NFTs, DeFi are heading to Bitcoin: What's next for Bitcoin Layer 2 use cases?

Break down the development changes of Bitcoin and the status quo of Layer 2.

Written by: imToken

Bitcoin Use Case Exploration Rises

Since Ordinals started the Bitcoin NFT experiment in early 2023, how to create rich decentralized use case projects on Bitcoin has become a hot spot in the industry.

Bitcoin (commonly referred to as "Bitcoin"), also known as the "Global Payment Network", is one of the most well-known public chains in the history of blockchain development. BTC, one of the tokens born on this chain, has already become the most watched digital asset in the world, and was even called "digital gold" at one time.

However, compared to Ethereum, the use case ecology of Bitcoin, a public chain, is rarely mentioned by the public. At present, various popular blockchain use cases, such as DeFi projects, NFT, blockchain games... Most of them are built on public chains such as Ethereum and Solana.

The reason for this situation comes from the differences in the concepts of the above-mentioned public chains at the beginning of their establishment.

• **Bitcoin was created with the goal of **becoming a censorship-resistant peer-to-peer payment platform.
• **Ethereum’s creation goal: **To become a world computer, an open data network, and a more general blockchain platform-able to serve the development of smart contracts and applications.

It can be seen that at the beginning of its birth, Bitcoin did not intend to turn itself into an underlying facility serving smart contracts and use case development. Therefore, Bitcoin has always followed a relatively simple design architecture, which corresponds to the observation in the theory of "Blockchain Impossible Trinity". Since it does not focus on the use cases on the development chain, Bitcoin pays more attention to the security and sustainability of the blockchain. And decentralization properties, there is no strong demand for scalability.

But now, Bitcoin is undergoing drastic changes, and developers have also begun to verify and work hard on the topic of Bitcoin "becoming the mainstream blockchain use case infrastructure", hoping to make Bitcoin change from a single public chain to a full of various use cases. Three-dimensional ecosystem transformation.

Expansion demand is coming soon

At the beginning of the transformation, it means that Bitcoin will also face the same challenge as Ethereum - how to improve scalability.

Therefore, with the focus on the ecology of use cases, the discussion on Bitcoin Layer 2 network (Layer 2) related to the improvement of scalability has also increased, and it has become another focus of recent industry discussions.

But in fact, even if the use case ecology is not developed, Bitcoin today is facing a potential crisis of computing power, and it is urgent to improve scalability:

On the one hand, like most blockchains, Bitcoin’s network congestion problem is becoming more and more serious, and fees soar during peak operating hours; on the other hand, with the increase in development difficulty and changes in Bitcoin block development incentives, developers get The block development rewards are decreasing, which may affect the enthusiasm for subsequent participation in development, resulting in a decline in the hash rate of the entire chain. It is urgent to find a new and sustainable development incentive method.

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Bitcoin's Block Development Incentive Mechanism

There are two main methods for block developers (Miners) on Bitcoin to obtain incentives: one is to obtain block development rewards; the other is to receive transaction fees from users.

For a long time in the past, Bitcoin block developers received far more block development rewards than transaction fees.

From the beginning of its birth, Bitcoin has chosen a mechanism of rewarding block developers on the chain with a constant speed and token quantification model. On the one hand, in the early days of Bitcoin’s development, the transaction volume on the chain was very small, the circulation of tokens on the chain (that is, BTC) was in short supply, and the market value was also on the rise, which really stimulated the development enthusiasm of block developers.

However, with more and more block developers on the Bitcoin chain and the iteration of computer hardware equipment, the development speed is getting faster and faster. In order to prevent the malicious proliferation of computing power and prevent the tokens on Bitcoin from becoming oversupplied and causing a decline in market value, a new mechanism has been added to Bitcoin since 2012: every four years, the reward for block development is halved .

Up to now, Bitcoin has experienced three reward halvings:

The first halving: occurred on November 28, 2012, and the block development reward was reduced from 50 BTC per block to 25 BTC per block.

The second halving: occurred on July 9, 2016, and the block development reward was reduced from 25 BTC per block to 12.5 BTC per block.

Third halving: Occurring on May 11, 2020, the block development reward was reduced from 12.5 BTC to 6.25 BTC per block.

Fourth Halving: Expected to occur in 2024, block development rewards are reduced from 6.25 BTC per block to 3.125 BTC per block.

Obviously, under the new mechanism, block developers will be able to obtain less and less block development rewards in the future, but due to the development positioning of Bitcoin, the transaction fees that block developers can obtain from users have not appeared significantly The change.

Until May 2023, with developers exploring the use case ecology on Bitcoin, especially the Bitcoin NFT experiment started by Ordinals and the emerging "Bitcoin-Fi" craze, the distribution of Bitcoin's incentive mechanism has also undergone significant changes ( The trend is shown in the figure below) - this is the first time since 2017 that the transaction fees obtained by Bitcoin block developers have exceeded the block development rewards, allowing block developers to see new developments under the mechanism of "reward halving". hope.

Bitcoin transaction fee change trend graph source/CryptoFees.info

Understanding Bitcoin Layer 2

According to the development orientation of Bitcoin, Bitcoin uses Layer 1 (Layer1, the main network) for settlement, focusing on maintaining its decentralization, durability, and anti-censorship capabilities.

Bitcoin chose to introduce an execution environment at layer 2. Therefore, Bitcoin's scalability (that is, capacity expansion) and use case development will focus on Bitcoin Layer 2 (Layer 2). Currently, Bitcoin Layer 2 has the following four types:

Lightning Network

As a layer 2 solution (Layer 2) of Bitcoin, the Lightning Network is mainly used to expand payment functions, focusing on faster and lower-cost peer-to-peer payments.

According to media reports in October 2022, within 4 months, the Lightning Network expanded by 1,000 BTC, and has now reached 5,000 BTC, processing millions of payments.

△ *Bitcoin lightning network capacity growth trend chart. *

*The blue curve represents the capacity change of BTC, reaching 4000 BTC in June 2022 and reaching 5000 BTC in October 2022. *

Image source/Look into Bitcoin & cointelegraph.com

The characteristics of the Lightning Network to help Bitcoin expand and improve payment efficiency are as follows:

• Off-chain channels: The Lightning Network can use smart contracts to create payment channels off the Bitcoin main chain and can track transactions. Users can conduct multiple transactions in this off-chain payment channel, and these transactions can be combined and sent back to Bitcoin's Layer 1 main network (Layer 1) for settlement. It is not necessary to send the transaction every time Back to the main network once, greatly improving the efficiency.
• Two-way transactions: Lightning Network supports two-way transactions, allowing users to have two-way circulation of assets in the off-chain payment channel, which can realize both receiving and payment.
• Multi-hop payment: Lightning Network allows users to pay through multiple intermediate nodes, and also allows users to find available payment channels and intermediate nodes in the network. It will be more convenient to build cross-link payment paths.

**Supported scenarios: **Especially suitable for high-frequency payment application scenarios such as micropayments and in-game payments, but does not support solving the problem of few native Bitcoin use cases.

Tier 2 providers: Strike, BlueWallet, BottlePay, etc.

Liquid Network

As the second layer side chain of Bitcoin, Liquid Network operates independently of Bitcoin, does not use the PoW consensus mechanism, and allows users to transfer BTC to Liquid Network or back to the Bitcoin main chain in equal proportions.

The liquid network can confirm the transaction within 2 minutes, quickly increasing the transaction throughput of BTC, and has better confidentiality-any third party cannot view the transaction details.

In addition, users can create digital assets such as NFT on the liquid network, and can also use DeFi facilities.

Support Scenarios: Build use cases, such as NFT, DeFi, etc.

Representative Use Case: Hodl Hodl et al.

Stack protocol Stacks (STX)

Stacks is the second layer protocol of Bitcoin. It can be regarded as a layer dedicated to smart contracts. It has its own consensus mechanism and is built on the Bitcoin chain, not a side chain protocol.

Stacks allows developers to use traditional programming languages, such as Java and Python, to build decentralized use cases on the Bitcoin chain, and uses a mechanism called "PoX", which can support the operation of relatively complex smart contracts while ensuring security . Transactions on Stacks are automatically settled on every Bitcoin block.

Compared with the development of Lightning Network and Liquid Network, the technical difficulty of using the Stacks protocol to develop use cases is relatively low. Therefore, since its launch in 2017, the industry has been paying close attention to it. In recent years, the number of Stacks developers has also been increasing. According to data published in online media articles, there are currently more than 150 different projects developing use cases on Stacks, and the number of active wallet addresses is also increasing, but compared to Ethereum’s layer 2 network Arbitrum, the number of active users is still small .

**Supported scenarios: **DeFi, NFT, blockchain naming system and other complex use cases.

**Represents use cases: **Arkadiko, Alex, Stackswap, etc.

Rootstock（ RSK）

Similar to Stacks, Rootstock also provides Bitcoin developers with an access layer that can be used to execute common smart contracts and enable use case development.

Rootstock introduces a virtual machine mechanism. Through RVM (Rootstock's virtual machine), developers can translate the smart contracts on Ethereum to the Bitcoin chain.

At the same time, Rootstock operates in a similar way to the liquid network. It is a side chain that runs in parallel with Bitcoin's main network (Layer 1).

The native digital assets on Rootstock are pegged to BTC at a ratio of 1:1, and have a high transaction speed, with an average block generation time of about 30 seconds.

**Supported scenarios: **DeFi, data insights, etc.

Represents use cases: Sovryn, RIF, Money on Chain, etc.