One of the hottest narratives in 2024 is BTC Layer 2, from sidechains to the highly hyped inscriptions. Curious about the differences between them? This article has the answers you’ve been looking for!
Bitcoin Layer2 TL;DR
- Bitcoin Layer 2 solutions are secondary protocols on the Bitcoin blockchain designed to improve scalability, transaction speeds, and reduce costs. Some also add smart contract capabilities. SegWit and Taproot upgrades have advanced solutions like the Lightning Network and the inscription ecosystem. Additionally, various execution layers are enabling complex smart contracts within the Bitcoin ecosystem.
- There are five operational mechanisms for BTC Layer 2: sidechains, state channels, client verification and single-use seals, inscriptions, and rollups. This indicates a lack of a relatively unified scalability solution, unlike Ethereum.
- In conclusion, for years, BTC has served as digital gold. Recently, Rollup projects have aimed to boost BTC’s productivity, challenging Ethereum’s dominance. However, they often mimic Ethereum without fully adopting BTC’s decentralization and security due to verification issues. The market is chaotic, with some projects copying solutions and fraudulently raising funds as BTC L2. Careful evaluation is crucial to avoid FOMO-driven pitfalls.
What Are Bitcoin Layer 2?
Bitcoin layer-two solutions (Bitcoin L2s) are secondary protocols designed to operate on top of the primary Bitcoin blockchain. Their main goal is to tackle scalability challenges, enhance transaction speeds, and lower transaction costs.
Additionally, some Layer-2 solutions introduce smart contract functionalities, thereby broadening Bitcoin’s range of applications. By implementing these Layer-2s, Bitcoin can achieve better overall performance while still leveraging its robust security and extensive network effects.
In summary, the benefits of these Layer-2 solutions for Bitcoin include:
- Increased scalability by addressing Bitcoin’s limitations in transaction throughput, block confirmation times, and transaction fees.
- Advanced programmability through the integration of sophisticated smart contract functionalities.
- Maintained high-level security provided by the Bitcoin network, as the foundational layer remains unaltered.
- Broadened capabilities for Bitcoin, enabling new applications in areas such as payments, DeFi, NFTs, and other market sectors.
The Origins of Bitcoin Layer 2: Why Bitcoin Needs Scalability Solutions and the Key Upgrades Before Layer 2
While Layer 2 solutions are widely recognized and utilized within the Ethereum ecosystem, with examples like Arbitrum and Optimism, the concept of Layer 2 was first proposed and adopted on the Bitcoin blockchain.
Bitcoin, launched in 2009, was designed with a primary focus on security and decentralization, using a minimalist approach to enable peer-to-peer transactions.
Initially, Bitcoin was considered highly efficient and fast, especially for international transactions. However, as the network grew, its scalability issues became apparent, leading to a significant decline in transaction throughput. This resulted in high fees, longer confirmation times, and decreased overall network performance, posing potential obstacles to Bitcoin’s widespread adoption in the future.
To address these inherent issues, two significant upgrades were introduced, paving the way for many of the expansion solutions we see today.
The first upgrade, SegWit, was implemented in 2015 to tackle the network’s transaction congestion problems, notably increasing block capacity. The second upgrade, Taproot, was first proposed in 2018 and comprised three different BIP proposals: BIP340, BIP341, and BIP342. Taproot aimed to enhance privacy, simplify transaction verification, increase efficiency, and improve the handling of complex smart contracts.
In summary, the SegWit and Taproot upgrades have significantly boosted the development and emergence of two major expansion solutions: the Lightning Network and the inscription ecosystem (such as BRC-20 and ARC-20). Furthermore, to overcome the limitations in implementing complex smart contracts, various execution layers with different approaches have started to integrate into the Bitcoin ecosystem.
The 2024 Boom of Bitcoin Layer 2
Some may wonder why there is a narrative of a BTC Layer 2 boom in 2024. The explanation can be broadly divided into two parts.
Since its inception in 2009, Bitcoin has faced few challenges in asset issuance and expansion for three main reasons. First, Bitcoin purists, or “BTC OGs,” view it as “digital gold” and resist any expansion that could compromise security. Second, Bitcoin was designed as an electronic payment system prioritizing security and stability, leading Satoshi Nakamoto to adopt a minimalist design.
This design includes a basic, non-Turing-complete scripting language to ensure the network’s safety. Third, the creation of the Ethereum Virtual Machine (EVM) by Vitalik Buterin enabled Turing-complete public chains, drawing developers and fostering a thriving blockchain ecosystem beyond Bitcoin.
Additionally, in 2024, the approval of the Bitcoin ETF led to a new all-time high for BTC. With the ongoing popularity of inscriptions and the maturation of modular concepts, Layer 2 projects on Bitcoin are experiencing significant growth. These projects, similar to Ethereum’s Rollups but utilizing various construction methods, are gaining traction and expanding the Bitcoin ecosystem.
Introduction to the Main Operation Mechanism of Bitcoin Layer 2
Unlike Ethereum’s Layer 2 solutions, which typically follow a standardized approach with Rollups as the common framework, Bitcoin’s Layer 2 lacks a consistent definition and method. If we regard any scalability solution as Layer 2, they can be broadly classified into five distinct categories based on their implementation techniques.
| Categories | Pros- solutions | Cons- challenges | Cases |
| Sidechains | Asset issuance/Smart contract support for DeFi | Centralization and lack of main chain security | Stacks/Liquid/RSK/Drivechain |
| State Channels | Enabling low-cost, fast, and scalable transactions while ensuring security | Slow progress and channel complexity can cause uncertainties | Taproot Assets |
| Client Verification & Single-use-seals | Full decentralization without intermediaries | Slow progress and non-interactive smart contracts | RGB Protocol |
| Inscriptions | Token contract creation (Deploy)/Token minting (Mint)/DeFi and other apps | Centralization issues, mainnet space usage, and fragmentation | Ordinals Protocol (BRC-20)/Atomicals Protocol (ARC-20) |
| Rollup | Aim to combine on-chain security with off-chain efficiency | No project can perfectly replicate Ethereum Rollup verification methods | Merlin Chain/BitVM/Spectra Chain |
Sidechains
The first comprehensive technical paper on Bitcoin sidechain solutions was published by Blockstream researchers in 2014, though this approach was later abandoned. In 2016, Blockstream proposed pegged sidechains as a way to extend Bitcoin. Sidechains, often called trust-minimized blockchains, are independent chains connected to the main chain via two-way cross-chain bridges.
They enable payments with external cryptographic assets and offer benefits such as user asset issuance, stateful smart contract support for DeFi, chain expansion, faster settlement finality, and enhanced privacy. Sidechains typically use their own consensus mechanisms and independent validators. Assets must be locked when moving from the main chain to the sidechain and unlocked when returning, with validators ensuring the legality of these transfers.
However, potential drawbacks include centralization risks due to a small number of nodes and not inheriting the main chain’s security.
State Channels
State channels, introduced in 2015 by Joseph Poon and Thaddeus Dryja in the Lightning Network protocol, enable off-chain transactions for cost-effective, rapid, and scalable processing. Transactions take place off-chain and are only recorded on the Bitcoin main chain when the channel is closed, easing the main chain’s load while preserving security.
Transactions are signed by the participants and recorded on-chain only for dispute resolution. However, state channels face limitations such as slow progress and the inability of smart contracts to interact with each other.
Client Verification & Single-use-seals
In traditional blockchain systems like Bitcoin and Ethereum, the entire network of nodes collectively verifies transactions and smart contracts, a process known as “full node verification.” In 2016, Bitcoin Core developer Peter Todd proposed client verification, which mimics traditional contract signing for better privacy, ensuring only the involved parties know the contract’s content.
This method achieves full decentralization without third-party involvement. Todd also introduced the concept of single-use-seals, which is relevant to the RGB protocol. Verification involves off-chain data storage, on-chain commitment, and client verification. However, challenges include slow development and the inability of smart contracts to interact with each other.
Inscriptions
In January 2023, Bitcoin developer Casey Rodarmor unveiled the Ordinals protocol, a Bitcoin-based asset issuance system comprising two core elements: Ordinals theory and Inscription. This protocol assigns unique identifiers to each of the 21 trillion Satoshis, Bitcoin’s smallest unit, by embedding content into Unspent Transaction Outputs (UTXOs).
The process is comparable to encoding data into witness fields and recording token details in JSON format as BRC20. Verification necessitates indexers to extract and validate JSON data, ensuring it complies with protocol standards. However, drawbacks include centralization risks with indexers, potential transaction balance discrepancies, mainnet space usage, and significant fragmentation.
Rollup
Rollup is a Layer 2 scalability solution intended to enhance the performance of blockchain networks such as Ethereum by shifting most transaction data and computations off-chain, only recording summaries on-chain.
This approach merges the security of on-chain operations with the efficiency of off-chain processes. However, Bitcoin cannot inherently verify Data Availability (DA), so current methods use special techniques like inscribing DA onto the mainnet or using Taproot address matrices for verification. Each project’s structure is distinct and varied. Drawbacks include the inability to exactly replicate Ethereum’s Rollup verification, leading to theoretical models or compromises, resulting in a diverse market.
Key Differences Between Bitcoin and Ethereum Layer 2 Solutions
The differences between Bitcoin and Ethereum Layer 2 solutions primarily stem from their original design goals. Vitalik Buterin’s creation of the Ethereum Virtual Machine (EVM) enabled Turing-complete public blockchains and programmability, attracting many developers and fostering a thriving blockchain ecosystem beyond Bitcoin.
As a result, Layer 2 solutions in the Ethereum ecosystem are highly developed and widely adopted, as reflected in the significant TVL (Total Value Locked) gap between Bitcoin and Ethereum Layer 2s.
Besides, Ethereum Layer 2 projects primarily aim to scale the network’s efficiency. In contrast, Bitcoin Layer 2 projects have two main goals: scaling network throughput and expanding applications.
Although Bitcoin doesn’t have a native virtual machine like Ethereum, Bitcoin Layer 2 projects are creating execution layers with virtual machines, some similar to Ethereum’s EVM. This approach indirectly equips the Bitcoin network with the capability to run smart contracts and other applications, bringing it closer to the functionality of newer blockchains.
| TVL | Major purpose | Main market types | |
| Bitcoin Layer 2s | ~ 43B | To increase speed, lower costs, and enhance programmability | State channels and sidechains |
| Ethereum Layer 2s | ~$2.7B | To boost speed and cut costs | Sidechains and rollups |
Debates Surrounding Bitcoin Layer 2
The debates around BTC Layer 2 focus on whether these solutions align with Bitcoin’s original purpose.
Initially, discussions about Bitcoin centered on its potential to replace legal tender and its use in payments. However, this conversation has evolved to include ecosystem applications, influenced by Ethereum’s shift in user perceptions towards public blockchains. Two major viewpoints have emerged: one group believes Bitcoin should remain purely a store of value, while the other contends that Bitcoin needs an ecosystem and can outperform Ethereum in this regard.
Market situation on Bitcoin Layer 2
Despite ongoing debates, the Bitcoin Layer 2 ecosystem continues to thrive and expand, albeit with some signs of decline. Let’s examine two prominent and relatively dynamic projects to highlight this trend.
Firstly, there is Merlin Chain, the first to conduct a TGE among the new Bitcoin Layer 2s, excluding Stacks. With eighteen protocols, it stands out as one of the BTC Layer 2 solutions with the most extensive ecosystem. Merlin achieved its highest volume and TVL between March and May; however, the chart indicates a continuous decline in volume, suggesting reduced on-chain activity. Additionally, TVL growth has stagnated, and negative net inflows imply that users may be exiting the platform.
Next, we turn to Stacks. The surge in TVL and volume occurred between December 2023 and April 2024. However, there has been a sharp drop in volume since January 2024, which may indicate declining user activity. Despite this, TVL has continued to grow, suggesting that users are still committing assets to the platform, possibly for staking or other long-term investments.
In summary, applying the Pareto principle, this analysis may indicates that the narrative of BTC Layer 2 is gradually declining compared to early 2024. However, the situation varies for each project, so it is crucial to do your own research.
Outlook on Bitcoin Layer 2
Continuing from the last paragraph, the BTC Layer 2 market may be declining. An expert on Twitter, @mononautical, has provided some advice on the surge of BTC Layer 2 in 2024 and offered insights on how to identify projects that may carry risks.
- If your Bitcoin L2 doesn’t support unilateral exit, it’s not truly L2—it’s just a multisig.
- If your Bitcoin L2 has VC investors and its own token, it’s not truly L2—it’s a pump-and-dump shitcoin.
- If your Bitcoin L2 offers “reciprocal rewards” based on your friends’ deposits, it’s not truly L2—it’s a pyramid scheme.
- If your Bitcoin L2 is backed by an upgradeable Ethereum contract controlled by a single company, it’s not truly L2—it’s a rug pull waiting to happen.
- If your Bitcoin L2 offers rewards for locking up your coins as long as possible, it’s not truly L2—it’s Hex 3.0.
- If your Bitcoin L2 claims to be Bitcoin-native but is actually just an Ethereum multisig, it’s not truly L2—it’s an affinity scam.
- If your Bitcoin L2 has no whitepaper or technical details, just 20 pages of documentation on depositing BTC and calculating future yields, it’s not truly L2—it’s Bitconnect in disguise.
All in all, for years, BTC has functioned as digital gold, serving as a store of value. Recently, Rollup projects have challenged Ethereum’s dominance (OP, ARB, Zks, Stark) to make BTC a productive asset.
However, these projects often mimic Ethereum without fully adopting BTC’s decentralization and security values, mainly due to verification challenges. The market is chaotic, with some projects copying solutions (like SatoshiVM) and fraudulently raising funds as BTC L2. Amidst this BTC gold rush, careful project evaluation is essential to avoid FOMO-driven pitfalls.
Top Bitcoin Layer 2 Networks
After understanding the surge of BTC Layer 2 and how they operate, let’s take a look at some dominant projects!
Merlin Network
Merlin is a Bitcoin-native, EVM-compatible Layer 2 rollup network. Unlike most other EVM Bitcoin Layer 2 solutions, users can access the Merlin network directly through their Bitcoin wallets, facilitated by BTC Connect, a native wallet protocol developed by Particle Network.
Additionally, Merlin supports EVM wallets like MetaMask. It uses zero-knowledge rollups to batch transactions on its execution layer for final settlement on the Bitcoin blockchain. By validating thousands of transactions simultaneously, Merlin significantly enhances speed and reduces fees while maintaining Bitcoin-level security.
Merlin’s EVM compatibility allows developers from Ethereum and other EVM networks to deploy their applications on Merlin without major code changes. It supports Ethereum and Bitcoin protocols and smart contracts, including BRC-420 and ERC token standards. DeFi applications are already launching on the network, and as of now, DefiLlama reports a TVL of over $362 million for Merlin.
Stacks Network
Stacks is an open-source project initiated by a group of experienced Bitcoin developers. These developers have extensive backgrounds in building applications and protocols on Bitcoin Layer 1. Following the block size wars in 2017, it became evident that the only way to scale transactions or introduce new uses was through additional solutions. Consequently, efforts were directed towards the Lightning Network and Stacks to address these challenges.
Contrary to the Lightning Network, which is a P2P payment network, Stacks is a Bitcoin layer designed for smart contracts. It allows decentralized applications to use Bitcoin as an asset in a trust-minimized way, settling transactions on the Bitcoin blockchain.
Launched in early 2021, Stacks introduced Bitcoin transaction settlement, the Clarity language for secure contracts, and atomic swaps with BTC. The upcoming Nakamoto release, expected in 2024, will enhance Stacks with a decentralized, two-way Bitcoin peg, Bitcoin-secured transactions, and faster transaction times. This upgrade aims to make Bitcoin a fully programmable asset, unlocking its potential for decentralized applications and making it the backbone of a more open and productive economy.
Bitlayer
Bitlayer is the first Bitcoin Layer 2 solution based on the BitVM paradigm, offering both Bitcoin-level security and Turing completeness. Derived from the white paper “BitVM: Compute Anything On Bitcoin” by ZeroSync’s Robin Linus, BitVM (Bitcoin Virtual Machine) enables Turing-complete contracts on Bitcoin without altering its consensus.
Bitlayer aims to enhance the Bitcoin ecosystem by providing secure scalability, diverse assets, and fostering innovation, ultimately offering users a faster, safer, and more flexible experience.
What sets Bitlayer apart from other L2 solutions is its introduction of BitVM, Discreet Log Contracts (DLC), the Lightning Network, and multiple VMs, including the Ethereum Virtual Machine (EVM). DLC allows two parties to execute conditional payments based on predefined conditions with the help of an Oracle, enabling new decentralized financial applications while ensuring Bitcoin deposit security. Bitlayer also offers 100% compatibility with EVM and the Ethereum toolchain, using BTC as the native token. This allows developers to migrate from the Ethereum ecosystem with minimal cost.
All in all, the landscape and main operations of BTC Layer 2 are still evolving and face significant challenges, including scattered solutions and a lack of unified definitions. Most importantly, user experiences must be taken into account to make effective comparisons with the Ethereum ecosystem!