The State of Bitcoin L2
Introduction
From the emergence of decentralized finance (DeFi) on the Bitcoin network to the implementation of the BRC-20 protocol and Ordinals, there has been a lot of activity on the Bitcoin network lately.
One of the most notable developments that have been introduced to the Bitcoin ecosystem is the creation of Layer 2 solutions for the network. These solutions have opened up new avenues for scaling and the development of decentralized applications. By leveraging Layer 2 solutions, developers are now able to build and deploy more complex applications that are not constrained by the limitations of the underlying Bitcoin network.
In this article, we will examine the current state of Bitcoin Layer 2 developments, distinguish between different L2 ecosystems, and explore their specific use cases.
The Need for Bitcoin Layer 2
Bitcoin requires Layer 2 solutions because the core function of the network’s base layer is to facilitate peer-to-peer payments, enabling individuals to send, receive, or hold coins in a Bitcoin wallet. However, for on-chain activity, there isn’t much that can be done beyond the basics.
Despite the recent Taproot upgrade, which makes the network a friendlier place for token contracts, Bitcoin’s functionality remains limited. People have turned to Ethereum and other alternative protocols that support smart contract deployment to deploy DeFi and NFT solutions. Although Bitcoin NFTs are witnessing tremendous traction, the high transaction cost and slower block confirmation rate make widespread adoption less feasible.
Since Bitcoin adoption increased, mining difficulty followed suit, and transaction fees spiked. High transaction fees, network congestion, and other factors have contributed to a generally poor user experience on Bitcoin.
Bitcoin adoption also resulted in a slower network overall. Transaction finality time increased, and the chain could only process a few transactions per second. If you send Bitcoin to a friend today, it could take minutes, hours, or even days for the transaction to go through. If you pay a higher fee, your transactions can be processed faster.
Bitcoin’s security and decentralization have remained unmatched, but the network’s scalability is a big concern. Bitcoin also has limited interactions with other blockchains, making it difficult to transfer its billions of dollars in value to other chains. Thus, the need for Layer 2 solutions that can deliver scalability, smart contract programmability, an improved user experience, decentralized applications (dApps), and interoperability while enjoying the security of and transaction finality on the Bitcoin blockchain.
Types of Bitcoin Layer 2 Solutions
Sidechains
Sidechains are L2 solutions that run parallel with the parent L1 chain and connect to the L1 using a two-way bridge. This bridge, or peg, allows users to move assets from the L1 to the sidechain and vice versa. Assets transferred across the bridge from the main chain (Bitcoin) to its sidechain (X) will maintain their value. On both sides of the bridge lie smart contracts, which are responsible for ensuring participants on both sides remain honest.
Bitcoin sidechains have a derivative of BTC, usually pegged to 1:1 to the original asset. For instance, when you transfer 0.1 BTC from Bitcoin to X, one smart contract locks your BTC on the L1, and another unlocks 0.1 xBTC on the sidechain (L2). In essence, sidechains are independent chains that interact with Bitcoin such that users can transfer value across both chains and probably, enjoy transaction finality on the Bitcoin network while transacting elsewhere.
Prominent examples of Bitcoin sidechains include Rootstock, Liquid Network, and Stacks.
State Channels
Like sidechains, Bitcoin state channels are a layer two solution. Built atop the Bitcoin network, state channels are simple P2P protocols that allow two players, each on one side, to transact off-chain as often as possible and only upload the final results of their transactions to the blockchain.
For instance, Jake and Kobe want to transfer BTC to each other daily. Instead of interacting with the blockchain every single time they make a transfer, they use a state channel, which allows them to transfer assets off-chain, and broadcast two transactions (to open and close the channel) to the blockchain at the end.
The Lightning Network is Bitcoin’s most prominent L2 that uses state channels. It facilitates peer-to-peer payments through smart contract functionality, allowing users to send and receive Bitcoin off-chain through secure channels.
Smart Contract Chains
Smart contract chains are Bitcoin L2s that support smart contract deployment — they serve as an application layer for Bitcoin. Although Bitcoin’s support for contracts has increased, thanks to the Taproot upgrade, native smart contracts are still far less flexible than those on Ethereum.
Bitcoin smart contracts are limited due to Bitcoin Script’s Turing completeness. Thus, for additional smart contract functionality, beyond time locks and multisig wallets, developers built L2 solutions with full smart contract functionality, bringing Bitcoin dApps to users.
Most Bitcoin L2s support smart contracts, but Stacks, Rootstock, and Liquid Network are building infrastructures that classify them as smart contract chains. Developers can build user-focused decentralized applications on these chains using complex smart contracts.
The Current State of Layer 2 Chains
Here are some of the prominent L2s and how far they have come:
Lightning Network (LN)
Thaddeus Dryja and Joseph Poon proposed the Lightning Network in 2016 as a layer two scaling solution for Bitcoin payments. In July 2018, the network hit the milestone of 10,000 live channels, and it has not looked back ever since.
Presently, over 16,000 nodes exist on the Lightning Network, with more than 70,000 channels. The network has a capacity of over 5,000 BTC (~$140 million), representing the total value locked on it and millions of users. The average transaction on Lightning Network costs about 0.0016 sats, about $0.00000043.
Lightning Labs, the company behind LN, has released several products like Loop, Pool, Taro, and Faraday. Crypto exchanges and wallets are also beginning to add support for LN. Lightning Network has been a success so far, and with more updates on the horizon, the protocol will continue to grow.
Liquid Network
This Bitcoin sidechain is a privacy-centric network that supports token/asset issuance, fast transaction settlements, and confidential transactions. The network is powered by a BTC-pegged token, L-BTC, which users can obtain by depositing Bitcoin to an address. Users can also issue fresh tokens, such as stablecoins and securities, on the Bitcoin timechain through Liquid Network.
After its genesis block went live in 2018, Blockstream’s Liquid Network has come a long way. Several crypto exchanges, wallets, and financial institutions have adopted it to facilitate Bitcoin trading.
As of May 2023, there are almost 4,000 L-BTC in circulation (~$108 million). Lending and trading applications also exist on Liquid Network. The sidechain also supports Bitcoin-based capital markets, transaction masking, and NFT marketplaces. Transaction settlement takes about two minutes on average.
RSK
Rootstock is a Bitcoin sidechain with full EVM-compatible smart contract functionality. RSK functions through merged mining, a decentralized identity solution, swift transaction finality, lower fees, and Ethereum interoperability. Rootstock is a leading figure in the Bitcoin DeFi ecosystem, as it allows developers to reuse their Ethereum smart contracts on RSK, making it easier to deploy applications.
As of May 2023, Rootstock has over $300 million in total value locked on the network. The sidechain’s token, RBTC, has a supply of over 3,500 coins (~$90 million), and the network records over 79,000 transactions monthly. RIF Flyover, RIF Relay, and RIF Name Service are some products available to Rootstock users.
Omni Layer
Omni Layer is a software layer built atop Bitcoin. The L2 supports token creation and issuance, Bitcoin and token trading, decentralized crowdfunding, and decentralized P2P trading.
As one of the earliest Bitcoin Layer 2 solutions, Omni Layer recorded increased traction in 2014 and 2018. Since then, the platform’s usage has reduced significantly, with only 27 transactions in 24 hours at writing time.
Stacks
Stacks is an innovative Bitcoin layer that aims to revolutionize decentralized finance (DeFi), non-fungible token (NFT), and smart contract space. Stacks L2 solution employs a consensus mechanism that is linked to Bitcoin, allowing users to stake its native STX and mine BTC simultaneously. With this mechanism, Stacks ensures that its network remains secure, scalable, and decentralized while still enjoying the benefits of the Bitcoin blockchain.
One of the unique features of Stacks is its Clarity smart contract language. Clarity is a programming language that is purpose-built for smart contract development on the Stacks blockchain. Unlike other smart contract languages like Solidity, Clarity is designed to make smart contracts more secure, predictable, and easier to audit. Clarity smart contracts are also more expressive, making it easier for developers to write complex and novel smart contracts.
Velar Protocol is also built on Stacks L2 leveraging Clarity smart contract language. Thanks to Stacks’ smart contract capabilities, Velar will feature a DEX, liquidity pools, yield farming solutions, staking infrastructure, and a launchpad, each of which can stand alone as an independent DeFi application.
Stacks has recently announced its plan to introduce a two-way peg protocol for its sBTC token. The two-way peg protocol will allow users to move value seamlessly between the Bitcoin blockchain and the Stacks blockchain. This will enable Bitcoin holders to participate in the Stacks ecosystem while still enjoying the security and finality of the Bitcoin blockchain. With this development, Stacks is poised to become a significant player in the Bitcoin L2 space.
Stacks has a lot going for it, with the upcoming Nakamoto release being one of its most anticipated updates. Scheduled for Q4 2023, the Nakamoto release is expected to unlock the locked monetary value in a decentralized way on Bitcoin. This will allow users to access the full value of their Bitcoin holdings while still enjoying the benefits of the Stacks ecosystem. The STX coin has a market capitalization of over $800 million, and the total value locked on Stacks is a little over $100 million. With upcoming updates such as Nakamoto Upgrade and sBTC, Stacks may steal the spotlight from other Bitcoin L2s.
In summary, Stacks is an innovative Bitcoin layer that offers users a secure, scalable, and decentralized platform for DeFi, NFTs, and smart contract development. With its Clarity smart contract language and two-way peg protocol for sBTC, Stacks is poised to become a significant player in the Bitcoin L2 space. The upcoming Nakamoto release is highly anticipated, and with the planned upgrades, Stacks is well-positioned to challenge other Bitcoin L2s in the market.
Conclusion
The Bitcoin L2 ecosystem is expanding rapidly and gaining more traction. With the rise in popularity, other innovative solutions like Mintlayer are also developing their infrastructure to support smart contracts, offer privacy, and scale Bitcoin without trading off security and decentralization.
There are several catalysts that lie ahead for Bitcoin Layer 2 solutions, signaling potential growth in the future. For instance, with the increasing adoption of cryptocurrencies worldwide, the overall demand for L2 solutions is expected to grow exponentially. As more and more people start using Bitcoin DeFi, the need for efficient and secure L2 solutions will grow in importance and urgency.
Furthermore, as the technology behind L2s continues to mature, the overall user experience will improve significantly. This, in turn, will encourage more people to use L2 solutions, leading to a more robust and resilient Bitcoin ecosystem. L2 solutions are not only essential for Bitcoin’s growth but also for its long-term sustainability.
In conclusion, Bitcoin’s future lies in the hands of Layer 2 solutions, and they will undoubtedly deliver. As the ecosystem continues to evolve, we can expect to see more innovative and efficient L2 solutions that cater to the needs of Bitcoin users worldwide.
This blog was first published on Velar Blog. For more info about Velar, join our community on Discord or follow us on Twitter.
