Why does Bitcoin need Layer 2 more than Ethereum?

Author: Callum@Web3CN.Pro

Since 2020, the DeFi business has grown rapidly, with TVL increasing from $600 million to $37 billion, a 60-fold increase. As the usage of on-chain transactions on blockchain networks surges, coupled with the development of DeFi application scenarios, blockchain networks are becoming increasingly congested, making mainnet expansion imperative.

So why do neither Bitcoin nor Ethereum directly choose to increase block capacity to enhance transaction throughput? The reason is that when block capacity expands, more small nodes may exit, gradually leading to centralization. Therefore, developers are turning their attention to developing Layer 2 solutions, which are built on top of existing blockchain networks to improve their efficiency by offloading some processing to reduce network congestion and the excessively high costs associated with on-chain transactions. This process does not affect the existing Layer 1 block capacity, avoiding a shift toward centralization.

Currently, Bitcoin processes an average of 7 transactions per second, while the Ethereum network can handle about 30 transactions per second. In contrast, Visa processes approximately 1,700 transactions per second. As the number of users utilizing these two blockchains grows over time, both Bitcoin and Ethereum have nearly reached their capacity limits, necessitating solutions to accommodate more users. In this article, we will delve into why Bitcoin needs Layer 2 more than Ethereum and analyze the current obstacles and prospects for Bitcoin Layer 2.

Bitcoin VS Ethereum

Fundamental Differences Between Bitcoin and Ethereum

Bitcoin is the first cryptocurrency based on blockchain technology, giving value to data. As a peer-to-peer electronic cash system, it operates independently of any central authority. Bitcoin primarily facilitates simple value transfers, such as Bob sending a certain amount of Bitcoin to Sally, with the only adjustable parameter being the amount of Bitcoin transferred.

Ethereum is a decentralized, open-source distributed blockchain network supported by its native cryptocurrency, Ether, used for transactions and interactions with applications built on the Ethereum network. While Bitcoin uses blockchain technology for monetary transactions and allows nodes and messages to be attached to each transaction, Ethereum goes further by using blockchain to create a decentralized computer. Ethereum relies on the programming language Solidity combined with blockchain technology to launch a smart contract development environment, enabling developers to perform more complex data processing and develop decentralized applications, breaking through Bitcoin's limitation of merely facilitating simple value transfers.

Although both Bitcoin and Ethereum networks are based on the concepts of distributed ledgers and cryptography, they differ significantly in technical specifications.

First, Bitcoin serves as a digital gold equivalent for value storage, essentially functioning as a currency for transactions, while the data attached to Bitcoin network transactions is solely for recording transaction information. In contrast, Ether powers the Ethereum network and its applications, allowing Ethereum transactions to include executable code to create smart contracts or interact with self-executing contracts and applications built using them.

Second, Bitcoin issues new tokens using the Omni Layer, a platform for creating and trading currencies on the Bitcoin blockchain, with Omni Layer adoption primarily focused on stablecoins. Ethereum tokens are issued according to different standards, the most popular being the ERC-20 standard, which defines the rules for tokens on the network. The ERC-20 standard includes multiple functions that developers must implement before launching a token, such as providing information about the total supply of the token, providing account balances on user addresses, and allowing funds to be transferred between addresses.

Finally, other differences between these networks include variations in consensus mechanisms, the time taken to add new data blocks, and the number of transactions processed per second.

Different Scaling Solutions

One of the scaling solutions for Bitcoin is technological improvement, which is an on-chain scaling solution. For example, the Segregated Witness (SegWit) upgrade in 2017 isolated some data outside the available space of each block in the propagation network, increasing the blockchain's block size limit by removing signature data from Bitcoin transactions. When certain parts of a transaction are removed from the block, it frees up space or capacity to add more transactions to the chain, with the SegWit upgrade expanding block space to 4MB. The Taproot upgrade in 2021 simplified transaction processing, making it easier and faster to confirm transactions on the Bitcoin network. It also increased the number of transactions that could be processed and reduced the overall costs of transactions on the network.

Additionally, developers have been researching off-chain Layer 2 scaling solutions, primarily building transaction layers on top of the Lightning Network's foundational blockchain. Transactions on the Lightning Network are fast and incur very low fees because they are sent through user-created payment channels. The user-generated payment channels on the Lightning Network are pre-funded with Bitcoin and allow most transactions to be transferred from the underlying blockchain to this second-layer network. These transactions are not settled on the Bitcoin network itself, as the only transactions settled on the underlying Bitcoin blockchain are those that open and close Lightning Network payment channels. In fact, Bitcoin sidechains are parallel chains established on the Bitcoin blockchain that are independent yet capable of interacting with the main Bitcoin chain. Sidechains leverage the security and stability of the main chain to build a relatively independent blockchain system. On Bitcoin sidechains, users can perform various operations, such as creating new digital currencies, running smart contracts, and implementing privacy protection. Compared to the Bitcoin main chain, Bitcoin sidechains can provide more functionality, enhancing Bitcoin's scalability and flexibility.

Ethereum's scaling solutions are also divided into on-chain and off-chain scaling. On-chain scaling involves performance improvements to the blockchain itself, modifying Ethereum to achieve better scalability; off-chain scaling operates separately from the first-layer mainnet, achieving higher scalability without changing the existing Ethereum protocol.

The core of on-chain scaling is a solution that achieves scaling effects by changing the first-layer mainnet protocol, which involves technical upgrades to Ethereum itself and requires consensus among Ethereum developers, researchers, and community members. Currently, on-chain scaling primarily employs sharding (to be gradually implemented after the Cancun upgrade in the second half of the year), which helps distribute the computational resources required to run Ethereum across a total of 64 networks, reducing the demand for random access memory on devices running the Ethereum blockchain.

Compared to Ethereum's on-chain scaling, Ethereum's off-chain scaling ecosystem is more diverse. Off-chain scaling involves executing transactions or processing off-chain, aiming to achieve scalability without altering the existing first-layer public chain protocol. For off-chain scaling, the key issue is the handling of transaction data; whether transaction data is processed on the Layer 1 mainnet affects its security. All off-chain scaling solutions differ in this regard. Ethereum's off-chain scaling solutions primarily use Rollups, which rely on servers that group a large number of transactions and then submit them directly to the Ethereum blockchain. Another Layer 2 solution called sidechains operates as an independent network running parallel to the Ethereum network, allowing users to exchange tokens between different network protocols, effectively enabling them to use applications built on Ethereum while paying lower fees.

Bitcoin Needs Layer 2 More Than Ethereum to Enhance Its Scalability

Expanding transaction volume urgently requires Layer 2 support

The block size of Bitcoin has always been a topic of controversy. In fact, when Bitcoin was first created, there was no limit on block size, and its data structure could theoretically reach up to 32MB. At that time, the average packed block size was 1-2KB, and some believed that a high upper limit on the blockchain could lead to wasted computational resources and make it susceptible to DDoS attacks. Therefore, to ensure the security and stability of the Bitcoin system, Satoshi Nakamoto decided to limit the block size to 1MB. Based on an average transaction size of 250B and a block being generated every ten minutes, the Bitcoin network can theoretically handle a maximum of 7 transactions per second. However, at that time, the number of Bitcoin users was small, and transaction volume was low, so there were no congestion issues on the blockchain network. However, after 2013, as the user base of Bitcoin grew, issues of network congestion and rising transaction fees began to emerge.

At the beginning of 2023, the Ordinals protocol introduced a new direction for Bitcoin, and the BRC-20 token protocol quickly gained popularity, leading to significant congestion in the Bitcoin network and rising operational costs. The fees for a single Bitcoin transaction block have exceeded the block reward, indicating a growing demand for block space from Ordinals and BRC-20. According to Bitcoin explorers, the number of unconfirmed transactions on the Bitcoin network has reached a peak of 504,182, and the processing speed of 7 transactions per second is clearly insufficient to meet user demand. At the same time, transaction fees on the Bitcoin network have surged, with gas fees exceeding 500 satoshis/byte.

Slow transaction speeds, long confirmation times, high transaction fees, and limitations on network scalability are all hindering the current development of the Bitcoin ecosystem, indicating that Bitcoin's current state of development requires Layer 2 support.

Block expansion is hindered; Layer 2 is the optimal choice

As early as 2010, when considering block expansion solutions, although the capacity was set at 1M, Satoshi Nakamoto believed that if there was a need for expansion, it would be sufficient to set the block height in the code to automatically upgrade block capacity. After Nakamoto's withdrawal, the task of developing and maintaining Bitcoin was passed to Gavin (Gavin Andresen), and gradually other developers joined, evolving into the current Core development team.

Later, there was a divergence within the Core development team regarding whether to implement a hard fork to remove the 1M limit as per Nakamoto's plan. Most developers felt that this limit should not be removed; the Core team believed that removing the 1M limit would lead to increasingly larger blocks, raising the threshold for running nodes, affecting the system's decentralization, and increasing systemic risk.

Ultimately, between security and scalability, the BTC community prioritized security. These developers proposed "Segregated Witness + Lightning Network." To address the scalability issues affecting the Lightning Network and to achieve partial expansion, the Core development team proposed the Segregated Witness (SegWit) solution in December 2015. Subsequently, Blockstream's CTO Gregory included the Lightning Network in the Bitcoin roadmap, forming the "Segregated Witness + Lightning Network" route. Thus, a divergence officially formed between Gavin's proposed block expansion solution and the Core developers at Blockstream, who held the dominant position in Bitcoin development. However, some rejected this technical upgrade, leading to the hard fork in August 2017 that resulted in BCH. After the hard fork, BCH increased the block limit to 8M and later to 32M, with an average TPS of around 120. Additionally, the BCH community split again in 2018 due to disagreements over the technical upgrade route, resulting in the hard fork of BSV (Bitcoin Satoshi Vision).

In fact, the complexity of Bitcoin's block expansion solutions is high, and the more widely accepted solution is to build a new layer based on Bitcoin Layer 1, which is compatible and does not affect the Bitcoin system while addressing on-chain congestion. From the final outcome of the expansion debate, the Core faction achieved a decisive victory, halting Bitcoin's block expansion. After completing SegWit, Bitcoin is now fully focused on developing Layer 2 solutions such as the Lightning Network and Sidechains.

Breaking the limitations of a simple ledger, non-Turing complete Layer 2 is the answer

As we mentioned in the first part, Ethereum broke the limitations of Bitcoin's simple ledger by establishing a smart contract system to achieve complex value transfers. Therefore, since its inception, Ethereum has been addressing the financial needs related to assets, whether through its issued assets ERC20 (tokens), ERC721 (NFTs), or its on-chain DeFi products like Maker Dao, UniSwap, OpenSea, all of which meet users' diverse needs. Particularly, Ethereum's Turing-complete virtual machine EVM resolves the issue of on-chain asset settlement, enabling the EVM ecosystem to support on-chain DEX for tokens/NFTs and leading to the success of many well-known DeFi applications.

The issuance and circulation of assets have long been part of Ethereum's narrative, but they have now also become part of Bitcoin's narrative. As early as 2014, when Ethereum emerged, Bitcoin began exploring the business needs for asset issuance, such as the well-known Omni Layer protocol that issued the earliest stablecoin, USDT. At that time, the world's largest crypto stablecoin was issued on the UTXO's OpReturn of the Bitcoin network. However, due to the 80-byte content space limitation of OpReturn at that time, the OmniLayer protocol failed. Subsequently, the Bitcoin network underwent continuous technical upgrades, including the aforementioned SegWit and Taproot upgrades, which provided possibilities for the subsequent development of the Bitcoin ecosystem.

Although Bitcoin's Segregated Witness resolved the expansion issue from 80 bytes to 4MB, it did not address the issue of on-chain computation. Therefore, Bitcoin can currently only perform the logic of asset issuance and cannot build on-chain computational applications like AMM DEX that support on-chain computation as Ethereum does. The achievements of asset issuance in the current Bitcoin ecosystem are indeed encouraging. For example, the number of transactions for BRC20 inscriptions has exceeded 10 million, and the market value of Bitcoin NFTs has reached parity with the Ethereum market. The next challenge for the Bitcoin network is to achieve independent asset settlement like Ethereum Layer 1.

From the aforementioned off-chain scaling solutions, current Ethereum Layer 2 solutions merely replicate Ethereum Layer 1 without addressing any actual business problems that necessitate Layer 2. If one must say what Ethereum Layer 2 has solved, it is the reduction of gas fees, especially after Ethereum implements sharding, which may pose additional challenges to current Layer 2 protocols. In contrast, Bitcoin's Layer 2 solutions are still relatively few; Bitcoin's non-Turing complete on-chain virtual machine can only register assets but cannot settle them. Therefore, Bitcoin Layer 1 must develop a Turing-complete Bitcoin Layer 2 to help resolve the asset issuance settlement issue. This is also why Bitcoin needs to develop Layer 2 more than Ethereum.

Compared to the prosperity of ecosystems like Ethereum, there are still very few projects in the Bitcoin ecosystem. Currently, the total value locked (TVL) in the entire Ethereum ecosystem is approximately $26 billion, while the TVL in the Bitcoin ecosystem is about $180 million. However, Bitcoin's market capitalization is nearly $600 billion, while Ethereum's market capitalization is about $230 billion. Therefore, in the long run, there is still considerable growth potential for Bitcoin Layer 2 development.

Prospects for Bitcoin Layer 2

In 2012, Colored Coins became a trend, utilizing the Bitcoin blockchain to "color" specific bitcoins to distinguish them from others, aiming to facilitate non-monetary transactions using Bitcoin and its existing infrastructure. Although colored coins never fully developed independently, they inspired the new technologies widely used today. The activation of the SegWit upgrade in 2017 expanded block space to 4MB, thereby increasing transaction throughput. By 2018, developers gradually introduced the Lightning Network and sidechains, bringing Bitcoin Layer 2 into the public eye. The Taproot upgrade in 2021 further enhanced Bitcoin's security, efficiency, and privacy. This year, the emergence of the BRC-20 protocol has further enriched Bitcoin's ecosystem. Currently, the more mainstream protocols in the Bitcoin ecosystem include sidechains and the Lightning Network. As transaction volume on the Bitcoin network continues to grow, how to enable Bitcoin to accommodate more transactions and ecosystems is the main development direction, whether through the Lightning Network, sidechains, or the RGB protocol. The development of Bitcoin Layer 2 is ongoing, ultimately aiming to achieve compatibility between the security and scalability of the Bitcoin network.

Currently, the scale of the Bitcoin ecosystem still lags behind Ethereum, with fewer well-known projects compared to Ethereum and a smaller user base. However, as the highest market capitalization blockchain network, its growth potential remains significant.

The infrastructure of the Bitcoin ecosystem is gradually improving, attracting more projects and investor attention. Projects based on the Lightning Network, such as OmniBOLT and the RGB protocol, will gain stronger development capabilities, while some Bitcoin Layer 2 projects compatible with Ethereum will also benefit from the ecosystem. In the future, the Bitcoin ecosystem will accelerate its development in areas such as payments, DeFi, and NFTs, covering more sectors and users.

References

https://bitcoin.org/bitcoin.pdf https://www.odaily.news/post/5187683 https://www.weiyangx.com/237032.html https://medium.com/@BTClayer2