains.

· A long-tail lending protocol secured by BTC.

· Fully integrated on- and off-ramps through Fold.

· An integrated wallet experience through 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 a consensus mechanism.

· CometBFT is software for securely and consistently replicating applications across multiple machines. By secure, we mean that CometBFT works as long as less than one-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. Secure 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 currency to elections to infrastructure orchestration. ——Source: CometBTF Documentation

CometBFT consists of two components: a consensus engine and a common application interface. Based on Tendermint core, the consensus engine is responsible for block production, validation, and finality. Tendermint is one of the earliest proof-of-stake consensus designs, providing Byzantine Fault Tolerant (BFT) consensus that can tolerate up to one-third of malicious nodes.

The Application Blockchain Interface (ABCI) decouples the consensus engine from the application. A major advantage of ABCI is that since consensus and applications are separate, developers do not have to build applications in the same language as the consensus engine. The interface acts as a medium to pass transactions to applications for execution. This capability makes the system more modular and helps attract more application developers. Initially, Mezo will only be compatible with the EVM runtime.

Mezo's economic design is such that as it becomes more popular, BTC holders may benefit directly or indirectly. They can stake BTC on Mezo to earn staking yield, or if they choose to continue holding BTC on the Bitcoin network, they will receive some benefit from BTC being taken out of circulation (used to pay fees on Mezo).

Mezo has a dual staking model, as shown in the figure below. Validators on the network can stake BTC and MEZO (the native token of the Mezo network). By staking BTC and MEZO, validators earn 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 assets are locked, the more ve tokens are issued. veBTC stakers earn BTC, and veMEZO stakers earn MEZO rewards. Part of the MEZO rewards can be burned to increase the BTC inventory.

Yield is one of the core features of Mezo, as the fees paid by users are distributed to validators who stake BTC. Mezo plans to further expand the application scope of BTC staking through the liquidity staking provided by its sister project Acre. When users deposit BTC into Acre, they will receive a liquid staking token stBTC in return. The deposited BTC 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 BTC at a 1:1 ratio.

Source — Acre Blog

Despite a market cap of over a trillion dollars, BTC barely plays a 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 the supply of WBTC, 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 after the Luna, 3AC, and Alameda incidents.

In the first phase of its rollout, Mezo has begun accepting BTC deposits with three lockup periods: two months, six months, and nine months. Deposits earn points in the form of HODL points. One BTC generates 1,000 points per day, and the longer the lockup period, the higher the multiplier. Users can also deposit other assets such as USDe, USDC, and USDT to increase the yield on BTC deposits. As of July 2024, Mezo's TVL (total locked volume) is $135 million.

In addition to rewarding holders, Mezo will also share part of the fees with the Bitcoin Core protocol.

Stacks

Stacks, formerly known as Blockstack, recently launched its much-anticipated Nakamoto upgrade, which aims to address issues such as forks and slow transactions before the upgrade. Stacks uses the Proof of Transfer (PoX) consensus mechanism.

Therefore, Bitcoin miners interested in generating blocks on Stacks need to send some BTC. Let's assume that miner Alice is randomly selected to generate a block on Stacks. This miner's BTC will be distributed to those who stake (lock/stake) STX, the native token of the Stacks chain. This is interesting because although the reward is smaller, it is provided in the form of BTC. On most chains, the reward is only provided in the chain's native token.

Once selected, Alice can keep generating Stacks blocks until the next Bitcoin block is mined. As she generates Stacks blocks, they are sent to signers for verification. When more than 70% of signers accept the Stacks blocks, they are accepted by the Stacks network. Let’s say Alice generates 10 Stacks blocks before the next Bitcoin block is mined, and Bob wins the chance to generate the next Stacks block.

Bob adds the hash of Alice’s first block generated on Stacks to the block submission transaction he submits to the Bitcoin chain. Stackers detect this transaction and create a term change transaction on Stacks that includes the hash of the last block Alice generated, which is block 10. This way, Bob knows he needs to build on Alice’s block 10.

Although the development of Bitcoin Layer is still in its early stages, below is a comparison of the above chains. It takes into account chain design, bridge design, and the dollar value secured.

We must also mention that in addition to the above teams, there are many other teams such as Alpen, Bison, BitLayer, Rootstock, SatoshiVM, and Soveryn that are also building extension layers for Bitcoin. Readers can find a full list here.

Relationship between L2 and L1

L2 helps L1 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 in the case of L2 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, Ethereum supported 7.1 million transactions 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 - supported 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 or trading value, etc. However, the fact is that Ethereum itself cannot support that many transactions.

One downside to this, however, is that L1s are no longer directly connected to their users. In traditional commerce, it is usually the businesses closer to the end user that capture the majority of the value. Amazon is a great example of this. Its massive distribution network gives it an advantage over suppliers and manufacturers.

Dollar Shave Club disrupted the razor industry by selling razors directly to consumers through a subscription model, eliminating the traditional retail channel. This allows them to sell their products at a lower price and retain most of the value rather than sharing it with the entire supply chain.

It is generally a bad idea to add another layer between you and your customers. So, why are L1s going this route? By bringing L2s into the mix, L1s are not losing customers. They are bringing a B2B model to what was previously a strictly B2C business model. But the question remains – are L2s capturing the majority of the value? Are they passing enough fees to L1?

Fortunately, Ethereum has already traveled this path over the past three years, and we can observe the impact of L2 on Ethereum’s value capture. There are two ways to understand whether L2 is predatory to Ethereum.

1. The first is to see if Ethereum loses revenue to L2. We can examine this by examining the change in Ethereum’s share of Ethereum’s ecosystem revenue. The following chart shows the revenue of Ethereum and the five leading L2s. Ethereum consistently captures more than 90% of the revenue stream.

2. Another way is to look at market cap or price. Because value capture is almost always reflected in price, ETH accounts for more than 95% of the total market cap of the Ethereum ecosystem, given the market cap of its top 10 L2s.

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 is settled on L1, healthy competition between L2 for L1 block space is good for the health of the base layer.

What's next?

Imagine the island metaphor again. For a true L2 to work, the two islands must work together to build a bridge. But this is impossible without internal consensus among the residents of Bitcoin Island. As it stands, projects that want to be Bitcoin Island L2 are working hard to build infrastructure as a temporary solution.

So once Bitcoin Islanders agree that bridging to other islands is needed to facilitate growth, L2 islands are ready. Until then, it is important not to try to find more complex ways to bridge and create L2s, but to focus on using infrastructure that has already been proven to work and has been battle-tested.

How different projects are modernizing Bitcoin Island and preparing bridge infrastructure to connect other islands

Bitcoin Islanders are known to be opinionated and take the security of their islands very seriously. Any changes to the islands are thoroughly discussed. Anyone who wants to propose a change to Bitcoin can draft a Bitcoin Improvement Proposal (BIP). After informal discussions on various forums, the author will incorporate feedback and make changes to the BIP. The BIP will then be numbered by a committee of islanders to make it official.

Some islanders understand the importance of being cautious about modernizing Bitcoin Island. Teams like Botanix, Taproot Wizards, and Thesis are laying the groundwork for adding opcodes to expand Bitcoin’s programmability. BIP-420, also known as OP_CAT, proposed by Ethan Heilman and Armin Sabouri, will open up a ton of exciting possibilities for Bitcoin. CAT stands for concatenate. It was part of the original Bitcoin opcodes but was removed by Satoshi Nakamoto due to security issues that have been mitigated as the Bitcoin execution environment has evolved.

This opcode allows two pieces of data to be concatenated together. It unlocks a multitude of possibilities from custom transaction types like dynamic escrow systems, smart contracts like atomic swaps, to different DeFi applications, and greater interoperability with external chains.

Teams like Starkware have suggested that OP_CAT could bring STARK verification to Bitcoin. This means that Bitcoin could verify Zk proofs, enabling rollups. This design paradigm not only allows for general purpose design on Bitcoin, but also improves its much-needed scalability.

Other designs from the Taproot Wizards team, such as CATVM, are already in progress. This design will use OP_CAT to create a trustless bridge. Unlike the current BitVM design, CATVM has no liquidity requirements. CATVM will enable decentralized trading of ordinals and runes, and its user experience is as good as other chains.

Segregated Witness paved the way for Taproot, which in turn is essential to Ordinals. Ordinals and inscriptions make BRC-20 and Runes possible. Recent enthusiasm from Bitcoin developers shows that they are increasingly supporting social consensus to implement BIP-420. It is also backwards compatible, so the network does not need a hard fork to activate it. We look forward to it going live and witnessing a new era of true Bitcoin native programmability.

It has been a long time since Bitcoin developers have seen a clear increase in interest. All the independent projects built around Bitcoin are like small modern islands surrounding the mighty Bitcoin island. With the introduction of BIP-420, there may be a way to merge these islands together to form one thriving and modern island.

With all the changes in Bitcoin, I hope that in the future we will be able to use BTC in different financial applications without having to understand the various layers underneath. The integration of the Bitcoin layer will be as natural as walking through Mumbai today, with no idea that this busy metropolis was once seven separate islands of Mumbai.

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