Development and Ecological Layout of BTC Layer2 Solutions

Introduction

The development history of blockchain can be summarized as a history of expansion. With the development of the ecosystem, blockchain networks continue to face some challenges, such as slow transaction speed, high transaction fees, low scalability, etc., so we have also witnessed Solutions such as Lightning Network, Segregated Witness, Raiden Network, and Rollup have been developed. The first three of them mainly occur in the Bitcoin system, bringing new possibilities to the Bitcoin ecosystem. There are also many representative projects in these expansion plans, but most of them fell into disuse due to the low efficiency of the plans and their inability to meet market demand.

As a representative of the industry’s value reserve, Bitcoin expansion has always been a focus of the industry. Its low scalability and halving every four years exert more restrictions on Bitcoin’s value and development. Compared with Ethereum’s Prosperity and development, Bitcoin expansion is imminent.

This article will discuss the development status, advantages and challenges of Bitcoin’s Layer2 technology, as well as the value brought by the development of Bitcoin’s Layer2 technology. Finally, by discussing the ecological projects and new narratives, we will deeply understand the possible future trends of Bitcoin’s Layer2 technology.

Table of contents

• Upgrades and challenges in Bitcoin’s Layer2 development history
• Why Bitcoin needs a new narrative
• The rise of Bitcoin’s Layer2 ecosystem
• The development prospects and challenges of Bitcoin’s Layer2 solutions

1. Upgrades and challenges in Bitcoin’s Layer2 development history

The Layer2 of Bitcoin first appeared after Bitcoin core developers Joseph Poon and Thaddeus Dryja proposed the Bitcoin Lightning Network solution in 2015. This technical solution aims to achieve fast, low-cost and efficient Bitcoin transactions by establishing payment channels and multi-signature technologies. Subsequently, the Bitcoin Lightning Network, officially launched at the end of 2018, gradually received widespread attention and exploration in the Bitcoin community. The launch of the Bitcoin Lightning Network marks the official birth and application of Bitcoin’s Layer2 technology, bringing new opportunities and prospects to the development and application of Bitcoin. It is regarded as the shining star of Bitcoin’s Layer2 technology.

After the Bitcoin Lightning Network, more Layer2 technologies have appeared in the Bitcoin ecosystem, such as Liquid Network, RSK, LNP/BP, etc. These technologies have different advantages and characteristics in terms of Bitcoin application scenarios and functions. For example, Liquid Network is a side chain technology based on Bitcoin that can realize fast, private and low-cost transactions of Bitcoin. RSK is a Bitcoin-based smart contract platform that can bring more applications and functions to the Bitcoin ecosystem, such as decentralized exchanges, digital identities, and electronic voting. LNP/BP is a Bitcoin-based protocol and tool set that can achieve more secure and reliable Bitcoin Layer2 applications and interactions.

1.1 Bitcoin Ecology Development Overview

The three major use cases of Ethereum in the last bull market were stablecoins, DeFi, and NFT, which directly monopolized the liquidity of the blockchain application market. However, at the end of 2021, Bitcoin launched the Taproot upgrade, indicating that the Bitcoin network will develop in the same way as Ethereum. Smart contracts open up the expansion of Bitcoin applications. The recent development of the Ordinal protocol has begun a siphon effect. Although it has been controversial, it has led to a surge in Taproot’s adoption and utilization, and the proportion of spend output associated with it has also increased sharply, which also means that more BTC transactions are packaged, bringing more benefits to miners.

Source: Glassnode

Although the current development of the Bitcoin ecosystem is in a positive state, compared to the development of Ethereum or other ecosystems, there are very few noteworthy projects on the Bitcoin chain. Defillama data shows that the TVL of Ethereum has reached about 50 billion US dollars. However, the valuation of the entire Bitcoin ecosystem is around US$2.7 billion, and the gap is still huge. However, with the continuous development of Bitcoin’s new narrative and the natural security, consensus and other advantages of the original chain, I believe that the subsequent development of the Bitcoin ecosystem will be even more exciting.

1.2 Upgrades and challenges

There is no doubt about the stability and security of the Bitcoin network. In the future, DeFi, NFT and other ecosystems based on the Bitcoin network will bring a different experience to the market than Ethereum, and this development process is inseparable from the upgrade of Bitcoin technology. .

The main technical upgrade development on Layer2 is:

• Scalability: The transaction processing capacity of the Bitcoin main chain is limited, with a restricted number of transactions processed per second. However, Layer2 technologies can provide higher transaction processing capacity by conducting transactions on Layer2 networks, thereby alleviating the burden on the Bitcoin main chain and enhancing the scalability of the entire system.
• Low cost: Bitcoin’s Layer2 technology can reduce transaction fees by processing multiple transactions in batches. For example, Lightning Network is a Layer2 payment channel network based on Bitcoin, which can realize fast and low-cost small-amount payments, avoiding the high transaction fees when conducting small-amount transactions on the Bitcoin main chain.
• Privacy protection: Transactions on the main chain are public, and the transaction amount and addresses of both parties can be traced. Layer2 technology can provide better privacy protection. By conducting transactions on the layer2 network, transaction details will not be disclosed, improvings user privacy.

But at the same time, Layer2 of Bitcoin also faces many challenges.：

• Centralization risk: Some Bitcoin Layer2 technologies may need to rely on centralized nodes or servers to run, which will lead to certain centralization risks. If these nodes or servers fail or are attacked, the security and reliability of Layer 2 technology may be affected.
• Network effect: The value and security of Bitcoin depend on its network effect, that is, the more users and nodes participate, the higher the value and security of Bitcoin. In Bitcoin’s layer2 technology, different L2s may appear, which may lead to dispersion and weakening of network effects. How to promote and adopt Bitcoin’s Layer2 technology while maintaining network effects is a challenge that needs to be solved.

To sum up, while the Layer Bitcoin technology is upgrading and developing, it also faces a series of challenges, including compatibility, user education and popularization, centralization risk, security, law and supervision, scalability, network security, user privacy and interoperability, etc. Solving these challenges requires the joint efforts of all parties, including technology developers, policymakers, users and all sectors of society. Through comprehensive efforts of technological innovation, policy norms and social participation, the healthy development of Bitcoin’s Layer2 technology can be promoted and its potential applications in the financial field can be realized.

2. Why Bitcoin needs a new narrative

Bitcoin serves as the fundamental consensus source for the entire industry. The narrative surrounding Bitcoin’s “halving” has long been a focal point, but this narrative has inherent flaws. As the block rewards diminish, relying solely on current Bitcoin transaction fees is insufficient to incentivize miners and maintain the coin’s price, thus impacting Bitcoin’s strengths: security and stability. To address this issue, the Bitcoin ecosystem needs continual development, including Bitcoin Layer2 solutions, decentralized finance (DeFi), etc. Layer2 solutions can offer faster, low-cost transaction methods, fostering increased transaction volume and liquidity, thereby providing miners with more transaction fees. Developing the DeFi ecosystem can expand Bitcoin’s use cases, such as lending, liquidity mining, etc. By improving Bitcoin’s transaction efficiency and expanding its use cases, broader global acceptance and adoption of Bitcoin can be achieved, further increasing its value.

Moreover, as Bitcoin ranks first in market capitalization and far surpasses other cryptocurrencies in stability, security, and liquidity, it has gradually become an investment target in traditional financial markets. However, with the emergence of new technologies and concepts, investors are no longer satisfied with Bitcoin investment alone but seek deeper involvement in the crypto market’s development. Therefore, only by accommodating more use cases can the Bitcoin system gain institutional trust, which will attract greater capital inflows.

In addition to the above points, the development of new narratives surrounding Bitcoin is mainly driven by changes in its underlying technological environment. Upgrades like SegWit and Taproot have laid the foundation for Bitcoin’s applications. Although the current Bitcoin ecosystem is not yet perfect, its unique security and consensus power will quickly reveal more possibilities for Bitcoin beyond its original chain to the market.

3. The rise of Bitcoin’s Layer2 ecosystem

Over the past few years, Bitcoin Layer networks have been continuously developing. As of now, there are hundreds of decentralized applications being built on Bitcoin Layer2 networks, covering various fields such as payments, financial derivatives, identity verification, decentralized exchanges, and more. This enriches the application scenarios within the Bitcoin ecosystem. Currently, market attention is primarily focused on four L2 solutions for Bitcoin: the Lightning Network, Liquid Network, RSK, and Stacks. Each of them has its unique way of interacting with Bitcoin and evolving its protocol.

3.1 Four major Layer2 ecological networks

3.1.1 Lightning Network

The Lightning Network is a layer2 solution that provides peer-to-peer transaction channels and enables efficient micropayments on Bitcoin. It uses smart contracts to create off-chain channels and remote ledgers to track payments back and forth, and uses the Lightning Network to complete small payments. Deposit payments greatly increase transaction speeds, reduce transaction fees, and make Bitcoin exponentially scalable.

• Lightning Network native asset: Lightning Bitcoin (BTC)
• Lightning Network use cases: micropayments, games
• Applications of Lightning Network: Strike, BlueWallet, BottlePay, etc.

3.1.2 Liquid Network

Liquid brings an asset issuance network to the Bitcoin system, allowing users to create stablecoins, issue TOKEN and NFT, and quickly increase Bitcoin transaction throughput. In addition, transactions and asset types on Liquid are more confidential.

• Liquid network native asset: Liquid Bitcoin (L-BTC)
• Liquid network use cases: asset issuance, private transactions
• Applications on Liquid Network: Hodl Hodl, SideSwap, etc.

From the above, it can be seen that both provide optimization solutions for transactions, but they still have differentiated advantages from each other.

3.1.3 RSK

RSK, also known as Rootstock, is a layer2 network that brings EVM-compatible smart contracts to Bitcoin. Through the RSK Virtual Machine (RVM), developers can port Ethereum contracts to Bitcoin.

• RSK native asset: Smart Bitcoin (RBTC)
• RSK use cases: DeFi, data insights
• Applications on the RSK network: Sovryn, RIF, Money on Chain, etc.

Tip: Liquid and RSK are often referred to as Bitcoin sidechains, which means they run parallel to the Bitcoin base layer protocol and their native assets (L-BTC and RBTC) are pegged 1:1 to BTC.

3.1.4 Stacks

Stacks is a programming layer that brings smart contracts to the Bitcoin system. The Stacks network is slightly different from other layer2 networks. Stacks has its own consensus mechanism Proof-of-Transfer. This mining algorithm ensures that the history of all Stacks blocks is settled in Bitcoin. The protocol also uses a smart contract language called Clarity to create decentralized applications. Clarity allows Stacks to read Bitcoin state and include Bitcoin-based logic in its smart contracts, which is not possible with any other layer.

• Stacks native asset: STX
• Stacks use cases: DeFi, NFT, domain name system
• Applications on the Stacks network: Arkadiko, Alex, Stackswap, etc.

3.2 Common Bitcoin expansion use cases

3.2.1 Build new applications based on the original Bitcoin chain

For example, the Bitcoin NFT protocol Ordinals has generated more than 1 million NFTs on the Bitcoin network in 5 months since its launch on December 14, 2022. In addition, the recently popular BRC-20 protocol is a token standard based on the Bitcoin network, similar to the ERC20 standard in the Ethereum network. It uses Ordinal inscriptions of json data to deploy token contracts, mint tokens and transfer tokens. It has currently completed the issuance of 1,575 BRC20 tokens, which, to a certain extent, proves the feasibility of building NFTs, issuing Tokens and other applications on the original Bitcoin chain.

Surce: ordinarys.market

3.2.2 Develop the ecosystem through the Bitcoin Layer2 network

Facts have proved that the original Bitcoin chain still has problems such as slow transaction speed and expensive handling fees. However, security and stability are indeed necessary attributes for ecological applications. Therefore, without changing the natural advantages of the original chain, the only way to expand application scenarios of Bitcoin is to develop a layer2 network. Currently, the two most popular Layer 2 networks are STX and RIF. Based on these two major networks, related ecosystems are already developing and growing. The following are some of the released projects.

According to relevant data from defillama, the TVL of the Rootstock series has reached 180 million US dollars, and the TVL of the Stacks series has reached 150 million US dollars. From the perspective of the amount of funds, the Rootstock series is better; from the perspective of ecological development, Stacks is the only currency-issuing and the most complete ecological system.

Source: defillama.com

Source: defillama.com

After a comprehensive evaluation, in addition to the two leading projects STX and RIF, other Bitcoin layer2 projects worth users’ continued attention include the Rootstock series Sovryn. Here is an assessment of the project:

• Based on the Bitcoin DeFi platform running on Rootstock, in addition to lending and stablecoin businesses, it also opens cross-chain bridges, price limit transactions, staking and other businesses. It can be said to be the largest DeFi application on Rootstock.
• EVM-compatible Ethereum-style smart contracts were introduced for Bitcoin, and EVM compatibility with Rootstock means that Sovryn can do things that are done on all other DeFi chains, such as leverage trading, order trading, cross-chain trading, and decentralization. In addition, Sovryn created the Bitocracy governance model. In addition to voting, SOV holders are also eligible to receive the platform’s protocol income.
• Overall, Sovryn is the BTCdefi platform with the most complete functions on the Rootstock chain.

Project evaluation of ALEX for Stacks series:

• The DeFi open source protocol on Stacks is also the leading DEX on Stacks, with a TVL of 93.63 million US dollars, contributing more than 90% of liquidity.
• The internal testing of Alex OrderBook product has just ended recently. The added functions are: fast withdrawal, contract trading, mobile application (coming soon), legal currency channel, multi-chain wallet integration. In addition, they also have IDO Launchpad. APower is required to participate in IDO through Launchpad. APower requires participating in liquidity mining and staking ALEX to obtain it. Therefore, with the development of the Stacks chain, ALEX has great future development prospects.

3.2.3 Enrich Bitcoin’s asset use cases through cross-chain ecology

In the past few years, a large number of developers have used cross-chain technology to realize the transmission of Bitcoin assets, allowing participants in the Bitcoin ecosystem to participate in the DeFi and GameFi ecosystem. This expands the influence and value proposition of Bitcoin, enriching the industry’s ecosystem development.

The above-mentioned cross-chain ecosystems do not settle transactions through the Bitcoin network, which may raise concerns about their security among users. However, these projects have already weathered both bull and bear markets, with their investment backgrounds and cross-chain technologies validated by the market. With the development of the Bitcoin ecosystem, it is believed that a cross-chain ecosystem specific to Bitcoin will soon be established on its original chain.

Compared to Bitcoin’s infrastructure development and DeFi ecosystem, its NFT and blockchain gaming development are still in the earliest and most primitive stages. Apart from the traffic brought by the Ordinals protocol mentioned above, there is currently not much supporting infrastructure in place, and both the community and products are still immature.

Below are some examples of Bitcoin ecosystem projects that have already received institutional investment, including Portal Finance, Finterest, and Atomic Finance, which can be considered key projects to watch in the DeFi ecosystem.

In summary, the new narrative of the BTC ecosystem has just begun. Currently, the market’s hotspots are mainly focused on the ordinals NFT sector, also reflecting the existing transactional barriers within Bitcoin. In terms of industry transaction volume, although the Bitcoin chain cannot match the transaction speed and convenience of the Ethereum chain, the value of Bitcoin is extraordinary for the entire industry. Once community consensus is reached, it will bring new perspectives and prospects for Bitcoin.

4. The development prospects and challenges of Bitcoin Layer2

As the ecosystem develops, both BTC and ETH require Layer 2 solutions. ETH already has four relatively mature Layer 2 solutions, which have always been the focus of the community’s attention. Conversely, in the case of BTC, there is still debate within the community about whether to implement Layer 2 solutions, and ecosystem development is still in its infancy. However, from the recent news about Bitcoin Layer 2, people are confident about the development of Bitcoin DeFi. Regardless of the technological, community, or operational aspects, there are inherent advantages.

Looking back at history, the hotspots in 2017 were ERC chains and ICOs, while in 2019 and 2020, it was DeFi. In 2021, it was NFTs and blockchain games. In 2023, the longest-lasting topic was Bitcoin and Ethereum Layer 2 solutions. Although the TVL of the BTC ecosystem is still very low, as the ecosystem matures, there will be greater room for growth. 7 O’Clock Capital is also very optimistic about the development of Bitcoin Layer 2 and has provided strong support in terms of funding, brand promotion, and more. From the perspective of investment institutions, the development prospects of the entire Bitcoin Layer 2 technology and ecosystem projects are optimistic, but they also face some challenges.

From a perspective of prospects:

• The development of Bitcoin Layer 2 can provide scalability for Bitcoin, such as the Lightning Network, which can provide higher transaction throughput and lower transaction fees, thereby creating better conditions for the widespread application and adoption of Bitcoin.
• Enriching the application scenarios of the Bitcoin ecosystem: Bitcoin Layer 2 ecosystem projects and protocols have already been applied in various fields such as payments, financial derivatives, identity verification, and decentralized exchanges. The development of Layer 2 technology will further enrich the application scenarios of the Bitcoin ecosystem, providing more functions and services to attract more users and funds.
• Breaking Ethereum’s monopoly on the application layer: Currently, almost all of the market’s liquidity is in the Ethereum ecosystem, especially after Ethereum’s transition to PoS. Nearly 60% of DeFi’s locked value is concentrated in the Ethereum network. However, with the development of Bitcoin Layer 2 technology, it will break Ethereum’s monopoly on the application layer due to its advantages in security and stability, bringing new opportunities and innovations to the industry.

However, there are also challenges in the current development of Bitcoin Layer 2:

• Technological risks: Bitcoin Layer 2 technology is still evolving and may face technical instability and risks. For example, there may be technical challenges such as network congestion, management of payment channels, and maintenance difficulties, requiring continuous technological innovation and solutions.
• User acceptance and education costs: Compared to the traditional Bitcoin network, Bitcoin Layer 2 technology and ecosystem projects may require users to accept new concepts and usage methods. Therefore, improving user acceptance and education are important challenges.
• Currently, Bitcoin has not reached a true consensus on the expansion of applications. Some opponents believe that developing the ecosystem will contradict Bitcoin’s original vision as a peer-to-peer transaction system, and developing the ecosystem will increase the burden on the Bitcoin network. How to develop applications while maintaining the advantages of the Bitcoin base layer and be adopted by more users is the main problem that needs to be addressed in the expansion of Bitcoin.

In summary, the development prospects of Bitcoin Layer 2 technology and ecosystem projects are positive, and they are expected to improve Bitcoin’s scalability, enrich ecosystem application scenarios, and improve user experience. However, it is also necessary to recognize challenges such as technological risks, user acceptance and education, and sustainability. Whether as an investment institution or an ordinary participant, it is important to fully consider these factors when investing in Bitcoin Layer 2 ecosystem projects and to adopt appropriate risk management and strategic planning to ensure the sustainability and long-term returns of investments.

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