Caliber May 14, 2024

Bitcoin's Layer 2 Overview

In the intricate landscape of financial technology, Bitcoin stands as a beacon of innovation, a digital currency that sidesteps the conventional financial mediators, enabling unmediated, peer-to-peer exchanges. However, with its rise comes a series of inherent challenges, most notably those tied to scalability and transaction throughput — important obstacles on the path toward more widely applicable.

These challenges aren't unique to Bitcoin, Ethereum - although also designed with flexible application development capabilities - also has similar problems. And many solutions have been proposed to solve this problem for both, such as side-chains, layer 2, or payment channels networks. With Ethereum, the layer 2 ecosystem is rapidly expanding, with diverse solutions like EVM rollups, sidechains transitioning to rollups, and projects striving for various degrees of decentralization and security. The security implications of layer 2 solutions, particularly focusing on asset guarantees and the ability of these systems to read and adapt to changes in the Ethereum blockchain. It underscores a key trade-off: higher security often comes at the cost of scalability and cost efficiency. [1]

While Bitcoin has made impressive progress in improving its features, it still faces some significant challenges in developing Layer 2 (L2) solutions similar to those found in Ethereum. Bitcoin's design limitation is particularly clear when it comes to ensuring withdrawal security within Bitcoin's Layer 2 solutions. It's scripting language is intentionally limited in functionality, lacking Turing completeness, which restricts its ability to perform complex computations and support advanced functions. This design choice prioritizes Bitcoin's security and efficiency but limits its programmability compared to more flexible blockchain platforms like Ethereum. And the probabilistic finality also can undermine the reliability and speed essential for layer 2 solutions, potentially leading to issues like chain reorganizations that affect transaction permanence. Despite Bitcoin being built on principles that make it reliable and secure, these aspects make it hard for its L2 systems to quickly adapt to new changes.

SegWit and Taproot are game-changers for Bitcoin. SegWit optimized Bitcoin’s infrastructure by segregating signature data, enhancing transaction speed and enabling the Lightning Network’s rapid payment processing. Following this, Taproot introduced efficiencies and privacy enhancements by compacting transaction data and masking transaction complexities. Together, SegWit and Taproot have ignited a new wave of Layer 2 innovations, becoming the backbone for future Layer 2 designs and significantly expanding Bitcoin's functionality beyond its original scope as a digital currency.

Further technical details on SegWit and Taproot can be found in the Appendix.

Understanding Bitcoin's layer 2 solutions

Bitcoin L2 trilemma

In Bitcoin's expanding universe of Layer 2 solutions, we see many different systems emerging, all designed with the intention of enhancing scalability and increasing adoption in various ways. These solutions offer unique approaches to overcome Bitcoin's built-in limitations. One way to categorize these solutions, as introduced by Trevor Owens [2], involves organizing them based on their approach to addressing the Bitcoin L2 trilemma, which segments L2 solutions into Off-Chain Networks, Decentralized Sidechains, and Federated Sidechains, each presenting unique approaches and trade-offs:

• Off-chain networks prioritize scalability and privacy but pose user experience challenges.

  • e.g., Lightning & RGB

• Decentralized sidechains introduce new tokens and consensus mechanisms, expanding functionality but potentially complicating user experience and raising centralization concerns.

  • e.g., Stacks, Babylon, Interlay etc.

• Federated sidechains streamline operations through a trusted consortium, offering efficiency at the possible cost of Bitcoin's foundational trustlessness.

  • e.g., Liquid, Rootstock, Botanix

This trilemma provides a useful way to categorize Bitcoin layer 2 solutions, but it might not fully capture all the complex details of their design. Additionally, it points out the trade-offs of current solutions instead of unresolvable barriers, showing that these elements of the trilemma are part of the decision-making process for developers.

For instance, Decentralized sidechains issue new tokens to increase security and boost network participation, which could make user interactions more complex and might not be welcomed by Bitcoin purists. On the other hand, Federated sidechains choose to skip new tokens, making the user experience smoother and reducing pushback within the Bitcoin community. Another option is to use a full VM/global state, which allows for complex functions, including the creation of new tokens on a smart contract platform. However, this approach makes the system more complicated and typically increases its vulnerability to attacks.

Technical classification

From another technical viewpoint, we group Bitcoin layer 2 solutions based on their main technical features. This different way of categorizing them looks into various technical details and structures, offers a nuanced understanding of how each solution contributes to the overarching goal of enhancing Bitcoin's scalability, security, and functionality. Each approach has its distinct purpose, and these purposes do not conflict with one another, nor do they create a trilemma. However, each approach has its own set of advantages and disadvantages concerning security and scalability. Therefore, some systems may utilize a combination of these approaches. We will discuss this in more detail in the next section of the article. Let's explore these categories:

• Sidechains utilizing 2-Way pegged protocol: These sidechains work like a layer 2 connected to Bitcoin through a method called two-way pegging. This setup enables the transfer of Bitcoins between the main blockchain and the sidechain, enabling both experimentation and the implementation of features not directly supported on the main blockchain. This method improves Bitcoin’s ability to handle more transactions and different types of applications by supporting a wider range of uses. The two-way peg mechanism plays a critical role in transferring BTC value to the sidechain. On these sidechains, developers set up various environments; some choose to use an EVM-compatible ecosystem, while others opt to create a VM environment with their own smart contracts.

  • e.g., Stacks, Rootstock, Liquid, Botanix,…

• Blockchain rollups: This method uses Bitcoin as a data storage layer for rollup techniques, inspired by the Inscription protocol. In this setup, each UTXO acts like a small canvas where more complex information can be written. Think of it as if each Bitcoin could store its own set of detailed data, this not only adds value but also broadens the types of data and assets that Bitcoin can handle. It opens up a wide range of possibilities for digital interactions and representations, making the Bitcoin ecosystem richer and more varied.

  • e.g., B2 network, BitVM

• Payment channels networks: Think of these as a network of express lanes within the broader Bitcoin landscape. They help speed up numerous transactions on Bitcoin's side roads, reducing congestion and ensuring that transactions are both fast and cost-effective.

  • e.g., Lightning & RGB

By breaking it down this way, we get a clearer picture of how each tool helps improve Bitcoin, making it more scalable, secure, and versatile. Let's dive in and get to know these tools a little better:

2-Way Pegged Protocols:

A 2-way peg allows assets to be transferred between two distinct blockchains—often a mainchain and a sidechain. This system enables assets to be locked on one chain and subsequently unlocked or minted on another, maintaining a fixed conversion rate between the original and pegged assets.

Understanding the Peg-In Process

Envision initiating a journey where your assets from the mainchain (like Bitcoin) are to be transferred to a sidechain. The peg-in process is your starting point. Here, your assets are securely locked on the mainchain, akin to depositing them in a vault for safekeeping. Subsequently, a transaction is crafted on the mainchain to solidify this lock. The sidechain, recognizing this transaction, mints an equivalent amount of pegged assets. This process is akin to receiving a voucher of the same value in a foreign land, enabling you to use your wealth in a new context while ensuring that your original assets remain intact and secure.

Navigating the Peg-Out Process

When you decide to revert your assets to the original mainchain, the peg-out process comes into play. This is the return journey where the pegged assets on the sidechain are metaphorically 'burned' or locked away, signifying that they are set aside and no longer in circulation on the sidechain. You then provide proof of this action to the mainchain. Once the mainchain verifies your claim, it releases the equivalent original assets back to you. This mechanism ensures the integrity and balance of asset distribution across both blockchains, safeguarding against duplication or loss.

Implementations of Two-Way Peg Systems:

Rootstock:

RSK's 2-way peg system is an advanced framework designed to seamlessly integrate Bitcoin with smart contract capabilities via RSK's platform. By utilizing SPV for efficient transaction verification, employing a robust federated model for transaction approval, and integrating SegWit and Taproot, RSK not only enhances its transaction efficiency but also closely aligns with Bitcoin’s security model. Moreover, the merge mining approach increases the security level of the system and incentivizes more miner participation.

• RSK federated model:

  Pegnatories, a select group of functionaries, are the guardians of this bridge or the custodians of trust in this federated model, ensuring that every peg-in and peg-out adheres to the agreed protocols. Picture them as a council of guardians, each holding a key to a collective vault. Their role is crucial—they ensure that every transaction crossing the bridge does so with integrity and consensus, maintaining a secure and orderly flow of digital assets across this vital passageway.

• Segwit and Taproot:

  SegWit helps by separating the signature information from the transaction data, which reduces transaction sizes and improves processing times. Additionally, combining the Schnorr signature scheme with MAST (Merkelized Abstract Syntax Trees) and other enhancements from Taproot could make transactions even more efficient and private.

• RSK merge mining:

  In RSK's merge mining approach, miners concurrently secure both the Bitcoin and RSK networks without additional computational demands, thereby boosting RSK's security. This method utilizes Bitcoin's mining strength, offering miners extra rewards and showcasing an innovative use of existing blockchain infrastructure. However, the success of this integration depend on accurately aligning the tags within Bitcoin blocks to correspond with RSK blocks, underlining the necessity for detailed and precise execution to uphold the security and consistency of the interconnected networks.

Botanix:

Botanix integrates a combination of a Proof of Stake (PoS) consensus layered on Bitcoin foundation and a decentralized EVM network Spiderchain multi-signature architecture to manage Turing-complete smart contracts off the main Bitcoin blockchain. While Bitcoin serves as the main settlement layer, Botanix ensures transaction integrity using advanced multi-signature wallets and cryptographic verifications off-chain.

• Spiderchain: A distributed network of multisigs that secures all the actual Bitcoin on Botanix.

  • Architecture: Spiderchain formed by a group of Orchestrator nodes - node runners and liquidity sources for the entire chain. It consists of a sequential array of multi-signature wallets that manage the custody of assets within the network. Each wallet in the series requires multiple Orchestrator approvals for any transaction, ensuring there is no single point of failure.

  • Dynamic operation: For each new Bitcoin block, the corresponding Orchestrators for the upcoming 'epochs' (a term used to define the periods between Bitcoin blocks in the Botanix system) are determined using a verifiable random function based on the Bitcoin block hash. Subsequent slot selections for Orchestrators are calculated by hashing the block hash with SHA256, then applying modulo arithmetic with the number of active Orchestrators (N) to ensure fairness and randomness in Orchestrator selection. This ensures fair and secure distribution of operational tasks, minimizing centralization risks.

• Two-way peg system: Multi-signature wallets play a crucial role here, requiring consensus among selected Orchestrators to execute any transactions.

  • Peg-in process: Users send Bitcoins to a new multi-signature wallet where they are securely locked. This action mints an equivalent amount of synthetic BTC on the Botanix chain. Creating this wallet involves several Orchestrators, they must all agree and sign off, making sure no one can control the wallet independently.

  • Peg-out process: Conversely, for peg-outs, synthetic BTC is burned, and the corresponding Bitcoins are released from the multi-signature wallets back to the user’s Bitcoin address. This process is secured by the same multi-signature protocol, requiring several Orchestrators to approve the transaction.

• PoS consensus and EVM implementation:

  • Consensus: In Botanix’s PoS system, Orchestrators stake their Bitcoin to participate in the network. They are responsible for validating transactions and creating new blocks within the Botanix chain. The selection process for these Orchestrators is based on their stake and is randomized using the method mentioned in the Spiderchain section.

  • EVM implementation: The EVM on Botanix supports all operations compatible with Ethereum, enabling developers to deploy and execute complex smart contracts.

Stacks:

Stacks platform aims to scale Bitcoin's infrastructure by enabling smart contracts and decentralized applications (dApps) through innovative mechanisms such as the sBTC two-way peg, Proof of Transfer and Clarity smart contracts.

• sBTC two-way peg protocol:

  • Threshold signature wallet: This wallet utilizes threshold signature schemes that require a predefined subset of signers (Stackers) to collaboratively sign pegging transactions. These Stackers are chosen using a Verifiable Random Function (VRF) based on the amount of STX they have locked up and rotate every cycle (typically two weeks), ensuring dynamic membership and continual alignment with the network's current state. This significantly enhances the security and robustness of the pegging mechanism by preventing dishonest behaviors and potential collusion among participants, while also ensuring fairness and unpredictability in the selection process.

• Proof of Transfer (PoX):

  • In PoX, instead of burning Bitcoin as in Proof of Burn, miners transfer BTC to participate in the Stack network, contributing to security by leveraging Bitcoin's robust proof of work system. This not only incentivizes participation through BTC rewards but also directly ties Stacks' operational stability to Bitcoin's proven security properties. Stacks transactions anchor to Bitcoin blocks, with each Stacks block recording a hash in a Bitcoin transaction using the OP_RETURN opcode, which allows embedding up to 40 bytes of arbitrary data. This mechanism ensures that any alterations to Stacks' blockchain would require corresponding changes in Bitcoin's blockchain, thus benefiting from Bitcoin's security without necessitating any changes to its protocol.

• Clarity:

  • Clarity, the smart contract programming language used on the Stacks blockchain, ensures predictability and security for developers by enforcing strict rules that guarantee all operations are executed as defined, without unintended outcomes. It offers decidability, where the outcome of every function is known before execution, preventing surprises and enhancing contract reliability. Additionally, Clarity makes direct interactions with Bitcoin transactions, allowing the development of complex applications that leverage Bitcoin's robust security features. It also supports traits for modularity, similar to interfaces in other languages, which aid in code reuse and maintain clean code bases.

Liquid:

The Liquid Network offering a federated sidechain to the Bitcoin protocol that significantly enhances transaction capabilities and asset management. Central to the Liquid Network's architecture is the concept of Strong Federations [6], which consists of a consortium of trusted functionaries responsible for block validation and signing.

• Watchmen: Watchmen manages the peg-out process from Liquid to Bitcoin, ensuring each transaction is authorized and valid.

  • Key management: The Watchmen's hardware security modules safeguard the keys needed for authorizing transactions.

  • Transaction Validation: Watchmen validate transactions through cryptographic proofs that confirm adherence to Liquid’s consensus rules, utilizing multi-signature schemes for enhanced security.

• The Peg mechanism:

  • Peg-Ins: Bitcoins are locked on the Bitcoin blockchain (by using multisig address of Watchmen) and equivalent Liquid Bitcoins (L-BTC) are issued on the Liquid sidechain using cryptographic methods to ensure accuracy and security in the transfer.

  • Peg-Outs: The process involves the burning of L-BTC on the Liquid sidechain, with the corresponding release of actual bitcoins on the Bitcoin blockchain. This mechanism is closely monitored by designated functionaries known as Watchmen to ensure only authorized transactions proceed.

• Proof of Reserve (PoR): a critical tool developed by Blockstream for providing transparency and trust regarding asset holdings on the network. PoR involves creating a Partially Signed Bitcoin Transaction that demonstrates control over funds. This transaction, although not valid for broadcast on the Bitcoin network, proves the existence and control of the reserves claimed. It allows entities to prove possession of funds without moving them.

Babylon:

Babylon is designed to integrate Bitcoin into the Proof-of-Stake (PoS) ecosystem by allowing Bitcoin holders to stake their assets to enhance the security of PoS chains, leveraging Bitcoin's vast market capitalization without the need for direct transaction or smart contract capabilities on the Bitcoin blockchain. Importantly, Babylon avoids the complexities and security risks of bridging by not attempting to move or lock Bitcoin through vulnerable bridges or third-party custodians, thus preserving the integrity and security of staked assets.

• Bitcoin-timestamping:

  • Babylon employs a timestamping mechanism that embeds PoS chain data directly into the Bitcoin blockchain. By anchoring PoS block hashes and critical staking events onto Bitcoin’s immutable ledger, Babylon provides a historical timestamp that is secured by Bitcoin’s extensive proof-of-work. The use of Bitcoin’s blockchain for timestamping not only leverages its security but also its decentralized trust model. This method ensures an additional layer of security against long-range attacks and state corruption across interconnected blockchains.

• Accountable assertions:

  • Babylon utilizes accountable assertions to manage staking contracts directly on the Bitcoin blockchain, allowing the system to expose a staker’s private keys in the event of misbehavior, such as double signing. The design uses chameleon hash functions and Merkle trees to ensure that assertions made by stakers are cryptographically linked to their stakes, enabling automatic slashing. This approach enforces protocol integrity through cryptographic accountability, where any deviation by a staker, such as signing conflicting statements, results in the deterministic exposure of their private key, thus triggering automated penalties.

• Staking protocol:

  • One of the significant innovations in Babylon is its staking protocol, which allows for rapid adjustments in staking allocations based on market conditions and security needs. This protocol supports fast stake unbonding, enabling stakers to quickly move their assets without the long lock-up periods typically associated with PoS chains. Moreover, the protocol is built as a modular plug-in, compatible with various PoS consensus mechanisms. This modular approach allows Babylon to provide staking services to a broad range of PoS chains without requiring significant modifications to their existing protocols.

Payment Channels & Lightning network:

Payment Channels are tools designed to enable multiple transactions between two parties without committing all of them to the blockchain immediately. Here’s how they streamline transactions:

• Initiation*: A channel is opened via a single on-chain transaction, creating a multisig wallet shared by the two parties.*

• Transaction process*: Inside the channel, parties transact privately with instant transfers, adjusting their respective balances without broadcasting to the blockchain.*

• Closure*: The channel is closed by another on-chain transaction that settles the final balances, based on the most recent mutually agreed transaction.*

Exploring the Lightning Network:

Building on the idea of Payment Channels, the Lightning Network extends these concepts into a network, allowing users to send payments across the blockchain through connected paths.

• Routing: Like finding a route through a city using backroads, the network finds a path for your payment, even if you don’t have a direct channel open with the final recipient.

• Efficiency: This interconnected system significantly reduces transaction fees and processing times, making Bitcoin practical for everyday transactions.

• Smart Locks (HTLCs): The network uses advanced contracts called Hashed Timelock Contracts to secure payments across different channels. It’s like making sure your delivery passes through several checkpoints securely before reaching its destination. It also mitigates the risk of intermediary default, making the network reliable.

• Security Protocol: In case of any disagreement, the blockchain acts as a judge to verify the latest agreed-upon balance, ensuring fairness and security.

Taproot and Segwit have turbocharged the Bitcoin network and also particularly benefiting the Lightning Network with enhanced privacy and efficiency:

• Taproot is like an aggregator for Bitcoin transactions—it bundles multiple signatures into one. This not only keeps off-chain transactions tidy but also makes them more private and cheaper.

• Segwit changes how data is stored in Bitcoin transactions, makes a block can contain more transactions. For the Lightning Network, this means opening and closing channels is cheaper and smoother, further reducing fees and improving transaction throughput

Inscription-based Layer 2 Solutions:

Inscriptions have sparked a new wave of innovation in the Bitcoin layer 2 ecosystem. With the advent of two groundbreaking updates (Segwit & Taproot), the Ordinals protocol was introduced, enabling anyone to attach additional data to UTXO's Taproot script, up to 4MB. This development has led the community to realize that Bitcoin can now serve as a Data Availability layer. In terms of security, inscriptions provide a fresh perspective. Data, like digital artifacts, are now stored directly on the Bitcoin network, making them unchangeable and safeguarded against tampering or loss from external server issues. This not only enhances the security of digital assets but also embeds them directly into Bitcoin's blocks, ensuring they are permanent and reliable. Most importantly, Bitcoin rollups have become a reality, with inscriptions providing a mechanism to incorporate extra data or functionalities within transactions. This allows for more complex interactions or state changes to happen off the main chain while still being anchored to the main chain's security model.

Implementations of Inscription-based Layer 2 Solutions:

BitVM:

BitVM utilizing a combination of optimistic rollup technology optimistic rollup technology and cryptographic proofs in it's design. By moving Turing-complete smart contracts off-chain, BitVM significantly enhances transaction efficiency without compromising security. While Bitcoin remains the foundational settlement layer, BitVM ensures transaction data integrity through clever utilization of Bitcoin's scripting capabilities and cryptographic verifications off-chain. Currently, BitVM is being actively developed by the community. [9] Additionally, it has also become the platform for several top-tier projects, such as Bitlayer [7] and Citrea [8].

• Inscription-like storage approach:

  BitVM utilizes Bitcoin's Taproot to embed data within Tapscript, similar to the concept of the Inscription protocol. This data typically includes important computational details such as the virtual machine's state at different checkpoints, the hash of the initial state, and the final computation results. By anchoring this Tapscript in an unspent transaction output (UTXO) stored in a Taproot address, BitVM effectively integrates transaction data directly onto the Bitcoin blockchain. This approach ensures the durability and immutability of the data while benefiting from Bitcoin's security features to protect the integrity of recorded computations.

• Fraud proofs:

  BitVM ensures the security of its transactions using fraud proofs. Here, a prover commits to the output of a computation for specific inputs, and this commitment isn't executed on-chain but rather verified indirectly. If a verifier suspects a commitment to be false, they can challenge it by providing a concise fraud proof that leverages Bitcoin's scripting capabilities to demonstrate the commitment's incorrectness. This system significantly reduces the blockchain's computational load by avoiding full on-chain computation, aligning with Bitcoin's design philosophy of minimal transaction load and maximum efficiency. Central to this mechanism are hashlocks and digital signatures, which secure claims and challenges and link them to the actual off-chain computational work. BitVM adopts an optimistic verification approach—operations are presumed correct unless proven otherwise, which enhances efficiency and scalability. This ensures that only valid computations are accepted, and anyone on the network can independently verify their correctness using the available cryptographic proofs.

• Optimistic rollups:

  BitVM employs optimistic rollup technology to significantly enhance Bitcoin’s scalability by batching multiple off-chain transactions for collective processing and validation. In practical terms, BitVM processes these transactions off-chain and intermittently records their outcomes on the Bitcoin ledger to ensure integrity and availability. The use of optimistic rollups in BitVM represents an approach to overcoming Bitcoin's inherent scalability limitations by leveraging off-chain computation capabilities while ensuring that transaction validity is maintained through periodic on-chain verification. This system effectively balances the load between on-chain and off-chain resources, optimizing both security and efficiency in transaction processing.

Overall, BitVM is not just another Layer 2 technology but represents a potential foundational shift in how Bitcoin could scale and evolve. It offers unique solutions to Bitcoin’s limitations but still requires further development and improvement to fully realize its potential and gain wider adoption within the community.

B2 network:

The B2 Network stands out as the first zero-knowledge proof verification commitment rollup for Bitcoin, utilizing rollup technology and zero-knowledge proof to enhance transaction speed and minimize costs. This setup allows for Turing-complete smart contract execution for off-chain transactions, significantly boosting efficiency. Bitcoin acts as the fundamental settlement layer for the B2 Network, where B2 rollup data is stored. This setup enables the full retrieval or restoration of B2 rollup transactions using Bitcoin inscriptions. Moreover, the computational validity of B2 rollup transactions is verified through zero-knowledge proof confirmations on Bitcoin.

• Important role of Inscriptions:

  The B2 Network leverages Bitcoin inscriptions to embed additional data within a Tapscript, which includes vital information like the storage path of rollup data, merkle tree root hash of the rollup data, zk proof data, and the parent B2 inscription UTXO hash. By writing this Tapscript into a UTXO and sending it to a Taproot address, B2 effectively embeds rollup data directly onto the Bitcoin blockchain. This approach not only ensures the permanence and immutability of the data but also utilizes Bitcoin's robust security mechanisms to protect the integrity of the rollup data.

• Zero-knowledge proofs for enhanced security:

  B2's commitment to security is further exemplified by its use of zero-knowledge proofs. These proofs enable the network to validate transactions without exposing the details of those transactions, thus preserving privacy and security. In the context of B2, the network breaks down computational units into smaller ones, each represented as a bit value commitment in a tapleaf script. These commitments are linked in a taproot structure, providing a compact, secure method for verifying transaction validity on the Bitcoin and B2 network.

• Rollup Technology for Scalability:

  At the heart of B2's architecture is the rollup technology, specifically ZK-Rollup, which aggregates multiple off-chain transactions into a single one. This method significantly increases throughput and reduces transaction fees, addressing two of Bitcoin's most pressing scalability issues. The B2 Network's rollup layer processes user transactions and generates corresponding proofs, ensuring the transactions are valid and finalized on the Bitcoin blockchain.

• Challenge-response mechanism: In the B2 Network, after transactions are batched and verified using zk-proofs, there's an opportunity for nodes to challenge these batches if suspected of containing invalid transactions. This critical phase leverages the fraud proof mechanism, where challenges must be conclusively resolved before the batch can proceed. This step ensures that only transactions validated as legitimate advance to final confirmation. The batch is confirmed on the Bitcoin blockchain if no challenges arise or existing challenges fail within the specified time lock. On the other hand, if any challenge is validated, the rollup is subsequently reverted.

Final thoughts:

The good:

• Unlocking DeFi markets: By enabling functionalities like smart contracts through EVM-compatible layer 2 solutions, Bitcoin can tap into the multi-billion dollar DeFi market. This is not only about expanding Bitcoin's utility but also about unlocking new financial markets that were previously accessible only through Ethereum and similar programmable blockchains.

• Widening use cases: More than just financial transactions, these Layer 2 platforms support a range of applications in sectors like finance, gaming, NFTs, or identification system,… thus expanding Bitcoin’s use cases far past its original scope as a simple currency [3, 4, 5].

The bad:

• Risk of centralization: Some of the mechanisms involved in some Layer 2 solutions could lead to increased centralization. For instance, in mechanisms that require a value of BTC to be locked up, unlike Ethereum’s Layer 2 solutions, the interaction from Layer 2 back to Bitcoin is not secured by Bitcoin's security model. Instead, it relies on a smaller decentralized network or a federation model, potentially weakening the trust model's security. This structural difference could introduce points of failure not present in decentralized models.

• Increased transaction fees and blockchain bloat: Data-heavy uses like Ordinals and other inscription protocols can lead to blockchain bloat, slowing down the network and increasing transaction costs for all users. This can lead to higher costs and slower transaction validation times, impacting the efficiency of the network.

• Complexity and user experience: The technical complexity of understanding and interacting with Layer 2 solutions can be a significant barrier to adoption. Users need to manage additional elements such as payment channels on the Lightning Network or handle different token types on platforms like Liquid.

The ugly:

• Regulatory and ethical concerns: The immutability of these inscriptions, while a technical strength, also raises potential regulatory and ethical issues. This poses significant challenges if the data is illegal, unethical, or simply erroneous, leading to permanent consequences without recourse.

• Impact on fungibility: If certain Bitcoins are "tagged" with non-financial data, it could affect their fungibility—where each unit is supposed to be indistinguishable from another—potentially leading to a scenario where some Bitcoins are less valuable or acceptable than others.

References

1. Buterin, V. (2023, October 31). Different types of layer 2s. Vitalik.eth.limo. https://vitalik.eth.limo/general/2023/10/31/l2types.html

2. Owens, T. (2023, November 1). Understanding the “Bitcoin L2 Trilemma.” Bitcoin Magazine - Bitcoin News, Articles and Expert Insights. https://bitcoinmagazine.com/technical/understanding-the-bitcoin-l2-trilemma

3. Nelson, J. (2024, April 4). Bitcoin Layer-2 Social Network Offers Rewards for “Touching Grass” in NFT Game. Decrypt. https://decrypt.co/224764/bitcoin-layer-2-social-network-touching-grass-nft-game

4. Crypto.com. (2023, May 3). Bitcoin’s Expanding Ecosystem: Layer-2, DeFi, NFT. Crypto.com. https://crypto.com/research/bitcoin-ecosystem-layer2-defi-nft

5. Nelson, J. (2024, May 2). MicroStrategy Is Building “Decentralized ID” on Bitcoin Using Ordinals-Like Inscriptions. Decrypt. https://decrypt.co/229087/orange-decentralized-identity-ordinals-inscriptions-microstrategy

6. Dilley, J., Poelstra, A., Wilkins, J., Piekarska, M., Gorlick, B., & Friedenbach, M. (2017, January 30). Strong Federations: An Interoperable Blockchain Solution to Centralized Third-Party Risks. ArXiv. https://doi.org/10.48550/arXiv.1612.05491

7. Chainwire. (2024, April 3). BitVM-Based Bitlayer, a Leading Bitcoin L2, Nets $5M in Funding, Unveils $50M “Ready Player One” Program. Chainwire. https://chainwire.org/2024/04/03/bitvm-based-bitlayer-a-leading-bitcoin-l2-nets-5m-in-funding-unveils-50m-ready-player-one-program

8. Citrea Team. (2024, March 21). Unveiling Clementine - Citrea’s BitVM Based Trust-Minimized Two-Way Peg Program. Citrea · Blog. https://www.blog.citrea.xyz/unveiling-clementine/

9. Rsync. (2024, May 9). Rsync25/awesome-bitvm. GitHub. https://github.com/Rsync25/awesome-bitvm

10. Poon, J., & Dryja, T. (2016). The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments. https://lightning.network/lightning-network-paper.pdf

11. Stacks Team. (2024, February 2). Whitepapers | Stacks Documentation. Stacks.co. https://docs.stacks.co/stacks-101/whitepapers

12. Tas, E. N., Tse, D., Gai, F., Kannan, S., Maddah-Ali, M. A., & Yu, F. (2022). Bitcoin-Enhanced Proof-of-Stake Security: Possibilities and Impossibilities. ArXiv:2207.08392 [Cs], 126–145. https://arxiv.org/abs/2207.08392g

13. Lerner, S. D. (2019, January 29). RSK Bitcoin Powered Smart Contracts. Rootstock. https://rootstock.io/rsk-white-paper-updated.pdf

14. Nick, J., Poelstra, A., & Sanders, G. (2020). Liquid: A Bitcoin Sidechain. https://blockstream.com/assets/downloads/pdf/liquid-whitepaper.pdf

15. B2 team. (2023, November 14). B2: The most practical bitcoin layer-2 network. B2 Network. https://www.bsquared.network/B2.pdf

16. Botanix Team. (2023). Botanix protocol: An EVM equivalent Layer 2 on Bitcoin. https://botanixlabs.xyz/en/r/whitepaper

17. Linus, R. (2023). BitVM: Compute Anything on Bitcoin. https://bitvm.org/bitvm.pdf

18. Babylon Team. (2023). Bitcoin Staking: Unlocking 21M Bitcoins to Secure the Proof-of-Stake Economy. https://docs.babylonchain.io/papers/btc_staking_litepaper(EN).pdf

Appendix

Key technical aspects of SegWit and Taproot

SegWit:

• Reduction in txs size: SegWit reduces transaction size by restructuring the transaction data, separating the signature data (witnesses) from the transaction inputs. This results in a smaller transaction size while ensuring that the transaction identifier (TxID) remains unchanged even if the witness data is modified.

• Increased block capacity: SegWit introduces a new concept called "block weight", by calculate 2 seperated part:

  • Non-witness data: This includes all the transaction details except for the signatures. It is counted normally, just like in the old format.

  • Witness data (signatures): This is where SegWit makes a fundamental change. Witness data is given a quarter weight - meaning it only counts as one-fourth of its actual size in the block weight calculation.

The "block weight" system allows a block to carry more data than the nominal 1MB limit would suggest. By reducing the weight of signature data, the total block weight can include up to 4MB of data while still being classified as 1MB under the block size limit. This arrangement significantly increases transaction throughput by fitting more transactions into each block without exceeding the traditional block size limit set by the Bitcoin network.

Taproot:

Taproot is like adding an extra boost to what SegWit already does. It brings in the Schnorr signature scheme and combines it with Merkelized Abstract Syntax Trees (MAST) along with some other improvements to make things even better. But remember, Taproot or Tapscript doesn't introduce Ethereum-style smart contracts because Bitcoin Script has its limits. It sticks to Bitcoin's design of being straightforward and secure at its core.

• Schnorr signature scheme: This scheme is not only shorter than the ECDSA signatures used pre-Taproot but also allow for the aggregation of multiple signatures into one.

• MAST Integration: By using MAST, Taproot allows for the potential conditions of transactions to be hidden unless they are actually triggered. This means that complex script executions can be made indistinguishable from standard transactions on the blockchain, significantly enhancing privacy and reducing transaction sizes.

Role of SegWit and Taproot in Bitcoin's Layer 2s:

The Inscription Protocol on Bitcoin employs a data storage technique called "envelope," which is a non-executable Bitcoin script that utilizes structures like OP_FALSE, OP_IF, and OP_ENDIF to wrap and secure data without triggering script execution. By not executing, envelopes do not consume any computational resources on the blockchain, thus helping to reduce the load and potential congestion on the network.

Based on SegWit and Taproot upgrades, these envelopes can embed up to 4MB of arbitrary data in a single transaction by maximizing the utilization of the witness space. This is achieved through multiple OP_PUSH commands, each capable of carrying up to 520 bytes. Taproot further contributes by simplifying transaction complexity and enhancing privacy through techniques like signature aggregation, which have the ability to combine multiple signatures into one to reduce transaction size and improve privacy.

Overall, these technological integrations in the Inscription Protocol demonstrate Bitcoin’s evolution toward a more scalable and flexible blockchain infrastructure while maintaining network efficiency and stability.