What can we learn from Ethereum L2 on the eve of the Bitcoin Layer 2 explosion?

With the birth of the Ordinals protocol in 2023, Bitcoin, once known as "digital gold," has welcomed a brand new asset type—"inscriptions." If Bitcoin is akin to gold, then inscriptions are similar to products processed from gold, possessing unique value.

This native asset issuance method on the first blockchain quickly gained market popularity, not only giving rise to more asset issuance protocols like BRC20, Atomical, Runes, etc., but also leading to the emergence of well-known inscriptions such as ORDI and SATS, along with numerous native NFTs on Bitcoin.

In no time, the Bitcoin ecosystem experienced a resurgence, attracting a large influx of capital, users, and developers. However, after a period of development, the number of assets on Bitcoin has indeed increased significantly, and people have gradually recognized the limitations of Bitcoin as a Layer 1 solution. On one hand, Bitcoin itself does not support smart contracts, making it challenging to expand richer application scenarios relying solely on inscriptions.

On the other hand, Bitcoin's performance and miner fees have also become significant obstacles to the further development of the Bitcoin ecosystem. During the active period of inscriptions, Bitcoin's transaction fees surged rapidly, even beginning to affect normal transactions. Moreover, if more application scenarios truly emerge, it would further lead to network congestion and prolonged high miner fees.

Naturally, the wave of enthusiasm sparked by inscriptions quickly spread to the Bitcoin scaling track, opening up another hot avenue—Bitcoin Layer 2.

From Enthusiasm to Disillusionment: What Lies Ahead for Bitcoin Layer 2?

Some older Bitcoin scaling solutions have regained attention, while new Bitcoin Layer 2 projects are increasingly being proposed. Among them, the Bitmap Tech team, which has deeply explored the inscription direction and is famous for its nested protocol BRC420 on the Bitcoin chain, took the lead in launching a Bitcoin Layer 2 while the heat of inscriptions was still present. This led to the emergence of the now-famous Merlin Chain.

Merlin Chain went live in February 2024 and quickly launched the staking activity called Merlin's Seal. The staking targets included Bitcoin, some inscriptions, and assets like the BRC420 blue box, which triggered a surge in the blue box's value. Riding the wave of Bitcoin inscriptions, Merlin Chain garnered a significant amount of Total Value Locked (TVL) after the staking began (data source: https://geniidata.com/ordinals/index/merlin). Within less than 30 days of the activity's launch, the TVL surpassed $3 billion, peaking at $3.5 billion, making it a star project in the current Bitcoin ecosystem.

On April 19, the highly anticipated Merlin finally launched, with its token MERL peaking at 2 USDT, but it quickly fell back and continued to decline over the following weeks, now down over 80% and nearing its cost price, a performance that shocked many.

Shortly after the launch of MERL, on April 25, Merlin opened the BTC unlocking feature, leading to a steep drop in its TVL, which has now fallen to around $1.3 billion, a decrease of over 60%. The previously staked blue box, which was valued at around 1 BTC at its peak, plummeted to less than 0.05 BTC.

As a star project in the Bitcoin Layer 2 space, Merlin faced a dual crash in both token price and TVL after its launch, causing significant losses for many who actively participated in Merlin. This inevitably raised doubts about Bitcoin Layer 2: is it a genuine narrative of potential, or merely a fleeting topic of speculation?

In reality, the development of the entire blockchain industry is a continuous exploration between skepticism and recognition. For blockchain scaling, Bitcoin is not the only ecosystem exploring this path. Ethereum, as a veteran Layer 2, designed its scaling solutions early on and faced the necessity of scaling. However, Ethereum, which began exploring scaling solutions after Bitcoin, has seen a flourishing development of its Layer 2 solutions, indicating that there are lessons to be learned. We might as well look at the development of Ethereum's Layer 2 to envision the future of Bitcoin Layer 2.

Reflecting on Ethereum's Scaling Journey

1. Learning and Exploration

Ethereum's scaling solutions initially drew from Bitcoin's experiences, exploring methods like state channels, the Lightning Network, and sidechains.

State channels can be likened to a channel opened outside Layer 1 by two parties, A and B, who wish to transact. Within this channel, both parties can conduct numerous transactions without being affected by Layer 1's performance and fees. The need for continuous state updates is to upload the latest off-chain state to the Ethereum main chain as the final settlement basis to prevent malicious actions. This indeed significantly improves efficiency and reduces fees; for example, Connext Network explores this based on state channels.

However, its limitation lies in its applicability only to the two parties within the channel, requiring both to remain online and continuously update the state, or there is a risk of asset loss.

The Lightning Network is an iteration based on state channels. If state channels represent a line between two parties, the Lightning Network connects many lines to form a network, allowing A and B to connect through multiple channels even if they are not in the same channel.

The Lightning Network is essentially the network version of state channels. On Ethereum, it borrowed from Bitcoin's Lightning Network to launch the Lightning Network. However, the Lightning Network is an off-chain network and does not support smart contracts, primarily serving as a payment transfer mechanism. Additionally, the Lightning Network is not part of a blockchain network, and its nodes can be easily controlled by centralized entities, posing certain risks, so it still has many shortcomings.

Subsequently, sidechain technology was introduced to fill the gaps of the Lightning Network. It is a form of blockchain that can also run smart contracts, thus offering higher security and stronger scalability than the Lightning Network.

However, sidechains also bring new issues. Due to their independence, sidechains are only responsible for their own ledgers and only relay transaction results back to the main chain, which may lead to losses from malicious actions on the sidechain. For instance, if sidechain nodes tamper with transaction records or refuse to execute transactions, it could result in erroneous outcomes being relayed back to the main chain, thereby affecting system security and reliability. Therefore, sidechains face data availability issues and have not been widely recognized.

At this stage, Ethereum's scaling solutions were primarily based on Bitcoin's scaling ideas. However, after numerous attempts, Ethereum did not stop exploring and began to take more advanced steps.

2. A Ray of Hope

In 2017, Joseph Poon (one of the creators of the Lightning Network) and Vitalik Buterin proposed a new off-chain scaling framework for Ethereum—Plasma. Plasma referenced some designs from state channels and improved upon the shortcomings of sidechains by adopting a tree-structured architecture composed of many child chains forming a Merkle tree. Compared to sidechains, Plasma hashes all transaction records occurring in these Plasma child chains, generates a Merkle root, and relays it back to the main chain, allowing the main chain to supervise transactions on Plasma. This Merkle root contains summary information of all transaction records on the Plasma chain, enabling the main chain to verify the integrity and validity of these transactions, thus ensuring their legality and security.

Although Plasma seems to address some issues of state channels and sidechains, it still has certain data availability problems and cannot support smart contracts, leading to a bottleneck in its development.

Just when it seemed that a promising solution had fallen into a dilemma, a new solution quietly emerged a year after Plasma's birth, which triggered a massive explosion in Layer 2—Rollup technology.

While Rollup also utilizes Merkle trees and child chain structures, it differs from Plasma in that it packages and compresses all transaction records from the child chain before sending them to the main chain, rather than hashing them like Plasma. Nodes on the main chain can directly access and verify all transaction details, not just the hash summary, thus providing sufficient data availability and transparency, enhancing the system's credibility and security.

With the introduction of Optimistic Rollup, projects based on this technology, such as Optimism and Arbitrum, were launched one after another. Since OP Rollup resolved critical issues like child chain data availability and supported smart contracts, its security and functionality gained widespread recognition. Optimism and Arbitrum attracted a large number of developers and projects, and users and funds dared to participate deeply, rapidly building their ecosystems. Thus, Ethereum Layer 2 finally got on track and experienced an explosion.

3. A Flourishing Landscape

The success of Layer 2 solutions like Optimism and Arbitrum has also attracted more teams to explore different Layer 2 solutions. Strong technical teams may develop their own Layer 2 solutions, while others may wish to operate their independent Layer 2 but lack sufficient technology. This demand was first identified by the Optimism team. They launched the OP Stack, a tool that allows any team to easily deploy their own Layer 2 based on Optimism. Other teams developing their Layer 2 solutions also released their own Layer 2 deployment tools, such as Arbitrum's Arbitrum Orbit, zkSync's ZK Stack, and Polygon's Polygon CDK.

As a result, more Layer 2 demands have been uncovered, leading to a feast of Layer 2 solutions. Currently, there are over 50 Layer 2 projects listed on L2beat, and the development of Layer 2 has entered a flourishing phase.

On the other hand, mainstream Rollup solutions often face the issue of malicious behavior by sequencers. In Layer 2, sequencers are primarily responsible for ordering transactions that occur in Layer 2 according to certain rules, packaging them into blocks, and submitting them to the main chain for confirmation. Sequencers typically determine the order of transactions based on rules such as transaction fees and timestamps, ensuring the validity of the blocks.

However, since sequencers have the power to control the order of transactions, there is a risk of malicious behavior, where sequencers intentionally adjust the transaction order to gain more MEV profits. Therefore, some teams have begun exploring decentralized sequencer solutions to enhance the security and maturity of Rollup.

Looking back at the development of Ethereum's Layer 2, it is evident that Ethereum's scaling journey has not been smooth sailing, but it has been exploring towards greater decentralization, data availability, and security. Only when more secure and decentralized solutions reach a certain level will they gain wider recognition from funds and users, allowing for faster development.

In theory, Bitcoin's Layer 2 can also learn from Ethereum's Layer 2 development to find its own "chain." Similarly, it will flourish like Ethereum once security and decentralization reach a level widely accepted by the market.

So, what are the current Bitcoin Layer 2 solutions, and what new changes are worth paying attention to? Let us turn our focus back to the Bitcoin ecosystem, armed with the development experiences of Ethereum's Layer 2.

Dilemmas and Breakthroughs in the Bitcoin Ecosystem

1. Current Scaling Dilemmas of Bitcoin

Currently, we do not see many professional organizations or institutions entering the Bitcoin ecosystem in large numbers, primarily because the security and decentralization levels have not met the satisfaction of these professional players.

When we discuss the development of BTC Layer 2, the draft of the Lightning Network white paper was released as early as February 2015, marking the earliest "payment protocol" based on BTC and leading later thoughts on Layer 2 itself. However, as is well known, the Lightning Network does not support smart contracts, thus limiting the development of Bitcoin-related ecological applications on the Lightning Network, which can only serve as a payment extension path.

Subsequently, in 2016, a company particularly optimistic about building L2 on BTC secured $55 million in funding led by Tencent. This company later became well-known in the industry as "Blockstream," and their L2 product is called Liquid Network—an asset interaction solution with the Bitcoin main chain through a two-way peg technology, which is a relatively well-known BTC sidechain. However, Liquid's cross-chain solution is relatively centralized, using 11 certified multi-signature nodes to manage Bitcoin, making the overall solution resemble a permissioned consortium chain rather than a true public chain.

Alongside Liquid Network, there was another sidechain called RSK, which was released earlier, with its white paper published in October 2015, but it did not become the widely discussed solution it could have been and is hardly mentioned today.

In the same year, a developer named Giacomo Zucco proposed the initial concept of the RGB protocol based on Peter Todd's ideas. However, it wasn't until 2019 that Maxim Orlovsky and Giacomo Zucco established the LNP/BP Standard Association to promote RGB's practical application. Subsequently, in April of last year, they released RGB v0.10, which brought full support for smart contracts to Bitcoin and the Lightning Network. Only then did RGB complete its important "deployable" functionality, leading to the recent popularity of "RGB++." However, both RGB and RGB++ still have some distance to cover in terms of true deployability.

Of course, we cannot forget another important player—Stacks. As a Layer 2 that claims to truly support smart contracts and enable decentralized application development on Bitcoin, it has been a leading player in the BTC Layer 2 space since its launch in 2018. With the arrival of the "Satoshi Upgrade," it garnered significant attention in the industry, but recent delays in upgrades have dampened the excitement.

A more recent BTC Layer 2 solution is BitVM, proposed only last year. Its implementation method is similar to Ethereum's Optimistic Rollup, thus attracting considerable attention. However, BitVM's smart contracts operate off-chain, and each smart contract does not share state, while BTC cross-chain uses traditional hash locks for asset anchoring, failing to achieve true decentralized BTC cross-chain functionality.

From the above review, it is evident that BTC Layer 2 has actually been developing longer than Ethereum, and these attempts have been continuously validated. Later generations have built upon the shoulders of their predecessors, leading to the present day in 2024. This has made the development of BTC Layer 2 no longer a mere spark; we can see the current status of several mainstream BTC Layer 2 solutions and representative projects in the market, which clearly illustrate the current dilemmas (thanks to the netizen for the image).

According to publicly available information, this year, more than 10 BTC Layer 2 projects have secured funding, and this number is still growing, making it a star track. However, so far, there are very few BTC Layer 2 solutions that can truly stand out and gain public recognition. Many are either hindered by technical bottlenecks, facing development delays, or like Merlin, experiencing a high opening and low closing, leading to community complaints. Additionally, due to insufficient decentralization, large funds remain hesitant to invest, merely providing "cover" from the periphery.

As analyzed above, the success of ETH Layer 2 is attributed to its effective balance of "decentralization" and "native functionality," which has encouraged funds to enter the Layer 2 ecosystem, resulting in a flourishing effect. Currently, BTC Layer 2 is similarly in such a dilemma, urgently needing a breakthrough.

2. Possible Breakthrough Directions for the Bitcoin Ecosystem

Recently, the Bitcoin Hong Kong Conference has just concluded, and I had the privilege of attending to listen to the shares from well-known BTC Layer 2 figures in the industry. On one hand, I was attending the conference, and on the other, I was seeking answers to my doubts, hoping to find BTC Layer 2 directions that are more decentralized, have better data availability, and are more secure. Two emerging BTC Layer 2 projects that received widespread attention entered my view.

Firstly, at the event, I had an engaging conversation with a partner from BEVM. Although I had previously seen news about their funding from Bitmain and learned about Taproot Consensus through RGB research, I wasn't particularly clear about their team background and specific situation.

In fact, they created ChainX back in 2017, which brought BTC into Polkadot in a decentralized manner, attracting over 100,000 BTC into protocol interactions. However, due to the use of an 11-person multi-signature scheme to manage users' Bitcoin assets, there was a certain degree of centralization risk. Subsequently, with the famous Taproot upgrade for Bitcoin, which brought more efficient, flexible, and private transmission methods, the ChainX team saw a new way to build BTC Layer 2, leading to the current BEVM network based on Taproot Consensus.

According to official materials, BEVM achieves a trustless BTC network solution through Taproot Consensus, which consists of three core functions: First, Schnorr Signatures allow Bitcoin multi-signature addresses to expand to 1,000 (greatly enhancing security compared to ChainX's 11-person scheme), thus achieving decentralization of multi-signature addresses. Second, MAST enables the coding of multi-signature management, relying on code rather than human signatures. Finally, the Bitcoin Light Node Network drives multi-signature through consensus from the Bitcoin light node network, achieving fully decentralized Bitcoin cross-chain and management.

Logically, the implementation of Taproot Consensus does not resemble traditional sidechain methods or the popular RGB; it seems to open up a new technical implementation logic. Of course, I am not a professional technician and cannot judge from a technical superiority or code perspective, but at least I see a brand new solution. Additionally, the core developers of BEVM mentioned BEVM-Stack at the event, a concept somewhat similar to OP Stack, which sparked considerable discussion. After all, if a one-click Layer 2 deployment could be achieved on BTC, it might bring a new landscape to BTC Layer 2 development.

Another project frequently mentioned at the Hong Kong event is Mezo, which completed a $21 million Series A funding round in April, with impressive investors including Pantera Capital leading the round, along with Multicoin, Hack VC, Draper Associates, etc. It can be said to be a true representative of Western BTC Layer 2.

Mezo uses tBTC as its foundation, which has been a bridge connecting Ethereum and Bitcoin DeFi for several years. tBTC allows any user holding BTC or ETH to create tBTC through a signer network. Unlike previous solutions, the locked Bitcoin does not have a centralized custodian; instead, signers are randomly selected, and different signer groups are chosen for each minted tBTC. Signers provide collateral to ensure they cannot easily run away with the funds, while also ensuring the network operates normally through over-collateralization.

Thus, tBTC, as an equivalent value of BTC in ETH, acts as a bridge between Bitcoin and Ethereum. BTC holders can deposit BTC into a smart contract and receive tBTC. Mezo achieves BTC Layer 2 functionality through tBTC. Although it is innovative, it resembles a "technical patchwork." The team behind this funding is also the development team behind tBTC, Thesis.

Additionally, from the currently known information, Mezo's security assurance method still seems to rely on multi-signatures, which, in a sense, is not very decentralized and is worth discussing.

Of course, the trust issue surrounding BTC Layer 2 is a stumbling block to its development. Although the ancient saying goes, "to attack one's shield with one's spear," we cannot use others' strengths to belittle their weaknesses. From the perspective of industry development, how to enlarge the track and establish role models is the goal of any project. To put it another way, if BTC Layer 2 can achieve the effects of ETH Rollup, why worry about the ecosystem's development or the inability to reach a trillion-dollar scale?

Outlook

Despite recent macroeconomic changes impacting the cryptocurrency ecosystem and causing Bitcoin's market capitalization to fall to around $1.2 trillion, this does not hinder the industry's progress, nor does it diminish people's confidence in the development of the Bitcoin ecosystem. Although projects like Merlin seem to have set a "bad precedent" for the BTC Layer 2 track, this will not prevent people from continuing to build BTC Layer 2.

It is important to note that the development of ETH Layer 2 also faced numerous challenges, even requiring one or two bull markets to solidify this trend. However, once the technical direction and path are confirmed, its growth trajectory can be exponential. Currently, BTC Layer 2 is likely in this difficult uphill phase.

From a utility perspective, we need more ecological projects like BEVM that embody "trustlessness," "native functionality," and "greater security." We also need established players like Stacks to contribute fresh blood and innovative projects like Mezo to add value to the track. Only when a flourishing ecosystem emerges can BTC Layer 2 welcome a new spring.

"Pessimists are always right, while optimists always move forward." As long as we continue down the right path, we are likely to witness a true explosion in the Bitcoin ecosystem, rather than a fleeting speculative bubble. After all, the magic box of this trillion-dollar track has been opened, and what we can do, besides holding expectations, is to exercise more patience and perseverance.