The Bitcoin Renaissance: Unlocking Trillions In Value

A dominant theme that has been gaining steam this crypto bull cycle is the emergence of Bitcoin layer-two networks (“Bitcoin L2s”). Bitcoin is commonly known as the largest, most decentralized and most secure crypto asset with a global holder base of over 100 million people and market cap of $1.2 trillion.

However, as a technology platform, it suffers from limitations such as slow transaction speed (~10-30 minute block confirmation times), low scalability (can only process about 7 transactions per second) and limited programmability (its scripting language and smart contract functionality are limited).

Historically, the most successful technology networks were built and scaled in layers, which is especially true for the development of the internet. The internet’s layered approach is called the Open Systems Interconnection model and consists of seven layers: physical, data link, network, transport, session, presentation, application layers. Every time an end user accesses her email or posts a comment on X, all of these technologies function and interplay in the background, unbeknownst to the user.

Similarly, to address Bitcoin’s limitations, while still inheriting its invaluable properties of network security and decentralization, the Bitcoin ecosystem has seen a rush of development to launch Bitcoin L2 networks. These projects have ushered a renaissance of development and programmability, bringing DeFi, NFTs, gaming and other use cases proliferating on competing blockchain ecosystems to Bitcoin.

This layered approach is in stark contrast to integrated blockchains that aim to provide all of the core functions of a blockchain (consensus, data availability, execution) on the base layer. Blockchains such as Solana, Near and Algorand aim to scale and deliver high performance computation without the need to offload data availability or execution to other networks, different from the “modular” approach taken by Bitcoin and Ethereum.

Total-value locked (TVL) serves as the main metric tracking the growth of DeFi for particular ecosystems. It represents capital that is deployed in various ways, such as lending assets to earn yield, providing liquidity in a pool, serving as collateral to access on-chain credit, etc. The development of Bitcoin layers enabled DeFi use cases to flourish on Bitcoin, although their growth is limited compared to more mature ecosystems such as Ethereum.

Current total DeFi TVL across the leading Bitcoin layers is ~$1.5 billion. This may seem like a large figure, but it is only 2% of Ethereum’s TVL which currently stands at $81.3 billion. Furthermore, if you look at the ratio of TVL to network market cap, Bitcoin’s is a paltry 0.13% compared to Ethereum’s 27%.

Given the amount of latent value stored in Bitcoin which is in excess of $1 trillion, there is an enormous market opportunity for the leading Bitcoin layers to unlock this value for various financial use cases. Assuming Bitcoin DeFi grows to the percentage on par with Ethereum, this represents $300 billion in deployable capital, at current market prices.

Meta-Protocols Versus Layer-Two Solutions

Ordinals and Runes are meta-protocols that emerged on Bitcoin and launched in January 2023 and April 2024 respectively. The Ordinals protocol, in particular, catalyzed greater interest in Bitcoin development and is often attributed to have kicked off “Bitcoin Season 2”.

Meta-protocols such as Ordinals and Runes operate directly on Bitcoin’s base layer without changing the core protocol. They embed additional functionality within Bitcoin transactions and are suitable for applications that can be built directly with Bitcoin’s existing scripting framework (i.e. NFTs and memecoins inscribed on individual satoshis).

Alternatively, Bitcoin L2 solutions operate on separate blockchains that are anchored to Bitcoin. They often use Bitcoin’s security for finality but provide more complex capabilities through their own consensus mechanisms. L2 solutions enable smart contracts, dApps and cross-chain interactions, often with their own tokens (i.e. DeFi, gaming, social media and other apps requiring more complex logic).

Both the meta-protocol and L2 solution approaches aim to enhance Bitcoin’s utility by enabling new use cases and applications, which will drive up demand for Bitcoin block space. This increased demand will in turn increase transaction fees on the Bitcoin base layer, playing an important part to sustain Bitcoin’s security model, especially as the block subsidy declines every four years due to the Halving.

Periodically, Ordinals have caused transaction fees to spike over the past two years, but Ordinals have not shown to be a sustainable source of fee revenue for Bitcoin miners quite yet. Since the most recent spike around the time of the Halving in April, Ordinals inscription average daily transaction fees have declined 98.8% from ~$2 million to ~$25,000 today. Other Bitcoin L2 initiatives will need to take hold to keep transaction fees healthy over time.

Low-value transactions such as those for micropayments, gaming, or DeFi require low transaction fees. Only L2 solutions can keep transaction fees low enough to make these economic activities viable, while still driving more revenue to miners. Meta-protocols bloat the Bitcoin state, driving up transaction fees on the base layer and pricing out these types of transactions.

Notably, meta-protocols are not new to Bitcoin, and several have launched throughout the network’s history. Omni Layer (formerly Mastercoin) launched in 2013 and enabled the issuance of new tokens and stablecoins such as Tether. Counterparty launched in 2014, and similarly enabled the issuance of new tokens and decentralized applications. Rootstock launched in 2018 and is a smart contract platform that is merge-mined with Bitcoin.

The Next Era of Bitcoin L2s

In recent months, we have seen dozens of new projects jump on the new “Bitcoin Season 2” narrative and claim to integrate Bitcoin in some way, A few recent examples include Build on Bitcoin (BOB), Bitlayer, CoreDAO, Babylon, Botanix, Merlin, BEVM, Citrea and many others. These newer entrants join existing stalwarts of the space such as Stacks, Lightning Network and Rootstock.

The holy grail for these projects is to enable open and permissionless applications to leverage the value of holders’ Bitcoin, in a trust-minimized way. For example, imagine being able to lend out your Bitcoin to earn Bitcoin-native yield, borrow against your Bitcoin to access credit or mint stablecoins backed by the value of your Bitcoin, without needing to worry about bridge risk or the L2 losing your Bitcoin.

What makes a Bitcoin layer a “true L2” is the ability for users to access these applications while also being able to unilaterally exit. This means a user can bridge her Bitcoin from the Bitcoin L2 back to the Bitcoin base layer without requiring any permissions. A true Bitcoin L2 also fully inherits Bitcoin’s security, benefitting from the hashpower generated by miners on the network.

The only two protocols that enable unilateral exit are the Lightning network and statechains. Other protocols, like sidechains and rollups, currently have bridging limitations that do not see them fit within this criteria. However, proposed bridging protocols are an improvement over the status quo, and are creating a path towards more flexible L2 designs.

Bitcoin L2 projects follow different frameworks with varying trust assumptions, structured mainly as sidechains, state channels, ZK rollups, or optimistic rollups (BitVM). Here is an overview of each framework and their trust assumptions and limitations:

Sidechains: independent blockchains, often with their own token, consensus mechanism and validator set, that are connected to a main blockchain and allow for assets to be transferred between the two while enabling additional functionality and scalability

Trust Assumptions: rely on centrally managed peg between the BTC base layer and Layer 2 solution through a multisignature contract controlled by the core team, with state and transaction finality verified by the sidechain rather than the BTC base layer

State Channels: off-chain transaction methods that allow participants to conduct multiple operations privately and instantly, only broadcasting the final state to the main blockchain, thus enhancing scalability and reducing fees while requiring trust in the cooperation of participants and vigilance against fraud. Typically do not have their own token or consensus mechanism

Trust Assumptions: assume that participants will act cooperatively off-chain, continuously monitor the blockchain to prevent fraud, rely on sufficient liquidity and honest node operators, and trust in effective dispute resolution mechanisms for channel closure

ZK Rollups: scaling solution that batches multiple transactions off-chain and generates a succinct cryptographic proof, which is then verified on-chain to ensure correctness and security while significantly reducing the data and computational load on the main blockchain

Trust Assumptions: involves centralized sequencers due to the inability to perform zk verification on Bitcoin, relying on the decentralized verifier network to accurately verify transactions checked by provers, and rollups are limited in transaction processing capacity because of the need to post data back to Bitcoin

BitVM: similar to Optimistic Rollups on Ethereum, BitVM is a conceptual framework that enhances Bitcoin’s smart contract capabilities by deconstructing contracts into logic gates and using fraud proofs for trustless execution. As a new conceptual framework, BitVM has yet to have any blockchains adopt it in production, with the first solutions expected to go live by early 2025

Trust Assumptions: assumes that its trustless bridge mechanism, which uses logic gates for fraud provers to detect inaccuracies, will work effectively, but it faces an economic challenge as operators must match the amount of liquidity being bridged with equivalent collateral, making scalability difficult

Catalysts on the Horizon

Let’s explore a few of the leading Bitcoin L2s and some of their upcoming developments.

Stacks is a leading Bitcoin L2 that first launched its mainnet in January 2021 and enabled the creation of smart contracts anchored to Bitcoin. Stacks supports a growing ecosystem of dApps, DeFi platforms, NFTs and other blockchain-based applications, all secured by Bitcoin’s underlying network.

The Stacks DeFi ecosystem has been steadily growing and includes core primitives such as liquid staking protocols (Stacking DAO), lending markets (Zest Protocol), decentralized exchanges (Bitflow, Velar) and crypto-backed stablecoins (Arkadiko, Hermetica, BSD).

Unique to Stacks is its Proof of Transfer (PoX) consensus mechanism. Stacks miners spend Bitcoin to compete for the right to mine new Stacks blocks and earn STX rewards. STX holders can also participate by locking up their STX tokens and earning BTC rewards. Historically, the reward has been ~8% APY for holders stacking their STX tokens and participating in consensus.

Stacks will soon be undergoing a major upgrade called the Nakamoto upgrade that will provide numerous enhancements to the protocol. Slated for August 28, the upgrade aims to bring true Bitcoin finality to Stacks transactions. This means that once a Stacks transaction is confirmed and anchored to the Bitcoin blockchain, it achieves the same level of security and immutability as a Bitcoin transaction.

The upgrade will tighten the integration between Stacks and Bitcoin, ensuring that any reorganization of Stacks blocks would require a reorganization of Bitcoin blocks, thereby significantly increasing the security of Stacks transactions.

Additionally, the upgrade introduces sBTC, a Bitcoin-equivalent token on the Stacks network, which will be backed one-to-one with BTC. This allows users to utilize Bitcoin directly within the Stacks ecosystem, enabling more seamless integration with Bitcoin’s liquidity and enhancing the utility of BTC within smart contracts and dApps.

These features collectively make Stacks, especially post-Nakamoto upgrade, a truer Bitcoin L2 solution compared to many other projects, by leveraging Bitcoin’s security, economic model, and decentralized nature more comprehensively.

Build on Bitcoin (BOB) and Botanix are two other leading Bitcoin L2 projects that have taken a different approach than Stacks. BOB is the first hybrid L2 powered by both Bitcoin and Ethereum. BOB’s rollup ecosystem aims to use Bitcoin for security while enabling users to access all of the on and off-ramps, stablecoins, NFTs, DeFi, etc. made possible by the Ethereum Virtual Machine (EVM).

BOB has completed the first phase of its roadmap which consisted of launching an optimistic ETH rollup using the Optimism (OP) stack. Settlement happens on the Ethereum L1, and BOB tracks the state of Bitcoin via a BTC light client, enabling cross-chain swaps and contracts to execute across both Ethereum and Bitcoin.

Phase one launched on May 1st and included support for the Sovryn decentralized exchange, the LayerBank lending market and the Velodrome decentralized exchange, among others. Future phases will introduce Bitcoin proof of work security to the ETH rollup and ultimately BOB’s roadmap will culminate with its own BitVM rollup implementation.

“BOB is live on mainnet with a growing ecosystem, we work closely with teams and prioritize solving product problems versus talking about fancy tech or pumping TVL with unsustainable incentives,” said Alexei Zamyatin, Co-founder of BOB.

“We brought things that are new on Ethereum to Bitcoin, including intents (BOB Gateway, 1-click BTC deployments) and smart accounts (BOB Pay, send BTC to email or Telegram with no wallet needed). Through BOB Gateway, BOB is the easiest place to go from BTC to wrapped BTC and BTC liquid staking tokens, as well as BTC yield positions soon.”

Botanix Labs aims to build the first fully decentralized EVM-equivalent L2 on Bitcoin. Leveraging Bitcoin’s proof of work as a base layer for settlement and decentralization, Botanix will use a proof of stake consensus model, where the stakes (represented by Bitcoin) are securely stored on the Spiderchain, a distributed network of decentralized multisignature contracts safeguarded by a random subset of participants.

“Botanix fully runs on Bitcoin, meaning it is not connected to any other chain and the gas fees are in Bitcoin,” said Willem, Founder of Botanix Labs. “It differentiates itself from rollups by having decentralized sequencers on day one, comprising 15 different node operators. Rollups follow a more centralized model with a single operator. Botanix will have extremely low gas fees and censorship resistance.”

Botanix launched its testnet in November 2023 and already has had over 200,000 active addresses. Although its mainnet is not yet live, users can interact with Botanix’s testnet allowing users to connect wallets, receive funds, and bridge in and out of the Botanix network. Mainnet is expected to go live in September and a few announced launch partners include Frax, Vertex, Kiln and Supra Oracles.

Both BOB and Botanix leverage the EVM to enable the creation and execution of smart contracts. This ensures compatibility with developer tooling and infrastructure already built on Ethereum such as wallets, block explorers, data analytics tools and consumer applications. This makes it easy for developers, tooling and applications to port over to their respective ecosystems.

Conversely, Stacks developed the Clarity Virtual Machine, taking a first principles approach to growing its developer community. This has a higher learning curve for blockchain developers, but can more easily court developers already familiar with Web 2.0 friendly technologies. It remains to be seen which approach is the right one to encourage developer adoption in the long run.

The Future is Orange

The emergence of Bitcoin L2 networks marks a significant evolution in the blockchain ecosystem. These solutions aim to address Bitcoin’s inherent limitations by leveraging its robust security and decentralization while enabling a wide array of applications and enhanced functionality.

The development of Bitcoin L2s, alongside meta-protocols, represents a promising path towards unlocking the substantial latent value within Bitcoin, potentially transforming it into a more versatile and powerful financial platform.

As these projects continue to mature and integrate seamlessly with Bitcoin, they are poised to drive significant advancements in the crypto space, making Bitcoin more scalable, programmable, and capable of supporting a diverse range of use cases.