Is NFT/DeFi heading towards Bitcoin – the next hot topic is Bitcoin’s layer 2 use case?
Is Bitcoin's layer 2 use case the next hot topic for NFT/DeFi?
Exploring Use Cases for Bitcoin on the Rise
Since Ordinals launched a Bitcoin NFT experiment in early 2023, how to establish rich decentralized use case projects on Bitcoin has become a hot topic in the industry.
Bitcoin (commonly abbreviated as “BTC”), also known as the “global payment network”, is one of the most well-known public chains in the history of blockchain development. One of the tokens born on this chain, BTC, has long been the most watched digital asset in the world, and has even been called “digital gold” at one time.
However, compared to Ethereum, the use case ecology of Bitcoin’s public chain is rarely mentioned by the public. At present, most of the popular blockchain use cases, such as DeFi projects, NFTs, and blockchain games… are mostly built on public chains such as Ethereum and Solana.
The reason for this situation lies in the differences in the philosophy upheld by these public chains at the beginning of their founding.
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The creation goal of Bitcoin: to become a censorship-resistant peer-to-peer payment platform.
The creation goal of Ethereum: to become a world computer, an open data network, and a more general-purpose blockchain platform that can serve the development of smart contracts and applications.
It can be seen that Bitcoin did not intend to turn itself into an underlying infrastructure that serves smart contract and use case development when it was born. Therefore, Bitcoin has always followed a relatively simple design architecture. Observing from the theory of the “Blockchain Trilemma”, since it did not focus on developing use cases on the chain, Bitcoin paid more attention to pursuing the security, sustainability, and decentralization properties of the blockchain, and did not release a strong demand for scalability.
But now, Bitcoin is undergoing dramatic changes, and developers are also verifying and striving for the topic of “Bitcoin becoming a mainstream blockchain infrastructure for use cases”, hoping to transform Bitcoin from a single public chain to a more three-dimensional ecosystem full of various use cases.
The Need for Scalability is Urgent
At the beginning of this transformation, it means that Bitcoin will also face the same challenge as Ethereum-how to improve scalability.
Therefore, along with the attention to the use case ecology, and related to the improvement of scalability, the discussion on the Bitcoin Layer 2 network has become another hot topic of recent industry discussions.
However, even without developing a use case ecosystem, Bitcoin is facing a potential computing power crisis and urgently needs to improve its scalability. On the one hand, like most blockchains, Bitcoin’s network congestion is becoming increasingly serious, with fees soaring during peak periods. On the other hand, with the increase in development difficulty and changes in the Bitcoin block development incentive mechanism, the block development rewards obtained by developers are decreasing, which may affect their enthusiasm for subsequent development, resulting in a decline in the overall hash rate. A new and sustainable development incentive method needs to be found urgently.
Learn more about the Bitcoin block development incentive mechanism
There are two main ways for block developers (miners) to receive incentives on Bitcoin: one is to receive block development rewards, and the other is transaction fees paid by users.
For a long period of time in the past, the block development rewards obtained by Bitcoin block developers far exceeded the transaction fees they could obtain.
From the beginning, Bitcoin chose a model of giving block developers on the chain a constant speed and a fixed quantity of tokens as block development rewards. On the one hand, in the early development of Bitcoin, the on-chain transaction volume was very small, and the circulation of on-chain tokens (BTC) was in short supply, and the market value was also on the rise, which did stimulate the enthusiasm of block developers.
However, with the increasing number of block developers on Bitcoin and the iteration of computer hardware equipment, the development speed is becoming faster and faster. In order to prevent malicious abuse of computing power and prevent the tokens on Bitcoin from becoming oversupplied, causing a drop in market value, a new mechanism was added to Bitcoin in 2012: every four years, the block development rewards are halved.
So far, Bitcoin has undergone three 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.
The third halving: occurred on May 11, 2020, and the block development reward was reduced from 12.5 BTC per block to 6.25 BTC per block.
The fourth halving: is expected to occur in 2024, and the block development reward will be reduced from 6.25 BTC per block to 3.125 BTC per block.
It is obvious that under the new mechanism, the block developers will inevitably receive fewer and fewer block development rewards in the future, but due to Bitcoin’s development positioning, there has not been a significant change in the transaction fees that block developers can obtain from users.
Not until May 2023, with the exploration of the use case ecology on Bitcoin by developers, especially the Bitcoin NFT experiment launched by Ordinals and the emerging Bitcoin-Fi craze, did the incentive mechanism allocation of Bitcoin undergo significant changes (as shown in the trend below)—this is the first time since 2017 that the transaction fees received by Bitcoin block developers have exceeded the block development rewards, giving block developers new hope under a round of “reward halving” mechanisms.
△ Trend of Bitcoin transaction fees. Source: CryptoFees.info
Understanding Bitcoin Layer 2
According to Bitcoin’s development positioning, Bitcoin uses Layer 1 (the main network) for settlement, focusing on maintaining its decentralization, durability, and anti-censorship capabilities.
Bitcoin introduced an execution environment in Layer 2. Therefore, Bitcoin’s scalability (i.e. expansion) and use case development will be focused on Bitcoin Layer 2 (Layer2). Currently, there are four types of Bitcoin Layer 2:
1. Lightning Network
As Bitcoin’s Layer 2 solution, the Lightning Network mainly serves to expand payment functions and focuses on achieving faster, lower-cost peer-to-peer payments.
According to media reports in October 2022, within four months, the Lightning Network expanded by 1000 BTC, reaching 5000 BTC, and processed millions of payments.
△ Trend of Bitcoin Lightning Network capacity growth.
The blue curve represents the change in BTC capacity, which reached 4,000 BTC in June 2022 and 5,000 BTC in October 2022.
Source: Look into Bitcoin & cointelegraph.com
The features of Lightning Network that help Bitcoin expand and improve payment efficiency are as follows:
Lightning Network: Lightning Network can create payment channels that are separate from the Bitcoin main chain using smart contracts, and can track transactions. Users can conduct multiple transactions within this off-chain payment channel, which can be merged together and sent back to Bitcoin’s first-layer mainnet (Layer1) for settlement, without needing to send each transaction back to the mainnet once, greatly improving efficiency.
Bi-directional transactions: Lightning Network supports bi-directional transactions, allowing the bi-directional circulation of assets within off-chain payment channels, enabling both receipt and payment.
Multi-hop payments: Lightning Network allows users to make payments through multiple intermediate nodes, and also allows users to find available payment channels and intermediate nodes in the network on their own, making it more convenient to construct cross-chain payment paths.
Supported scenarios: Particularly suitable for high-frequency payment scenarios such as small payments and in-game payments, but does not solve the problem of Bitcoin’s limited use cases.
Second-layer service providers: Strike, BlueWallet, BottleBlockingy, and other platforms.
2. Liquid Network
As a second-layer sidechain of Bitcoin, Liquid Network operates independently of Bitcoin, does not use PoW consensus mechanisms, and allows users to proportionally transfer BTC into or out of Liquid Network or back to the Bitcoin main chain.
Liquid Network can confirm transactions within 2 minutes, rapidly increasing BTC’s transaction throughput, and has better confidentiality—no third party can view transaction details.
In addition, users can create digital assets such as NFTs on Liquid Network, and can also use DeFi facilities.
Supported scenarios: Building use cases, such as NFTs, DeFi, etc.
Representative use cases: Hodl Hodl, etc.
3. Stacks Protocol (STX)
Stacks is a second-layer protocol for Bitcoin that can be seen as a layer specifically designed for smart contracts. It has its own consensus mechanism, is built on top of the Bitcoin chain, and is not a sidechain protocol.
Compared to the development of Lightning Network and Liquid Network, developing use cases using the Stacks protocol is relatively easier, so it has garnered high industry attention since its launch in 2017, and the number of Stacks developers has been increasing in recent years. According to data published in network media articles, there are currently more than 150 different projects being developed on Stacks, and the number of active wallet addresses is also growing, but compared to Ethereum’s Layer 2 network Arbitrum, the number of active users is still relatively small.
Supported scenarios: DeFi, NFT, blockchain naming systems, and other complex use cases.
Representative use cases: Arkadiko, Alex, Stackswap, etc.
4. Rootstock (RSK)
Similar to Stacks, Rootstock also provides an access layer for Bitcoin developers to execute general smart contracts and implement use case development.
Rootstock introduces a virtual machine mechanism. Through RVM (Rootstock’s virtual machine), developers can migrate smart contracts on Ethereum to the Bitcoin chain.
At the same time, Rootstock’s operating mechanism is similar to Liquid Network, which is a sidechain that runs in parallel with Bitcoin’s main network (Layer 1).
The native digital assets on Rootstock are pegged to BTC at a 1:1 ratio, with high transaction speed and an average block time of about 30 seconds.
Supported scenarios: DeFi, data insight, etc.
Representative use cases: Sovryn, RIF, Money on Chain, etc.