This year, the Bitcoin network’s Ordinals protocol and BRC20 have become hugely popular, injecting new vitality into the Bitcoin ecosystem. In May, Beosin and SUSS NiFT jointly researched and published an article titled “In-Depth Report | The New Era of Bitcoin: Opportunities and Risks of BRC-20”, which detailed the origins, development, value, and risks of the Ordinals protocol and BRC20.

Starting from October, with the push of Bitcoin ETF news, while the value of Bitcoin has been returning to its glory, the ecosystem of its various derivative protocols has also been rapidly developing: UniSat launched BRC20-swap, Atomicals protocol and ARC20 went live, Taproot Assets integrated with the Lightning Network released its v0.3 alpha version, and Tether, the issuer of USDT, plans to issue USDT on the RGB protocol… In this article, Beosin will introduce common Bitcoin derivative protocols, helping to understand their potential value and hidden risks.

1. The Resurgence of Ordinals and BRC20

The Ordinals protocol, launched by Bitcoin core contributor Casey Rodarmor, allows for the creation of Bitcoin NFTs by assigning different “attributes” to each Satoshi. Similarly, by defining a uniform “format” and “attributes”, the protocol can create fungible Bitcoin tokens. Inspired by the Ordinals protocol, Twitter user @domodata created the BRC20 token standard on March 8, 2023, utilizing JSON data ordinal inscriptions for deploying token contracts, minting, and transferring tokens.

After nearly a year of explosive growth, silence, and resurgence, top exchanges have now announced support for the BRC20 protocol. Many BRC20 tokens have broken new price records, with Ordi’s market cap exceeding $400 million and a daily trading volume of $800 million. UniSat’s Brc20-swap provides enhanced liquidity for top BRC20 tokens through decentralized trading.

While trading is booming, the following are unavoidable security risks of the BRC20 protocol:

(1) Fake Deposit/Double Spend Attacks

On the evening of April 23, a BTC address starting with bc1pw conducted a double-spend attack on UniSat’s BRC20 Marketplace. It minted Ordinals NFTs to transfer 5,000 and 35,000 Ordi tokens to its address and attempted to sell these artificially minted Ordi inscriptions in the market. Subsequently, UniSat suspended its BRC20 inscription service and launched an investigation. Beosin immediately used Beosin KYT to analyze and track the address. Later, UniSat reindexed and restored 70 affected transactions, preventing potential losses of millions of dollars.

source: Beosin KYTUniSat subsequently retrieved the inscriptions and restored 70 affected transactions, avoiding millions of dollars in potential losses.

(2) Centralization Risks

The BRC20 protocol uses inscriptions as a ledger to record the deployment, minting, and transfer of BRC20 tokens. Since smart contracts cannot run on Bitcoin, BRC20 tokens cannot query their current information through a program. Instead, BRC20 relies on centralized servers to retrieve Bitcoin blocks and record all BRC20 token activities. This centralized settlement process can lead to different platforms showing different token balances for the same account. Even though all operations are recorded on the blockchain, their verification is managed by a specific client. The entire BRC20 ecosystem needs to achieve a decentralized indexing service.

2. Atomics and ARC20

The Atomicals protocol uses Bitcoin’s smallest unit, the satoshi, represented by UTXOs (Unspent Transaction Outputs), to signify tokens. UTXOs, the basic unit of Bitcoin transactions, are utilized in verifying Atomicals transactions by simply querying the corresponding satoshi’s UTXO on the Bitcoin network. Consequently, ARC20 token transactions are entirely processed by the Bitcoin network, significantly minimizing issues associated with centralized retrieval services.

Currently, there are only 11 types of ARC20 tokens, with a total transaction volume considerably lower than BRC20. The leading token, ATOM, has a market value of around 31 million USD. Its derivative ecosystems, such as Realm (domains) and Collection (NFTs), are still in their early stages. Atommap, one of the more popular aspects, requires users to mint NFTs through proof of work, presenting a high entry barrier.

Atomicals protocol transaction market: https://atomicalmarket.com/

Given that the Atomicals protocol is in its early stages, there have been instances of users being scammed in off-exchange OTC transactions. Beosin KYT has marked the fraudulent addresses and is continuously tracking their fund movements.

source: Beosin KYT

Apart from being wary of OTC scams, users should also be cautious of the following risks associated with the Atomicals protocol:

Unaudited Atomicals Wallet: The Atomicals wallet plugin, developed based on the UniSat wallet, is open-source but has not completed a security audit. Previously removed from the Google Store, it has now been re-listed.
Liquidity Risk: According to data from Atomical Market, approximately 5,000 users are holding ARC20 tokens. Many ARC20 tokens suffer from poor liquidity, with almost no trading activity. Due to liquidity issues, the price of the leading ARC20 token, ATOM, is exceptionally volatile. Therefore, users should control their FOMO (Fear of Missing Out) and be cautious of insufficient liquidity.

3. Integration of Taproot Assets with the Lightning Network

Taproot Assets is a protocol released by the Lightning Network development team, Lightning Labs. It achieves asset recording by writing various information into the UTXO script of the Bitcoin network. As such, Taproot Assets can be used for issuing tokens, NFTs, and other types of assets.

Currently, NostrAssets has issued two tokens, Trick and Treat, based on the Taproot Assets protocol, and is about to launch the Fairmint feature, allowing users to issue tokens themselves.

NostrAssets Trading Market: https://mainnet.nostrassets.com/#/marketplace/listing

It’s important to note that assets issued with Taproot Assets must be deposited into the Lightning Network before they can be traded. Therefore, users must either run a full Bitcoin node and a Taproot Assets client themselves or use a third-party service. The transaction records of the tokens also rely on third-party indexers for storage, which poses a potential risk of centralization.

The Slow Progress of the RGB Protocol

The RGB protocol, which was introduced in the Lightning Network, adds smart contract functionality to Bitcoin, based on a zero-knowledge proof state channel protocol, allowing users to conduct privacy-protected transactions off-chain. Since its proposal in 2016, the RGB protocol has progressed very slowly due to its design complexity, with the RGB v0.10 version officially launching in April 2023.

All data of the RGB smart contracts are entirely stored off-chain, operated by RGB nodes. The RGB protocol uses UTXO to store state transition proofs to track and verify the status of smart contracts. Users/validators can confirm the correctness of smart contract states by scanning the UTXOs on the Bitcoin network.

The RGB protocol is still under continuous updates and has not yet formed an ecosystem. In the future, the main use of the RGB protocol will still be for the issuance and trading of assets, with Tether Ltd. actively pushing to issue USDT using the RGB protocol.

4. Slow progress on RGB protocols

The RGB protocol adds smart contract functionality to Bitcoin on the Lightning Network, a state channel protocol based on zero-knowledge proof, allowing users to conduct privacy-protected transactions off-chain. From the RGB protocol being proposed in 2016 to the official launch of the RGB v0.10 version in April 2023, the RGB protocol has progressed very slowly due to its design complexity.

All data for RGB smart contracts is stored entirely off-chain and is run by RGB nodes. The RGB protocol uses UTXO to store state transition proofs to track and verify the status of smart contracts. Users/verifiers can confirm whether the status of smart contracts is correct by scanning UTXO on the Bitcoin network.

At present, the RGB protocol is still being continuously updated and has not yet formed an ecosystem. In the future, the RGB protocol will mainly be used for the issuance and trading of assets, and TEDA is actively promoting the use of the RGB protocol to issue USDT.

5. Introduction of Smart Contracts in BTC Layer2

Due to the limitation of Bitcoin’s inherent lack of support for smart contracts, the development of more complex ecosystems within the Bitcoin sphere has been restricted. Consequently, numerous Bitcoin sidechains and Layer2 solutions have begun to emerge. Currently, the most market-focused Bitcoin Layer2 is Stacks, which executes smart contracts on the Stacks network and settles transactions on the Bitcoin network, inheriting the security of the Bitcoin network. For a detailed analysis, refer to Beosin’s publication in June titled “What are Stacks? What challenges may BTC layer 2 network Stacks face?

Presently, Stacks has released a developer version of sBTC, allowing developers to test applications and their integration with sBTC in a local environment. In the Stacks ecosystem, the DeFi project Hermetica has integrated sBTC for testing. In the future, the BTC DeFi ecosystem could become a hot topic. Beosin KYT is about to support the Stacks network, providing address analysis and tracking services for it.

While Stacks is steadily developing, it may face the following risks:

Stacks Protocol Vulnerability: On April 19th, a vulnerability in the stacks-increase function of the Stacks consensus contract allowed certain addresses to receive more STX token rewards than theoretically calculated. Additionally, Stacks uses the relatively immature smart contract development language Clarity, and there has been ongoing discussion within its developer community about improving Clarity.
sBTC Risk: sBTC in the Stacks network manages BTC locked on the Bitcoin network using threshold signature wallets. In the Stacks network, sBTC is minted on a 1:1 basis through smart contracts, thereby achieving decentralized BTC custody and anchoring. It’s threshold signatures and smart contracts require rigorous auditing to prevent the exploitation of potential malicious vulnerabilities.

Conclusion

Protocols such as BRC20, ARC20, Taproot Assets, and RGB can serve as asset issuance protocols. BTC Layer2 networks and sidechains like Stacks have resolved the issue of Bitcoin’s inability to run smart contracts. The BTC ecosystem is currently at a very early stage. Users should pay attention to this field but also be aware of the aforementioned risks to avoid asset losses.

Disclaimer：

This article is reprinted from [ Beosin]. All copyrights belong to the original author [Beosin]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
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