What will the next Bitcoin macro narrative be?
In today’s most popular narrative, Bitcoin is the QE2.
It’s a gigantic ship, plodding along in one direction and pumping out vast quantities of diesel fumes as it chugs away. The underlying technology was cutting edge, once. Now it’s old and rusted. Surpassed by more exciting, more nimble fleets.
And so the famous ‘digital gold’ moniker has become an albatross around Bitcoin’s neck.
It’s a store of value. A rather boring part of essential portfolio allocation, nothing more. But there are some powerful forces working to alter this perception.
“It’s frustrating,” Alyse Killeen told Bloomberg’s Odd Lots podcast. She’s the founding partner at Bitcoin-centric venture capital fund Stillmark.
“We are seeing an explosion of technological advancement, both at the core protocol level, at the Lightning Network level and in sidechains.”
This much is true: on 1 May one of Bitcoin’s most significant technical upgrades was released: Bitcoin Core 0.21.1. This software includes the activation codes for a string of important updates, including the Taproot soft fork and Schnorr signatures. These are not just esoterically-named ephemera.
Schnorr signatures allow transactions on the Bitcoin blockchain to be verified much more simply than the current elliptic curve algorithm. They allows developers to add a swathe of add-on features, including off-chain smart contract execution. They also allow multiple parties to sign transactions as one, instead of each public and private key needing their own individual signatures. This saves space and improves scalability.
Taproot, which goes live in Novermber 2021, implements scripting efficiencies that allow for larger smart contracts: the relevant parts of a contract are only revealed when spending occurs. Hiding the back-end code in this way is another way to improve privacy, speed and scalability. It is slated to be even more important for Bitcoin’s mass ecosystem development than the Segwit soft-fork in 2017.
“It’s disappointing to me to hear that it feels like that sort of work has been overlooked as a result of the hype around altcoin DeFi,” says Stillmark.
Killeen dismisses what she calls ‘altcoin DeFi’ as a distraction to what she sees as the truly important and exciting thing happening in the space. That Bitcoin adoption will see it used by billions of people — not tens of thousands of traders — that include corporations, governments, municipalities and populations for its original purpose, as an alternative payment method.
“It’s interesting to see folks making money in a quick way and it attracts media attention. On the Bitcoin side what’s happened it has been declared legal tender in El Salvador – and we see folks using BTC on a daily basis through the Lightning Network. Bitcoin is held on the balance sheet of multiple public companies.
“I’ll take a conservative position and say I think this adoption is much more important than a set of trading tools for tens of thousands of folks but perhaps the media runs behind it a bit. Bitcoin has been growing in terms of adoption at a more rapid clip than the internet did at a comparable time.”
On that final line, crypto fans do love this comparison. The underlying blockchain, whether Bitcoin or Ethereum or anything else is the fundamental base layer, Layer 1, like the application layer in TCP/IP that allows computers to be networked together so they become a string of machines sharing information.
Layer 2 protocols are the later applications like email and HTTP that sit on top, interacting with Layer 1 so data can be moved around and information confirmed, but ultimately, they shift processing power away from the base layer.
On Ethereum, Layer 2 technologies like zk-Optimistic rollups and sharding help applications process far more information far more quickly than if the base Layer 1 is used for the same computing task. The net result, there, is a far lower latency, a vast reduction in bottlenecks for processing transactions and lower gas costs for end users.
Bitcoin’s headline Layer 2 tech is the Lightning Network.
And El Salvador is certainly its first real-world testing ground. That much is correct.
Copper covered the early iteration of Lightning Network back in August 2019. At that point, we reported, there were 4,000 active nodes supporting 31,000 payment channels. As of 19 July, Lightning Network has 23,112 active nodes with 57,608 live channels. By those metrics, over the course of nearly two years, the Lightning Network has barely grown at all.
The way Bitcoin is set up is that miners secure the network and maintain the golden copy of the transaction ledger. For expending this energy they are rewarded by being allowed to choose which transactions they include first. SImple economics dictate that miners will choose the transactions that offer the largest fee per byte. Unconfirmed transactions sit in a data buffer called the mempool waiting to be picked up by miners.
If Bitcoin’s Layer 2 was working well, the number of transactions sitting in Bitcoin’s mempool waiting to be confirmed should be falling, right?
Extreme variance in the size of the mempool makes drawing conclusions a little difficult. In 2021 so far, the lowest daily total was 266 unprocessed transactions, on 7 July 2021. The highest was 132,612 on 17 April. But by taking a 30-day average we can at least tease out very general trends.
The dream — realistic or not — is that Bitcoin payments will become as fast as sending an email. It will take milliseconds, not minutes.
Imagine you are standing at the till in Starbucks, with a familiarly long queue forming behind you. You buy your pumpkin spice latte, tap the merchant machine and pay with Bitcoin. If you must now wait 10-15 minutes while your transaction sits in the mempool waiting for a miner to pick it up, accept your fee — which will be as small as you can possibly make it? Next time you want coffee you are likely to try to avoid the tutting behind you and the pained smile of the barista, and choose a much faster payment method.
Moving processes away from the Bitcoin’s main chain does shorten the queue of unconfirmed transactions. But can Lightning Network — which according to explorer 1ML has a current network capacity of $60m (1,880 BTC) — really help move the billions of dollars of transacting value around the world?
Layer 2 to Layer 3
Stillmark continues: “Everything that’s possible in other protocols is possible in Bitcoin and also more. An example of that would be Lightning Network, but products being built on Lightning Network include financial chat products like Sphinx – a Layer 3 tech that takes advantage of Lightning Network to create this Bitcoin-native financial chat.
With Sphinx, both messages and sats (fractions of a bitcoin) are sent through Lightning Network nodes. You can also make and receive calls in the same way.
So instead of talking about crypto on Reddit or Twitter, you login to Sphinx and do all of your gossiping and analysing on the Bitcoin blockchain. The application is filtered through these layered technologies that sit on top of the base layer, interacting with Layer 1 for security but taking all of the processing power away from it so that everything else — the processing of transactions and whatnot, can continue undisturbed and unclogged.
There are podcasters and some content creators now building audiences on Sphinx chat. Stillmark likens it as a competitor to WeChat which is quite the bold claim. China’s gargantuan mobile app, released in 2011, now has over 1.2 billion monthly active users. It of course includes mobile payments which in this instance are replaced by Lightning Network nodes.
The other Layer 2 tech that is interesting for Bitcoin is Bitcoin DeFi.
Around 10% of the major applications tracked by DeFiPrime are built on Bitcoin. This number has not moved higher in the last 12 months and this provides more evidence for the anti-Bitcoin-maximalists, that developers are just not that interested in building out Bitcoin’s app ecosystem, when Ethereum, Solana or Polkadot are so much more flexible and useful.
“There are founders building things to rival the best of what’s been built on altcoin DeFi that will be released on Bitcoin sidechains by the end of the year,” Stillmark says.
The Bitcoin Core software upgrades mentioned above, Schnorr and Taproot, enable much more functional use of smart contracts on Bitcoin.
Applications like Stacks could be key here.
It’s very definitely not a Layer 2 Bitcoin-native project, as its founder repeatedly points out, nor a Bitcoin sidechain, but a parallel chain that settles on Bitcoin and is a sovereign system in its own right. It uses a novel consensus mechanism called Proof of Transfer which is too complicated to get into here, but in a nutshell has fully-functional smart contracts with up to $1bn in aggregate value.
With its use of a new Bitcoin-friendly smart contract language called Clarity, this could rival Ethereum’s Solidity. The key thing to note here is that Stacks greatly expands Bitcoin’s scripting language and as a bridge to Bitcoin, brings a whole host of new use cases to bear.
“My expectation is that we will see a Uniswap-like protocol being built in a Stacks-like environment,” says Stillmark.
In the public imagination, Bitcoin cannot do smart contracts. That’s only possible on Ethereum with its Virtual Machine. But the public are wrong.
It remains to be seen if enough non-Bitcoin devs can be tempted back to the mothership to make new apps and help BTC take over the world. What is certain is that this mission is now more attractive than it has been at any point in history.