The next stop for Bitcoin is on the way: from digital gold to L2, from value storage to programmable platform

Authors: NOTDEGENAMY, RAM & JOMO

Compiled by: Deep Tide TechFlow

Introduction

In 2009, an anonymous individual named Satoshi Nakamoto released Bitcoin, the world's first decentralized cryptocurrency. It enables peer-to-peer currency transfers without intermediaries (such as banks).

Due to its early origins, anonymous founding team, extensive miner network, and lack of traditional funding methods, Bitcoin has become the most decentralized cryptocurrency. With no single controller, it is extremely difficult for malicious actors to rewrite transactions on the Bitcoin network. Even if collusion occurs among multiple individuals, coordinating an attack to compromise the network's accuracy is challenging due to its decentralization. To understand the degree of decentralization of Bitcoin, one can consider the Satoshi coefficient, which represents decentralization with a single number. This coefficient indicates the number of participants/nodes that control more than one-third of the entire network. The estimated Satoshi coefficient for Bitcoin is around 7000. As of this writing, the second most decentralized network is the Mina protocol, with a coefficient of 151. Other notable networks include Solana, with a coefficient of 18, and BNB with 7. Bitcoin's uniqueness lies in its exceptional decentralization.

In addition to decentralization, Bitcoin is also special due to its fundamental characteristics. The supply of Bitcoin is capped at 21 million BTC, making it an attractive hedge against inflation and economic instability. Therefore, Bitcoin is often referred to as "digital gold."

In summary, Bitcoin:

1. Simple functionality ------ it enables peer-to-peer currency transfers.

2. Decentralized ------ it far surpasses all other cryptocurrencies.

3. Secure ------ it is resistant to attacks, with security exceeding 15 years.

These factors have granted Bitcoin the highest level of regulatory transparency. It is classified as a commodity, indicating that institutions recognize its decentralized nature. Its ETF was also approved in January 2024, bringing Bitcoin into traditional financial markets.

The bottom line is: Bitcoin has established a baseline level of credibility, and this credibility continues to grow. If we can build applications on top of Bitcoin, they will benefit from the secondary effects.

However, this is not an easy task. Bitcoin was not originally designed to serve as a foundational layer for other applications.

First, transactions on Bitcoin are expensive and slow

If I send you 5 BTC, this transaction must be recorded on the Bitcoin network. More specifically, this transaction must (1) be included in the ledger, and (2) the updated ledger must be distributed to thousands of computers.** Including the transaction in the ledger requires numerous miners to compete to solve cryptographic puzzles to verify and confirm the transaction—this is a resource-intensive and costly process. Ensuring the distribution of the ledger also slows down the number of transactions we can process per second. Ordinary computers run by individuals do not have unlimited storage capacity. Here, we observe that Bitcoin's focus on decentralization leads to a trade-off between cost and speed.

Second, Bitcoin is not friendly to smart contracts

Suppose we want to do something more complex than peer-to-peer currency transfers. For example: we want to program a vending machine on the Bitcoin network. Based on the value of the input, the vending machine outputs a product, and the remaining quantity of products in the vending machine is continuously tracked by the Bitcoin network. This vending machine is similar to a smart contract: a set of rules that automatically execute based on specific trigger conditions.

Bitcoin does not directly support smart contracts, and this limitation stems from two intentional design choices.

1. Bitcoin uses a limited stack-based scripting language that is deliberately non-Turing complete, lacking advanced features such as loops and complex conditions. In other words, writing complex logic on Bitcoin is difficult. It only supports simple operations like digital signatures and time locks.

2. Bitcoin employs an Unspent Transaction Output (UTXO) model to track state—i.e., the current state of all information on the blockchain—which is efficient for tracking wallet balances but less efficient for tracking the state of other types of transactions.

These architectural decisions sacrifice programmability for security and predictability. Therefore, while Bitcoin excels in secure value transfer, it is very unfriendly to the complex state-dependent logic required to support smart contract applications. Networks like Ethereum later emerged as solutions to these limitations.

Early attempts to overcome these limitations—Segwit, Lightning Network, and Taproot

The first major upgrade to Bitcoin is known as Segwit, released in 2017. It allows Bitcoin transactions to be processed more quickly while enabling modifications to transaction IDs before blockchain confirmation. This makes it possible to securely batch process multiple transactions. Ultimately, multiple transactions occurring off the blockchain can be combined into one transaction and then stored on-chain.

This led to the first Bitcoin Layer 2 (L2), known as the Lightning Network, launched in 2018. L2 is a protocol that settles on the underlying L1 (in this case, Bitcoin is L1).

Here’s a brief explanation of what happens in the Lightning Network:

• If I send you 10 BTC, and you send me 5 BTC, there would typically be 2 transaction records. The Lightning Network creates a new mini ledger between the two parties. It settles the net result after a period (e.g., A sends B 5 BTC), reducing the transaction records on the main ledger from 2 to 1.

• The Lightning Network batches multiple transactions into one and records that single transaction on the Bitcoin blockchain. Although there are some trade-offs in decentralization, the Lightning Network offers significant flexibility. For small transactions, users benefit from its speed and lower transaction costs. Bitcoin's transaction fees are around $1, while the Lightning Network charges only $0.001 per transaction.

The Lightning Network increases speed but does not support programmability or other interesting application scenarios. Using the Lightning Network, I still cannot send you stablecoins and have that transaction secured by the Bitcoin network, let alone program smart contracts on Bitcoin.

The Taproot upgrade activated in 2021, laying the groundwork for smart contract programming on Bitcoin. Essentially, it relaxed the restrictions on the amount of arbitrary data that can be included in Bitcoin transactions.

Introduction of Ordinals

Thanks to Taproot, users can now inscribe data directly onto a single satoshi (100,000,000 satoshis equal 1 Bitcoin). More specifically, a satoshi can (1) be assigned a specific number for future reference, and (2) be inscribed with data such as text, images, or complex files. This process effectively transforms fungible satoshis into non-fungible satoshis, creating what is commonly referred to as non-fungible tokens (NFTs).

Ordinals have sparked mixed opinions.

On one hand, Bitcoin Ordinals can be considered superior to NFTs stored on other blockchains.

The reasons are as follows: When NFTs are stored on the Bitcoin network through inscription, the actual data—images, videos, etc.—is stored on the blockchain. In contrast, non-Ordinals NFTs typically store metadata/URL pointers on the blockchain rather than the actual data. Therefore, Ordinals are more resistant to censorship, link rot, and data loss.

On the other hand, many in the Bitcoin community believe that forcing Bitcoin nodes to download and store images wastes resources. Below is a famous Ordinals collection, the Taproot Wizards collection.

Some NFTs from the Taproot Wizards collection

In reality, Ordinals currently attract less attention compared to a few months ago. As shown in the chart below, the resources consumed in creating Ordinals have decreased, and the overall number of Ordinals created is also declining.

Efforts to create Bitcoin Ordinals have decreased over time (Source: Dune Analytics)

Concerns about whether Ordinals should occupy block space on the Bitcoin network are the main drivers of this slowdown, but it is worth noting that this is not a phenomenon limited to Ordinals. Due to market saturation, interest in NFTs may have declined.

This decline in enthusiasm is not unique to Bitcoin Ordinals—it's a downturn across the entire NFT space (Source: The Block)

So far, this article has repeatedly emphasized Bitcoin's focus on security and decentralization, which reduces its scalability. This is why Ordinals are criticized—many believe that images are not worth adding extra congestion to the Bitcoin network. This leads us to Bitcoin's L2.

Enter Layer 2s (L2s)

Understanding L2s

Before diving into Bitcoin-related content, it is essential to understand the basic concept of L2s. L2s can be confusing because different people have different definitions. In this article, we categorize L2s into two main types: sidechains and rollups. At Ocular, we believe rollups represent true L2s.

Sidechains

Sidechains are independent blockchains that do not settle their transactions on the main chain. In other words, not every transaction on L2 can be directly verified on L1.

Liquid Network is a good example of a Bitcoin sidechain. You can transfer BTC from the Bitcoin network to the Liquid Network via a bridge. This involves sending BTC to an address managed by "watchers"—a pool of about 65 trusted members elected by the community, including representatives from exchanges, financial institutions, and Bitcoin-related companies. Then, for each BTC transferred to this watcher-managed address, users receive a synthetic BTC called LBTC. This is a two-way pegged mechanism.

The security of the Liquid Network relies on these watchers and their ongoing reputation; the Liquid Network does not inherit security from Bitcoin L1. If most watchers collude or are attacked, the security of the sidechain may be compromised. The main benefit of the Liquid Network is that it helps parties needing fast and private transactions without completely leaving the Bitcoin environment—transactions are faster, and users can trade stablecoins and other tokens as well as LBTC on the network.

Rollups

We consider rollups to be true L2s because each transaction has a proof submitted to L1 as support; this proof can be directly verified on L1. In rollups, several transactions are rolled up into one transaction. Then, this transaction is submitted to L1 along with a validity proof. The validity proof states: "Hey, I have checked these transactions and can confirm they follow all the rules. You can check me and gain cumulative certainty. You don't need to check each transaction one by one!"

Illustration of the connection between L1 and L2 (Source: Limitless Insights)

Each transaction is protected by a verifiable proof, so rollups inherit high security from the Bitcoin blockchain, and we can consider them true L2s. Rollups that help make Bitcoin more programmable include MerlinChain, BOB, BEVM, Bitlayer, and Botanix.

Other Approaches

Stacks demonstrates a non-rollup, non-sidechain approach that still inherits a degree of security from Bitcoin L1.

How Stacks interweaves with Bitcoin: Stackers receive BTC, while Bitcoin miners receive STX, intertwining these two blockchains (Source: Stacks Documentation)

Stacks is essentially an independent blockchain that calls on Bitcoin miners to validate its blocks in exchange for rewards. However, Stacks does not publish any proofs or hashes on the Bitcoin blockchain, so it is not directly related to Bitcoin like rollups.

Other Exciting Programming Attempts on Bitcoin

B² Network

B² Network is a true L2 example that allows us to delve deeper into rollups. Transactions on B² are batched and generate a verifiable proof that demonstrates the correctness of the batch. This proof is then recorded on the L1 Bitcoin blockchain.

The proof used by B² is called zero-knowledge (zk) proof, which is generally considered the best implementation because it allows for on-chain verification of the batch's validity without revealing its contents. In simple terms, zk proofs ensure privacy. The B² Network is also compatible with the Ethereum Virtual Machine (EVM), meaning that code written for Ethereum can run the same applications on B². This makes B² attractive to developers.

L2s like B² expand the Bitcoin ecosystem by supporting user-facing platforms such as Master Protocol.

Master Protocol

Master Protocol is a financial platform within the Bitcoin ecosystem designed to facilitate interest rate swaps and yield farming for liquid staking tokens (LSTs) and other yield-generating assets.

Master Protocol improves liquidity in the Bitcoin ecosystem in several key ways:

1. Asset Aggregation: Master Protocol acts as an aggregator of users and assets, deeply integrated into the Bitcoin ecosystem. It consolidates various LSTs and yield-generating assets from different protocols and L2 solutions, creating a centralized liquidity hub.

2. Yield Market Platform: The core product of Master Protocol, Master Yield Market, packages Bitcoin ecosystem assets into Master Yield Tokens (MSY), which are then split into Master Principal Tokens (MPT) and Master Yield Tokens (MYT). This allows users to trade these tokens, creating yield markets and improving overall liquidity.

3. Simplified Access: Aggregating multiple assets and protocols simplifies user interactions within the Bitcoin ecosystem. Users can access yield opportunities from different protocols without constantly switching, increasing ecosystem participation and liquidity.

4. Liquid Staking and Re-staking: Master Protocol allows users to stake Bitcoin across various L2 networks and receive LSTs as staking receipts. These LSTs can be re-invested or further staked to earn liquid re-staking tokens (LRT), enhancing investment capabilities and asset liquidity without affecting the original stake.

5. Interest Rate Swaps: As an interest rate swap market, Master Protocol facilitates the trading of yield assets, helping to manage liquidity risk and optimize capital efficiency.

6. Ecosystem Synergy: As a one-stop yield trading center for the Bitcoin ecosystem, Master Protocol not only improves its adoption but also directs traffic and users to multiple Bitcoin ecosystem protocols, enhancing overall liquidity.

7. Fragmentation Solutions: Master Protocol helps address the fragmentation caused by the growth of Bitcoin L2 solutions, improving composability and operability within the Bitcoin ecosystem. The integration of various DeFi protocols and layer two solutions enhances overall liquidity flow.

As a central hub, Master Protocol connects Bitcoin enthusiasts with various applications, supporting the development of new applications and enhancing the overall utility of Bitcoin infrastructure. Additionally, it addresses the fragmentation caused by the growth of Bitcoin L2 solutions by improving composability and operability.

Babylon

Babylon is an innovative project aimed at extending Bitcoin's unparalleled security to various proof-of-stake (PoS) chains, particularly those within the Cosmos network.

By leveraging Bitcoin's robust proof-of-work (PoW) consensus mechanism, Babylon enhances the security of PoS chains through a process known as "re-staking." This involves locking Bitcoin on its network and using it to secure other PoS chains, providing economic security and allowing Bitcoin holders to earn staking rewards. The protocol employs advanced cryptographic techniques and consensus innovations to facilitate this process without complex smart contracts.

Babylon's architecture is based on the Cosmos SDK and is compatible with Inter-Blockchain Communication (IBC), allowing seamless aggregation and communication between the Bitcoin chain and other Cosmos application chains. By combining Bitcoin's security features with the flexibility of PoS networks, the Babylon protocol is expected to play a key role in the future of the Bitcoin ecosystem, driving a more secure, scalable, and interconnected blockchain ecosystem.

The Next Frontier of Bitcoin Programming and Areas of Focus

The Ocular team closely monitors applications built on Bitcoin and has identified the following areas as key focus points for innovative development:

1. More L2 Solutions: There is a need for improved L2s to enhance transaction speed and reduce costs while maintaining Bitcoin's security.

2. Smart Contract Platforms (remorachains): Initiatives like RSK (Rootstock) that enable Ethereum-style smart contract functionality on Bitcoin are becoming increasingly relevant. These platforms allow for the development of decentralized applications (dApps) and DeFi services on Bitcoin.

3. Cross-Chain Compatibility: Platforms that allow applications from other blockchains (such as Solana) to run on Bitcoin represent an exciting investment opportunity in the realm of blockchain interoperability.

4. DeFi on Bitcoin: As programmability increases, the potential for a robust DeFi ecosystem on Bitcoin is also growing. Projects focused on lending, decentralized exchanges, and stablecoins built natively on Bitcoin may be interesting investment areas.

5. Bitcoin Native Application Platforms: These platforms aim to enhance Bitcoin's programmability while maintaining its core principles of security and decentralization.

6. Zero-Knowledge Proof Technology (ZK-Proof Technology): Bitcoin projects implementing zero-knowledge proofs may offer enhanced privacy and scalability features, making them attractive investment prospects.

7. Custodial Solutions: As programmability increases, there will be a growing demand for secure custodial solutions to meet Bitcoin's expanding functionalities while adhering to the principle of "not your keys, not your coins."

8. Developer Tools and Infrastructure: As interest in Bitcoin programmability grows, there may be a surge in demand for developer tools, SDKs, and infrastructure to support this wave of new Bitcoin applications.

Conclusion

These areas represent the frontier of Bitcoin's evolution from a simple store of value to a more versatile and programmable platform. As the ecosystem develops, it may attract more developers, users, and investors, driving the next growth phase for Bitcoin and the broader crypto market.