Layer-2 Networks Mark The Dawn Of A New Golden Age For Bitcoin

Bitcoin is the indisputable king of the crypto realm, standing head and shoulders above the crowd in terms of its adoption, value, security, decentralization and recognition. As of May 2024, its market capitalization stood at more than $1.3 trillion, dwarfing the amount of money invested in any other cryptocurrency.

Its popularity stems from the fact that Bitcoin was the first-ever cryptocurrency to emerge. Created by Satoshi Nakamoto back in 2009, it’s often referred to as “digital gold”, celebrated for its anti-inflationary design and its rapid price increases over the years.

But despite its status, Bitcoin is far more basic than most other cryptocurrencies, with its utility limited to nothing more than a store of value, payments and “hodling”, where people simply hold it and hope the price goes up. Other cryptocurrencies do so much more, serving as the foundation for an alternative financial system known as DeFi that has opened the door to decentralized and uncensorable, peer-to-peer borrowing, lending, investing, yield farming and more.

Bitcoin holders want to see similar utility, and it’s easy to understand why. In December 2023, the amount of idle liquidity in Bitcoin amounted to almost four-times the value that existed in all of the DeFi apps, blockchain games, SocialFi platforms and NFTs that existed on every other blockchain platform in the industry, as this illustration from Spartan Research shows:

That capital is untapped because Bitcoin simply doesn't offer any easy way for holders to put it to work. Bitcoin’s lack of functionality stems from its design. It’s built using a more basic scripting language that doesn’t allow for innovations such as smart contracts. But as the value in the Bitcoin ecosystem has grown, so too have the demands of its users. Many of them are no longer satisfied with simply hodling their Bitcoin – they want to put their BTC to work, using it as an investment tool to grow their savings.

Enter Bitcoin L2s

The earliest Bitcoin Layer-2 networks emerged simply to solve the network’s scalability challenges. Bitcoin transactions have, for years, always been notoriously slow to complete, due to the design of its blockchain, which can only process 7 transactions per second. Scaling solutions such as Lightning Network emerged in the latter part of the 2010s to fix this, essentially bundling multiple transactions off-chain so they can be settled and processed as one, increasing the capacity of the network.

As the first L2s emerged, Bitcoin’s developers also got to work, improving its design with two notable upgrades, known as SegWit and Taproot.

SegWit was implemented in 2017, increasing Bitcoin’s block capacity and fixing a key security issue that potentially enabled transaction details to be modified before they were confirmed on the blockchain.

The more important upgrade was Taproot, which had the effect of making Bitcoin much smarter than it used to be. One of its key innovations was the introduction of smart contract capabilities, which paved the way for developers to create decentralized applications that can tap into the value and security of the Bitcoin network.

These upgrades opened the door to more revolutionary Bitcoin Layer-2s, which can not only process transactions off-chain but do much more. For example, Bitcoin L2s can now create new token standards, enabling the issuance of alternative Bitcoin-based cryptocurrencies. These networks also deliver much higher throughput, support the creation of Bitcoin NFTs and even “synthetic BTC” tokens that are pegged to the value of BTC, much like the stablecoins on Ethereum and other smart contract blockchains.

How Do Bitcoin L2s Work?

Bitcoin L2s all operate on the same principle, processing transactions off-chain to increase the capacity of the underlying L1 network. By creating L2s, it’s possible for users to perform thousands of transactions without needing to add every single one to the Bitcoin blockchain. Instead, they can just be bundled together and posted as a single transaction. Not only does this scale Bitcoin, but it also significantly reduces the transaction fees, which are shared by hundreds, if not thousands of users.

A number of popular mechanisms are used to create Bitcoin L2s. For instance, the Lightning network relies on state channels, which are encrypted payment channels that process hundreds of payments off-chain, reporting only the opening and closing balances of all of the wallet addresses involved.

Another technique is rollups, including optimistic and zk-rollups, which consolidate a series of transactions into a single piece of data that’s added to the blockchain on a periodic basis. Merlin Chain is a primary example of a Bitcoin L2 that uses rollups.

Third are independent chains , such as Stacks, which has a unique consensus mechanism that allows it to periodically settle its transactions on Bitcoin’s blockchain. Stacks connects to Bitcoin via a two-way bridge to support asset transfers between them, expanding the functionality of BTC.

Bitcoin’s Most Promising L2s

Merlin Chain 

Merlin Chain is a rapidly-growing Bitcoin L2 that relies on zk-proofs, a decentralized oracle network for off-chain data and on-chain anti-fraud components to improve Bitcoin’s capabilities.

It’s an EVM-compatible chain that can bridge to Ethereum and other networks, with support for multiple protocols including BRC-20, BRC-420, Stamps, Bitmap, Atomicals and more.

Merlin Chain officially launched its testnet in January 2024, and quickly followed with its mainnet just one month later, and has become an instant hit with BTC users, with its total value locked rising from nothing to an incredible $800 million by April of that year. It has gone from strength to strength since then, with its TVL rising to over $1.196 billion as of May 24, 2024.

The purpose of Merlin Chain is to provide a platform for the development of Bitcoin-native DeFi, GameFi, NFTs and more. Developers who build dApps on Merlin Chain will be able to leverage BTC assets, while its compatibility with Ethereum means they can also bridge any ERC-20 token easily, as well.

Merlin has only been around just over five month, but has already given rise to a lively ecosystem of Bitcoin-native dApps, including DeFi projects like BitGenie and bitSmiley, games such as Ascendant and Dragonverse Neo, wallets such as Nabox and SafePal, derivative trading platforms such as Deri Protocol, launchpads such as Merlin Starter and Lessgas, NFT projects such as Banana, and many more besides.

Stacks

A more recognizable platform building on the world’s oldest blockchain is Stacks, which was previously known as Blockstacks and brings smart contract-based dApps to Bitcoin.

Stacks is distinct from other Bitcoin L2s through its innovative consensus mechanism, proof-of-transfer, which enables it to connect directly to the Bitcoin blockchain, where all of its transactions are ultimately settled. This capability means Stacks can share Bitcoin’s strong security and decentralization, while also supporting native BTC in its dApp ecosystem

One of the main reasons for its popularity is that Stacks was the first project to bring DeFi-like utility to BTC, enabling Bitcoins to be staked and replaced with the native Stacks token, STX, which can then be used for fast and affordable transactions with almost instantaneous finality. Stacks is also notable for being the first token offering qualified by the U.S. Securities and Exchange Commission.

Stacks boasts a TVL of over $112 million, and its ecosystem is even bigger than Merlin’s, with over a dozen DeFi tools alone, including ALEX, Light Finance and Hermetica, social projects like the Ordinal News Standard and Frens, DAOs such as Quorum and communication platforms such as BitFari, to name just a few.

Rootstock

Another well-known Bitcoin L2 is Rootstock, which debuted in 2017 and is said to host the world’s most secure smart contracts. Like Stacks, it’s a sidechain that’s linked to Bitcoin by a “merged mining” mechanism. With this, miners secure and earn Rootstock’s native RSK token in addition to BTC, using a similar staking system to Stacks

Rootstock currently has a TVL of more than $190 million and has fostered the rise of a healthy ecosystem of projects including various NFT projects, Game-Fi, SocialFi and DeFi apps, plus payments services and stablecoins.

Babylon

Like Merlin Chain, Babylon is a relatively new Bitcoin L2 that introduces the ability to stake Bitcoin directly through its protocol in order to earn yield on what is otherwise an idle asset. Babylon’s Bitcoin Staking Protocol is designed in such a way that it enables proof-of-stake blockchains that struggle to attract liquidity to take advantage of the strength of Bitcoin’s secure network.

What’s especially innovative about Babylon is that it allows BTC holders to stake their coins without needing to bridge them to another chain or use a custodian. This is done via a trustless, self-custodial mechanism that enables stakers to validate transactions on third-party PoS chains and earn rewards.

Babylon’s protocol is attractive to PoS chains because many of them are unable to attract enough capital to their networks, which leaves them at risk of so-called 51% attacks. Because many PoS chains don’t have enough staked capital, it would be relatively easy for an attacker  to gain control of 51% of the network to manipulate transactions. Babylon offers these chains a way to attract additional capital from BTC holders, strengthening their overall security.

One of the attractive things for BTC holders, besides the yield, is that Babylon supports fast unbonding and scalable staking, providing greater flexibility. It’s possible for users to stake the same BTC tokens to multiple PoS chains at once, meaning they can earn multiple yields.

L2s Mean Bitcoin Will Always Be King

The crypto renaissance that began in the latter half of 2023 and accelerated in the new year has led to Bitcoin L2s gaining significant momentum. While it’s hard to tell if the L2s are contributing to that growth, or simply benefiting from it, it’s clear that they bring some major benefits to the Bitcoin network.

These days, L2s do so much more than just scale Bitcoin to enable cheap and fast transactions. They’re unlocking exciting new capabilities and paving the way for Bitcoin itself to become the foundation of a new generation of DeFi and Web3 applications and services.

Bitcoin’s dominance of the crypto industry has never really been under threat, contrary to the forecasts of many who claimed its lack of utility would eventually result in it giving way to more capable blockchains. Thanks to its L2s, Bitcoin is now able to match those capabilities, cementing its status as the king of crypto forevermore.