The current status of BTC ecology and the new chapter in the future

In May 2023, we launched a three-month research project hypothesizing a recovery in the Bitcoin ecosystem. This led to our paper “The Panda Renaissance” published in November 2023. Since then, interest and capital investment in this topic have grown exponentially. In this post, we will share updated thoughts on the previous article and reflections on the following questions:

1. Current status of BTC ecosystem: observations and comments

2. How our thinking has evolved

• We still have a firm belief

• Areas where our perspectives have shifted

3. A new chapter for BTC: What will happen next?

• predict

• White Space: White space verticals that excite us

For the sake of brevity, we will present our observations, opinions, suspicions, and predictions in bullet point format.

1. Current Status of Bitcoin Ecosystem: Industry Observations and Comments

1. Intense competition between EVM L2s/sidechains with indistinguishable value propositions : Competition has shifted from “who is the least trustworthy” to who can 1. execute the most complex airdrop games, and 2. access the deepest liquidity through Bitcoin “whales”. This shift also explains the geographic concentration of L2s in the Asia-Pacific region.

2. Increasing fragmentation

• Liquidity and Scaling Solutions: 80+ sidechains/rollups, and 5+ meta-protocols .

• Token standards: There is a duopoly between BRC20 and RUNE, followed by a long tail of other meta protocols such as ARC, CRBC, RGB, etc.

• Indexers: Each token standard requires its own indexer.

3. Sidechains and Rollups hope that BitVM can re-anchor them to L1 in a trustless manner : I am skeptical of “L2” , which was initially positioned as a sidechain and claimed to become “trustless” after integration with BitVM. My suspicions are twofold:

Technical feasibility : Implementing "optimistic rollup" style verification on-chain requires the development of millions or even billions of logic gates. This process is not only costly (because it runs on the base layer), but it is also slow due to the limitations of BTC block time. In addition, it may take a lot of time to complete. As far as I know (please correct me if I am wrong), BitVM has become a community project and faces the usual challenges of decentralization: no single entity is responsible for its development timeline, milestones, quality, and overall success.

GTM Timing : According to various sources, BitVM is still 18-24 months away from being ready. Even if everything goes well with BitVM and they deliver on their promises, it means these L2s will remain centralized via multisig for the foreseeable future. Until then, what will they be competing on?

4. There are a lot of trust assumptions in L2 (sidechains + Rollup) and meta-protocols

It’s worth clarifying the classification of sidechains and rollups. The following table details the difference based on our conversations over the past few months - feedback is welcome.

Trust assumptions of sidechains:

• The peg between the BTC base layer and layer 2 solutions is primarily centrally managed via multi-signatures controlled by the core team.
  

• The finality of the state and transactions is not verified by the BTC base layer, but by the project team.

Trust assumptions of ZK Rollups:

• Currently, there is no way to perform zk-validation on Bitcoin. Collators need to be centralized (similar to ETH L2s) and there is a trust assumption that the decentralized network of validators will correctly verify the transactions checked by the prover.

• Because of the need to transmit data back to Bitcoin, Rollups are limited in the number of transactions they can process.

Trust assumptions of BitVM (Optimistic Rollup):

The main use case for BitVM is to commit to a trustless bridge. The high level step is that the BitVM code can be broken down into logic gates so that a fraud prover can do a binary search and find the point where the execution is inaccurate.

While anyone can provide a fault proof to confiscate the operator's collateral (if the operator behaves maliciously), BitVM presents an economic challenge. The amount of bridged liquidity that is used as collateral needs to be matched. For example, if I bridge 10 BTC through BitVM, the BitVM operator needs to provide 10 BTC as collateral for this single transaction, which is economically difficult to scale.

Trust Assumptions of the Meta-Protocol: Indexers

BRC20, RUNE, PIPE, Trac, etc. all need their own indexers to convert the "state" of the account-based model from BTC's native UTXO model to BTC's native UTXO model. Ethereum has internalized the indexing function because its VM can calculate the state, and BTC's indexer is similar to Ethereum's GETH.

To understand the concept of an indexer, imagine all UTXO transactions as raw Excel data with a thousand addresses transacting with each other. To understand who owns what and the final balance (account status), indexers act like pivot tables. They calculate additions and subtractions and determine the final balance by address. Currently, indexers such as BestInSlots, GeniiData, and ALEX Labs Oracle provide APIs for developers to directly extract balances or "account status" for meta protocols such as BRC20.

Discrete Log Contracts (DLCs) : Dependence on External Oracles

DLCs ​​in Bitcoin rely on external oracles to determine the outcome of a contract. In a DLC, the role of an oracle is to sign a message indicating the outcome of an event. The parties to the contract then use that signature to construct and broadcast a transaction that settles the contract on the Bitcoin blockchain. The security and trustworthiness of a DLC depends heavily on the reliability and honesty of the oracle, as its data directly affects the resolution of the contract.

5. Continued skepticism about Western Hemisphere VCs : I have had many discussions with other investors about the value of BTC L2. While we agree that most Bitcoin "L2s" are considered "fake" because they do not necessarily inherit BTC security, and many L2s may disappear in the coming months, we believe that this vertical still has value because

Flawed, nascent, and inevitable: Over the past decade, the community of BTC holders who want to put their BTC into a hard wallet and bury it in their backyard has become saturated. While BTC’s second-layer solutions are subpar in terms of security and trustlessness compared to their Ethereum counterparts, the past year is just the beginning of Bitcoin’s scaling and programmable solutions. The genie of Bitcoin’s metamorphosis into a more general, programmable chain, in addition to its existing store of value identity, is out of the bottle. This trend is reflected in the public’s enthusiasm for staking, trading, and the parabolic rise in Bitcoin’s on-chain transaction fees since 2023 (as high as $40/transaction in December). With the emergence of OP_CAT, various Rollups, and sidechain solutions, use cases that were once exclusive to Ethereum and Solana are now being explored on Bitcoin.

Improving BTC’s capital efficiency: BTC remains one of the most valued assets among institutions. There is a need for more financial instruments based on or derived from Bitcoin. However, design limitations of the base layer make such products difficult to implement. This highlights the necessity of a second-layer programmable solution.

This trend solves BTC’s existential crisis: more programmability creates demand for Bitcoin block space, which leads to more fees as a new incentive for miners to secure the network. This is especially important at each halving. The previous article discusses this in more depth.

6. More and more creative ways to use Bitcoin block space

• As a method of burning data in witness blocks and transaction blocks

• As permanent on-chain data storage (this is an excellent product-market fit for luxury/collectibles use cases)

2. Review: How our ideas evolve or persist

Where we got it right : The overall trends, timing, and demand are related to issuing digital assets on top of Bitcoin (meta-protocols), programmable solutions (Layer 2s, Rollups), and efforts to make BTC more capital efficient (Babylon, Lorenzo).

Where the jury is still out : The future of BTC may be native or it may be xVM . While this is not a consensus view, we believe that BTC should develop its own native ecosystem rather than adopting the seemingly "convenient" Ethereum Virtual Machine (EVM) approach. While we fully acknowledge the benefits of the EVM approach (such as interoperability with the existing defi ecosystem, easy onboarding of solidity developers, and solidity being the most battle-tested language, etc.), having a BTC Layer 2 token in the ERC-20 format seems contradictory, just as Arbitrum launched its token as Solana SPL.

How our position has shifted: The original “ Panda Renaissance” article proposed two paths: making BTC more “programmable” like a general-purpose L1, or making it more “capital efficient” to expand its functionality and become a more productive financial asset.

At the time, I leaned toward the latter. BTC’s inherent scripting language limitations made it unsuitable for complex programmability. However, over the past year, my view has shifted. The market has shown demand for Bitcoin block space, transforming it from a dormant “digital gold” chain to a programmable general-purpose chain. Ethereum has now effectively become a “sandbox”: the Bitcoin community is learning from Ethereum’s 7 years of DeFi development to innovate on Bitcoin.

3. A new chapter in the BTC ecosystem: predictions and blank areas

predict:

1. Each method will have 1-2 winners. This means that there will be 1-2 winners on EVM (such as Botanix), meta-protocol (probably BRC20 or Rune), bridgeless base layer methods (such as Arch), ZK rollup, and STX (already a pioneer). There will be a total of 5-6 major players in the next cycle, and each participant will be valued at more than $50 billion at its peak.

2. Safe haven : Currently, various scaling solutions are competing for attention and liquidity. However, over time, especially after security-related incidents, liquidity will shift to the safest L2/rollup with the least trust assumptions.

3. Most other Layer 2 solutions, sidechains, and Rollups will not survive. Until then, the competition will remain fierce to see who has the best airdrop program, who can reach high-signal investors, and who can establish connections with Bitcoin giants.

4. Developers will gradually wake up from the BitVM dream and realize that it is too late, too slow, and too costly to meet the builders' needs for trust minimization.

5. BTC DeFi will surpass ETH : I have always believed that Ethereum is a testing ground for BTC. Everything that has happened on Ethereum since 2017 has been based on the false belief that "BTC can't". However, this is no longer the case. If I take risks with my tokens (staking, farming, leverage), would I prefer low-value tokens or BTC's returns? I fully believe that BTC's future will have a DeFi and infrastructure ecosystem comparable to or even stronger than Ethereum.

6. There will be a native “ERC-20” token standard on Bitcoin : Bitcoin needs its own ERC20-like token standard that can operate on different L2s and base layers. It can operate on various L2s and base layers. One way to achieve this is through a collaboration between Arch (a bridgeless base layer programmability solution) and Auran (a native interoperability solution based on Bitcoin TSS). Such a standard will become an important unlock for the winners who will eventually stand out in the field of stablecoins, institutional adoption, on-chain yield products, etc.

White space we are interested in

1. Bridgeless experience (better suited for base layer use cases) : It is unlikely that any scalable/programmable layer will be completely trustless - frankly, this is not something most users care about unless a hack occurs. While keeping trust assumptions unchanged in most rollups/L2s, there will be a large number of low-speed use cases (such as exchange of high-value collectibles, lending, native yield, staking, etc.), and users and developers prefer to achieve the same level of programmability on the base layer (through solutions like Arch Network) without bridging to another L2.

Of course, the trade-off here is speed, as transactions will be limited by BTC block times. However, not all operations need to be extremely fast on-chain. Bridgeless solutions are critical to unlocking a new segment of “slow and steady” use cases on the base layer, such as stablecoins, lending, prediction markets, etc.

2. Unify infrastructure by orchestrating states across various L2s (better suited for Layer 2 use cases) : Provide a “one-stop” developer/consumer experience to address the rampant liquidity and functionality fragmentation in today’s Bitcoin ecosystem. Auran Network is a pioneer in this space and we are excited about it.

“Secrets to startup success: Find a large, highly fragmented industry with a low NPS; vertically integrate solutions to simplify valuable products” - Keith Rabois, Founders Fund

3. Exporting BTC liquidity to other L1s : Many high-profile new/existing alt L1s are exploring ways to leverage BTC liquidity to grow their ecosystems. Solutions like Zeus Network, which creates a messaging layer between Solana and BTC, may be welcomed.

4. Winners of stablecoins : There are already more than 10 stablecoin projects. In-depth cooperation with mainstream programmability and interoperability solutions will be the key to dominating the market.

5. OP CAT : OP_CAT (BIP-347) is a Bitcoin Improvement Proposal that aims to simplify and expand Bitcoin's functionality to implement logical loops and conditions. It will allow the creation of rules or conditions for how Bitcoin is used, opening the door to many development possibilities, including Layer 2, smart contracts, and more. The timeline looks to be more than 12 months away.

6. Native Ordinals Exchanges : If history repeats itself like SOL and ETH, most of the trading volume will be dominated by native professional exchanges such as Blur or Tensor. So far, most of the trading activity for Ordinal has occurred on Magic Eden and OKX. As the NFT winter subsides, we expect native Ordinal exchanges like Ordinal Hive to flourish.

7. Alternatives to BitVM to achieve trustless, or at least minimize L2 <> base layer bridging

8. On-chain BTC-on-BTC yield products for institutions: Given STX’s BTC yield affordability and regulatory compliance, it may become a winner.

9. Liquidity staking on Bitcoin : Similar to ETH, LST-on-BTC projects such as the Lorenzo Protocol have their advantages and can optimize the liquidity of BTC Defi.