Bitcoin Layers: What Are They & Why Do They Matter?
Bitcoin layers are playing an increasingly important role in the growth of the Bitcoin ecosystem.
Bitcoin layers help scale Bitcoin and bring more utility to the network. In this guide, you’ll learn about Bitcoin layers and the role they play in the growth of the Bitcoin ecosystem.
What Are Bitcoin Layers?
Bitcoin layers are secondary protocols, also known as layer-2 networks, built on top of the Bitcoin base layer to improve scalability.
Layer-2 (L2) networks optimize Bitcoin’s performance by processing transactions off the main chain. They also offer Bitcoin users extended functionalities like enhanced privacy, better smart contract programmability, and asset issuance.
While all Bitcoin layers process transactions off-chain to scale the base layer, they aren’t built similarly. Instead, each Bitcoin layer uses a unique and innovative design to scale Bitcoin.
Why Does Bitcoin Need Layers to Scale?
Bitcoin has always been focused on security and decentralization. However, that has come at the cost of a comparatively low transaction throughput. The Bitcoin network can process approximately seven transactions per second (TPS), resulting in higher transaction costs when network activity increases.
Furthermore, Bitcoin doesn’t support complex smart contracts due to the limited functionality of Bitcoin’s Script programming language. This limited programmability has hindered developers from building decentralized applications (dApps) directly on Bitcoin.
Although Bitcoin scalability could be addressed by modifying the core protocol, Bitcoin core developers prefer to keep upgrades minimal to preserve the network’s integrity.
This is where Bitcoin layers come in.
Bitcoin layers allow developers to implement scalability solutions without interfering with Bitcoin’s secure and decentralized nature. For this reason, layer-2 networks are the foundation for building diverse applications on Bitcoin.
However, the popularity of the Ordinals protocol has driven transaction fees higher, highlighting that layer-2s may be the most effective solution for unlocking new Bitcoin use cases.
Examples of Bitcoin Layers
Now, let’s take a look at some of the most exciting Bitcoin layer-2 protocols.
The Lightning Network (LN) is a Bitcoin Layer-2 scaling solution that enables cheap, near-instant transactions. Joseph Poon and Thaddeus Dryja introduced it in a 2016 paper that proposed using payment channels to process Bitcoin micropayments off-chain, thereby addressing Bitcoin’s scalability problem.
Using smart contracts, the Lightning Network creates a direct payment channel between two parties, allowing them to transact off-chain as often as they want. Users must fund the channel and sign off on fund spending. The final smart contract state is only broadcasted to the main chain when the channel is closed, enabling two parties to transact near-instantly, privately, and at minimal fees while the channel is open. As a result, the Lightning Network has become a popular solution for small bitcoin transactions.
The Liquid Network is a layer-2 sidechain that scales Bitcoin by enabling fast, large-volume transactions. It also permits users to settle transactions confidentially and issue assets. Liquid is a Blockstream project launched in 2018. Although Blockstream developed the network, it is governed by a Federation made up of financial institutions, exchanges, and other Bitcoin companies.
Liquid is connected to the Bitcoin network through a two-way peg system that permits users to move BTC from the main chain to Liquid and back. Users enjoy a fast 2-minute settlement time on Liquid.
To move funds from Bitcoin to Liquid, users send BTC to the Liquid client software and receive an equivalent amount of Liquid Bitcoin (L-BTC). The sent bitcoin is then locked on the Bitcoin network until a peg-out transaction is made to release it. Once BTC is unlocked, L-BTC is sent to a burn address, where it is permanently destroyed.
Liquid uses a consensus mechanism called Strong Federations. It also relies on functionaries to process transactions on the network and secure the locked BTC. Liquid suits exchanges, enterprises, and traders that desire high transaction throughputs and enhanced privacy.
Rootstock (RSK) is an EVM-compatible layer-2 sidechain that enables developers to write and deploy smart contracts using Ethereum’s Solidity language. It is secured by Bitcoin’s Proof-of-Work consensus protocol through merged mining, a process that permits miners to simultaneously mine blocks on the two networks using the same resources.
RSK connects to Bitcoin via a two-way peg. This allows users to convert BTC to Smart BTC (RBTC) and vice versa. Through a peg-in transaction, users can send BTC to a special address and get an equal amount of RBTC. RBTC is needed to pay gas fees when interacting with smart contracts on RSK. The BTC is locked on the Bitcoin network until a request is made via a peg-out transaction to release it. Functionaries facilitate peg-in and peg-out transactions.
Besides giving Bitcoin users enhanced smart contract functionalities, RSK offers fast payments by processing 10 to 20 transactions per second. It is suitable for building Bitcoin-secured DeFi applications. Rootstock was launched by RSK Labs in 2018.
Stacks is a Bitcoin protocol that brings smart contracts to Bitcoin, making it one of the most exciting Bitcoin layers for developers who want to build a wide range of dApps.
Like RSK and Liquid, Stacks has its own two-way peg token, sBTC, which Bitcoin backs in a 1:1 ratio. This token allows users to interact with smart contracts on Stacks by locking BTC on the Bitcoin network to acquire an equal amount of sBTC. Conversely, users can burn sBTC to unlock their BTC.
Besides the two-way peg, Stacks connects to Bitcoin through a consensus model called Proof-of-Transfer (PoX). This model allows Stacks miners to transfer BTC to mine STX (the network’s native token). The use of BTC by participants on the Stacks network effectively helps secure it. PoX also ensures that all Stacks blocks are settled on the Bitcoin base layer.
Stacks is one of the go-to networks for building DeFi applications and minting NFTs secured by the Bitcoin blockchain. Stacks uses microblocks to process approximately 19 transactions per second. The layer-2 protocol was introduced by Muneeb Ali in 2017.
The Benefits and Drawbacks of Bitcoin Protocol Layers
- Bitcoin layers unlock new use cases for Bitcoin users, such as DeFi.
- Bitcoin protocol layers offer faster transaction speeds than the base layer by processing transactions off-chain.
- They provide additional features like better privacy, asset issuance, and enhanced smart contract functionality.
- Bitcoin layers could promote centralization when network participants are limited to a small number. For instance, Liquid depends on only 15 functionaries to process transactions and secure the BTC locked on the base layer.
- Layer-2 networks may also face scaling challenges, especially when they rely heavily on the base layer. For example, Lightning opens and closes channels on the base layer, requiring potentially costly on-chain transactions to scale.
More & More “Building on Bitcoin” is Happening on Layer-2
The new features and functionalities added to the Bitcoin ecosystem thanks to Bitcoin layers are attracting an increasing number of builders (back) to Bitcoin.
While Bitcoin’s robust security is arguably the primary incentive encouraging more developers to build decentralized applications on Bitcoin layers, the ability to deploy more complex smart contracts and build web3 applications is very enticing for developers looking to build decentralized applications.
Bitcoin dApps currently cover the areas of finance, insurance, gaming, social, collectibles, data analytics, and identity management, highlighting the diversity of what can be built on Bitcoin layers.
As the Bitcoin layer-2 ecosystem continues to grow, we can expect more builders to come and build on Bitcoin.
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What’s the Difference Between Bitcoin Layer-1 and Layer-2 Protocols?
Bitcoin layer-1 refers to the Bitcoin blockchain. It has its own consensus mechanism and network participants in charge of confirming transactions and securing the blockchain.
On the contrary, layer-2 protocols are built on top of the Bitcoin layer-1 network and rely on its security. Their main goal is to scale the Bitcoin network by optimizing its performance. Each layer-2 protocol uses a unique design to achieve this goal.
What is Layer-1 vs Layer-2 Scaling?
Layer-1 scaling involves using on-chain solutions to address performance issues. These solutions are implemented by making changes to the core protocol. For instance, Bitcoin underwent the SegWit upgrade in 2017, which enhanced transaction data storage in blocks.
Conversely, layer-2 scaling solutions are designed to improve the base layer’s performance by processing transactions off-chain. This action saves block space on layer-1 and reduces network congestion.
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