Comprehensive exploration of Bitcoin L2 ecosystem and projects

"Bitcoin Layer: Tapestry for the Age of Trustless Finance" is a research report on the development of the entire Bitcoin ecosystem. The report was written by Kyle Ellicott of the Spartan Group team and multiple experts who provided feedback and insights and generously spent their time reviewing the final version of this article. This part is the third of four articles in the series.

The concept of “Bitcoin Layers” introduced in 2018 represents a key shift in Bitcoin’s development, addressing its scalability challenges. Historically, various efforts aimed at enhancing Bitcoin’s L1 have had a common goal: facilitating off-chain transactions to improve the network’s scalability. These efforts have all built on the secure settlement layer provided by L1. Bitcoin Layers has emerged as a suite of solutions spanning L2, L3, data and application layers, drawing insights from Ethereum’s layered architecture. These innovations reflect the network’s adaptive response to its inherent limitations, demonstrating a path toward a more powerful and general blockchain infrastructure.

New layers of Bitcoin have emerged that introduce a variety of features that change the capabilities of the network. These layers provide:

• Smart contract programmability: Implement complex financial and contractual transactions directly on the Bitcoin network.

• Improved throughput speeds: Significantly reduce transaction processing times, with speeds of less than 30 seconds at certain tiers.

• BTC moves to L2 with minimal trust: Facilitates the secure and efficient movement of BTC between layers, providing a solution to the centralization problem of the federated approach.

• Lower costs: Lower transaction costs, making Bitcoin transactions more accessible to a wider user base.

• Asset Issuance and Rollup: Providing new ways to create and bundle assets for greater efficiency.

• Interoperability and privacy measures: Enhance the network’s ability to interact with other blockchain systems and protect user privacy.

• Virtual machines (VMs) and specialized functions: Supporting a variety of applications including gaming, finance, media, and decentralized science (DeSci).

These layers are strategically built on top of Bitcoin’s L1, leveraging L1 as a base platform, similar to “cold storage” for BTC assets. This layered structure not only allows for seamless asset movement across different layers, but also unlocks Bitcoin’s $850 billion in idle capital. As a result, applications leveraging these layers benefit from Bitcoin’s renowned security and stability.

Bitcoin Layers Overview (March 2024)

As of Q4 2023, Bitcoin layer development has made significant progress, with L2 solutions making notable advances. The ecosystem has expanded to include sidechains, drivechains, merged mining chains, and PoS chains. This period also marks the emergence of various protocols, token standards, cross-chain bridges, Rollups, and other innovative solutions.

These developments are not only technical improvements, but also technological advancements. They represent a paradigm shift in Bitcoin's utility, opening new avenues for user adoption and application deployment. This layered approach emphasizes Bitcoin's ability to evolve and adapt, solidifying its place in a rapidly evolving digital world. The following sections detail key innovations in these categories, illustrating the dynamic and forward-looking nature of Bitcoin's layered ecosystem.

Four major Bitcoin L2

The existing major Bitcoin layers are dominated by the “Big Four” — Stacks, Lightning, RSK, and Liquid. Together, these four entities conduct the majority of L2 transactions and shape the landscape of Bitcoin scalability solutions. Each of these L2 solutions has unique features and capabilities that make unique contributions to the growth and scalability of the Bitcoin ecosystem.

1. Stacks

The Bitcoin L2 project was launched in 2017 by Princeton computer scientists Ryan Shea and Muneeb Ali to enable smart contracts for Bitcoin. The initial version of the Stacks network was launched in January 2021, allowing smart contracts and decentralized applications to use Bitcoin as a secure L1. Stacks Bitcoin L2 activates the Bitcoin economy with its Proof of Transfer (PoX) consensus mechanism, which is similar to Bitcoin's Proof of Work (PoW) consensus.   Run in parallel and reuse their computing power .

• The network is further secured through “Stacking,” where Stacks token holders submit native tokens STX ($252.87 million in the current Stacking cycle) to validate transactions, secure the Stacks network, and earn BTC rewards.

• Smart contracts on Stacks are coded in Clarity, a native human-readable language that can respond to Bitcoin transactions and atomic swaps of assets with BTC.

• The STX token, which is used as Gas on L2, was the first SEC-qualified token issuance in 2019 and later updated its decentralized filing with the SEC as a non-security before the mainnet launch in 2021.

• STX is a top 50 project and the only Bitcoin L2 with a native token , and is also listed in CoinMarketCap's top 100 at the time of writing. The company was ranked 38th in developer activity across the industry in the 2022 Electric Capital Developer Report, with an increasing number of monthly active developers since 2015, with 175 active developers as of October 2023.

Monthly active developers on Stacks. Source: Electric Capital

Upcoming Catalysts:

• The Nakamoto network upgrade (Q2 2024) will enable Stacks to enable fast and cheap BTC transfers on L2 with 100% Bitcoin security (resistance to reorganization). Additionally, transaction speeds on the network will be reduced from the current Bitcoin settlement time of over 10-30 minutes to about 5 seconds, a 1,000x improvement. As of December 2023, two major milestones in the upgrade development have been achieved, v0.1 (called "Mockamoto") and the Neon (v0.2) "controlled" testnet, with a single miner, a single Stacker, and Stacker signatures.

• sBTC is a decentralized 1:1 Bitcoin-backed asset that can deploy and move BTC between Bitcoin and Stacks (L2) and use it as Gas in transactions without the need for additional assets. sBTC transfers are 100% guaranteed by Bitcoin hashrate. To reverse a transaction, Bitcoin itself must be attacked.

sBTC releases roadmap. Source: sBTC

The resulting Stacks layer makes Bitcoin a fully programmable asset in a decentralized manner. If successful, it will drive more demand for Stacks and Bitcoin. This could provide an environment for accelerated development of the Bitcoin economy, unlock hundreds of billions of dollars of passive Bitcoin capital, and make Bitcoin the backbone of a more secure network.

2. Lightning Network

Released in 2018 (white paper in 2016), the Lightning Network supports Bitcoin micropayments that can be sent anywhere instantly and at almost no cost. The Lightning Network's powerful transaction processing capabilities and its growing popularity highlight its role in enhancing Bitcoin's scalability and transaction efficiency.

• The protocol leverages smart contracts to create payment channels that combine on-chain settlement and off-chain processes.

• When the channel is closed, the transactions are merged and sent to the Bitcoin network. The native asset of the Lightning Network is Lightning Bitcoin (BTC).

• In August 2023, the network was processing approximately 6.6 million routing transactions, or about 213,000 per day, or about 52% of the network’s public capacity. These approximate numbers represent a 1,212% increase compared to K33’s estimate of 503,000 Lightning payments in August 2021.

• Additionally, on average, the Lightning Network processes at least 47% of all Bitcoin on-chain transactions every day.

The Lightning Network is increasing Bitcoin’s daily transaction volume. Source: River

3. Rootstock (RSK)

Founded by RSK Labs in 2015, the network brings EVM-compatible smart contracts to Bitcoin through its RSK Virtual Machine (RVM). With RVM, developers can port Ethereum contracts to Bitcoin. RSK's native asset is the Smart Bitcoin (RBTC). RBTC maintains a 1:1 peg to BTC, but is not trustless. Since its block security is based on "merged mining", it continues to rely on centralized custodians, which highlights the trade-off between security and decentralization in L2 solutions.

4. Liquid Network

Released by Blockstream in 2018, the Liquid Network sidechain enables users to perform fast, secure, and confidential transactions on Bitcoin. Liquid operates independently of Bitcoin, has its own ledger, and forgoes utilizing Bitcoin’s PoW consensus mechanism in favor of the Liquid Alliance, which consists of about 60 members who act as creators of new blocks. Liquid’s native asset is Liquid Bitcoin (L-BTC), a “wrapped” version of BTC. This independent operation of the Liquid Network demonstrates the diversity of approaches within the Bitcoin L2 ecosystem.

Today, while no Bitcoin L2 holds more than 10,000 BTC or has a user base in the millions, the potential for exponential growth remains enormous, highlighting the critical role these solutions play in Bitcoin's future scalability and functionality. As Bitcoin L2 technologies advance, they have begun to open up multiple avenues to enable rapid experimentation around BTC while maintaining the stability of the core network. The success of future L2 solutions depends on their ability to provide a full execution environment similar to the EVM, address current limitations, and foster a more inclusive development environment.

Dealing with the L2 Dilemma

In the pursuit of unlocking scalability at the Bitcoin layer, a new problem has emerged: the L2 impossibility trinity. Revisiting the blockchain impossibility trinity and applying it to Bitcoin L2, we find that it remains the same, but with slightly different tradeoffs. For the L2 impossibility trinity, the choices are limited to:

A. Become an open network or federation.

B. Whether to introduce new tokens.

C. Own a full/global virtual machine (VM) or have limited off-chain contracts.

The industry has already witnessed attempts to square this triangle to repurpose existing Bitcoin miners to mine L2. RSK (formerly Rootstock) and Drivechains are examples of these attempts. In this approach, incentives for miners become an open question, similar to how gas fees (especially in the early days) may not be enough to handle incentives.

• Lightning selects A and B, but has no global state for the complete VM.

• Stacks chose A and C using a new token (STX).

• Liquid selected B and C to operate as an alliance.

Early discussions among developers have centered around new opcodes for Bitcoin(L1), which could, in theory, help eliminate today’s triangle. New opcodes, such as op-snark-verify, could be used in Bitcoin(L1) to verify L2 computations. However, the historical challenges of implementing soft or hard forks in Bitcoin suggest that this solution may not be feasible in the short term.

Looking ahead, the Bitcoin ecosystem is likely to expand beyond the current handful of L2 solutions, with hundreds more needed to fully explore and develop the network’s potential. Currently, developers are considering these options to balance the trade-offs in the L2 dilemma. There is an emerging trend to leverage open networks where anyone can mine and enter/exit freely, provide a complete virtual machine (VM) environment for smart contracts, and have global state as a fundamental property. This approach mirrors the successful structures of other blockchain ecosystems such as Ethereum and Solana, and is expected to shape the future trajectory of Bitcoin’s L2 progress.

Emerging Innovations

In addition to the established four L2s, rapid experimentation continues with numerous projects involving infrastructure tools, standards, and protocols. These innovations are actively introducing new taxonomy definitions as technology stacks take shape, filling existing technology gaps in application requirements.

Ark is an experimental L2 protocol launched in May 2023. Ark allows users to provide liquidity to the network through its always-on, trustless intermediary Ark Service Provider (ASP), making off-chain, scalable Bitcoin payments in a low-cost and anonymous manner. Because transactions are conducted on this protocol, recipients can receive payments without obtaining inflow liquidity, while protecting the recipient's privacy at a lower cost than the Lightning Network.

Released during Cosmoverse 2023, Babylon is a PoS network consisting of two security sharing protocols between Bitcoin and other PoS networks, Bitcoin timestamping and bridgeless staking.

Botanix (Spiderchain L2) is a PoS Bitcoin EVM that leverages a distributed network of multi-signatures to facilitate a two-way peg with Bitcoin and enhance its interoperability.

Interlay is a modular programmable network between Bitcoin and the multichain ecosystem, running as a Polkadot parachain. Interlay creates a decentralized Bitcoin bridge that can mint iBTC or “valued BTC,” an asset backed 1:1 by Bitcoin on its multichain.

MintLayer is a PoS network designed to act as a sidechain to Bitcoin, optimized for DeFi related activities including atomic swaps. With MintLayer, there is no need to create tokens using a wrapped version of Bitcoin or smart contract languages ​​(i.e. Solidity, etc.) because the network is UTXO-based and requires creating transactions with additional data embedded. The network aims to generate a block every 120 seconds using a verifiable random function and finalize after 1,000 blocks.

Ordinals. The innovative Ordinals theoretical framework was released in June 2022, sparking a cultural revolution built on top of Bitcoin. In December 2023, just a few months after the release of Ordinals (Ord), developers began using Ordinals, which does not require a separate sidechain, token, or Bitcoin Core update and supports Bitcoin Inscriptions. Inscriptions are immutable Bitcoin NFTs that contain original file data (video, audio, image, executable software, etc.) that is permanently recorded on Bitcoin and can be transferred or sent to a Bitcoin address, wallet, etc.

Number of inscriptions. Source: Dune

Ordinals’ dramatic growth will only grow exponentially as new experiments, infrastructure tools, and standards emerge. One year since the first inscription on December 14, 2022, the total inscriptions in the first 90 days exceeded 460,000, and the year-to-date has exceeded 46.2 million, generating approximately 3,365 BTC (approximately $148.8 million) in fees during that period.

The RGB Network (Really Good Bitcoin) is a Bitcoin-based protocol that utilizes the Lightning Network, not a token protocol.

Threshold Network is a privacy-focused fusion network between Keep and NyCypher, allowing users to leverage Keep Network’s ability to protect private data through off-chain containers and NuCypher’s privacy tools for key management and dynamic access control. Threshold is the creator of the tBTC Bitcoin bridge, a decentralized and permissionless bridge between Bitcoin and Ethereum.

These protocol experiments represent only a small fraction of what developers release each week. The constant introduction of new protocols and standards shows that the Bitcoin technology stack is vibrant and evolving. The momentum generated by these developments, especially in the context of the upcoming Bitcoin halving event in Q2 2024, indicates a bright future for further innovation and adoption within the Bitcoin ecosystem.

The rise of token standards

Following several emerging protocols, the community has also begun experimenting with new token standards, providing early previews of token designs that can take advantage of Bitcoin’s unique architecture. In its infancy, it is important to highlight those that have been introduced to developers and note their similarities to their counterparts in the Ethereum ecosystem.

BRC-20 is an experimental token standard created by DOMO and released in early March 2023 to create fungible tokens on Bitcoin. The standard utilizes Ordinals inscriptions and JSON data, mirroring Ethereum's ERC-20 standard, but tailored for the Bitcoin ecosystem with limited functionality. Several platforms soon followed suit, rapidly developing tools and launchpads for experimental token standards (ALEX, Bitget, Leather, OrdinalsBot, UniSat Wallet, Xverse, etc.). Notably, the ORDI token was the first token deployed under the standard, and by May 2023, it had a market cap of over $1 billion, ranking #52 on CoinMarketCap with a market cap of over $1.3 billion at the time of writing.

BRC-721E is an experimental token standard similar to the widely adopted ERC-721, implemented in collaboration between Bitcoin Miladys, Ordinals Market and Xverse. In its initial state, the experimental standard allows users to connect NFTs from Ethereum to Bitcoin, documenting a less detailed version of the NFT with a link back to the original Ethereum version and airdrop functionality. Once the NFT is bridged, it will automatically appear on the Ordinals Market. The experiment opens up many possibilities for cross-chain interactions between the two networks.

ORC-20 is an experimental open token standard that aims to improve the BRC-20 experiment, achieve backward compatibility between BRC-20, flexible namespaces, and introduce UTXO to prevent double spending in future development.

ORC-CASH is an experimental token standard based on the Ordinals protocol, designed to best fit the UTXO security model and serve as a simplified version of the ORC-20 standard.

RUNES is an experimental homogeneous token protocol proposed by Ordinals creator Casey Rodarmor in September 2023 as an alternative to the BRC-20 standard. Runes does not intend to rely on off-chain data or require native tokens, but instead holds balances through UTXO and uses specific script conditions to identify transactions.

SRC-20 is a token standard created by Mike In Space and is known as Bitcoin Stamps (Bitcoin Secure Tradeable Art Maintained Securely), which are digital artifacts stored directly on the Bitcoin blockchain that cannot be pruned because they exist in the UTXO set (Unsent Transactions).

STX-20 is an experimental inscription protocol standard released in December 2023 for creating and sharing digital artifacts on the Stacks blockchain by embedding protocol information in the metadata of STX token transfers (subject to a 34-symbol limit). The release of STX-20 resulted in one of the largest blocks ever on the Stacks network, with over 10,000 transactions.

Privacy and Security Solutions

In addition to scaling, developers have also made great efforts to bring Rollup to Bitcoin and add important security layers. Some notable experiments in this category in the early development stages include Urbit, Rollkit, ZeroSync, Alpen Labs, Bison Labs, Chainway, Kasar Labs, and many more.

Other experiments in the ecosystem include purpose-built protocols such as 1btc, BNSx, and Rooch Network, as well as emerging taxonomy definitions such as Drivechains, Spiderchains, Federated Chains, Spacechains, and Softchains, each of which is being developed with the goal of contributing to a broad technology stack.

These innovations enhance the intrinsic value of the network and position Bitcoin as a more versatile and secure platform. They are essential to scaling the network and improving its ability to support a wide range of applications. As these technologies continue to develop, they are expected to greatly improve the network's ability to handle increasing transaction volumes and diverse applications while maintaining the fundamental principles of privacy and security. The ultimate goal is to create a user experience that is smooth enough without having to worry about supporting infrastructure.

The Future of Bitcoin Finance

Bitcoin’s layer, marked by advances in Layer 2 solutions and privacy-enhancing technologies, is shaping a trustless financial ecosystem. These developments represent a significant shift in Bitcoin’s capabilities and potential impact on the financial sector. With its enhanced privacy, security, and scalability, Bitcoin is expected to support a wide range of financial applications, from traditional transactions to innovative DeFi solutions. This shift highlights the growing role of Bitcoin not only as an asset, but also as a foundational element of a safer, more efficient, and more inclusive financial landscape. As these technologies gain popularity, Bitcoin’s contribution to the trustless financial system becomes increasingly important, solidifying its position as a key pillar of future finance.

Note: The latest Bitcoin L2

Since our initial report, the Bitcoin ecosystem has evolved significantly. Notably, Bitcoin’s value surged above $63,000 for the first time since November 2021, marking a significant market rebound. At the same time, the Bitcoin L2 landscape is rapidly expanding, highlighted by DWF’s tracker, which now lists 28 new Bitcoin L2 projects. How can we accurately assess the potential of these L2s?

Bitcoin Magazine sparked the discussion by developing an editorial policy that defines a true Bitcoin L2 based on three criteria: use of Bitcoin as a native asset, use of Bitcoin for trade settlement execution, and functional reliance on Bitcoin.

This definition categorizes many emerging platforms, especially those that use their own tokens for decentralized scaling, as “meta-protocols” or “parasite chains” rather than true L2 solutions.

Despite these categorizations, the broader goal remains to enhance the entire ecosystem. Notable innovations that piqued our interest include:

Merlin Chain: Spearheaded by the team behind BRC-4 ​​20 and Bitmap, this asset-centric L2 aims to connect well-known L1 assets and their user base to L2, with a total value locked (TVL) of over $2 billion as of the end of February.

B-squared Network: The platform introduces a modular approach, combining zk-rollup as an execution layer with B² Hub, integrating decentralized storage with the Bitcoin network to form a comprehensive ecosystem that includes consensus, data availability, and settlement layers.

BounceBit: This is a Bitcoin re-hypothecation chain where users can earn raw CeFi returns while using LSD for BTC staking and on-chain farming, essentially “re-hypothecation” of Bitcoin. With the successful financing, TVL also soared to over $500 million this month.

BOB: This project utilizes the Ethereum Virtual Machine (EVM) to create and execute smart contracts.

BEVM: Decentralized interaction between Bitcoin and BEVM is achieved through the combination of Bitcoin light node and Taproot threshold contract's POS consensus.

Citrea: This is zkEVM on Bitcoin, where proofs are engraved into Bitcoin and optimistically verified via BitVM.

It is worth noting that the rise of new Bitcoin L2s, driven primarily by Chinese teams and supported by large Chinese-speaking communities, has brought in a large amount of TVL, indicating that the Bitcoin ecosystem is undergoing a major shift to the East.

These projects have successfully improved Bitcoin’s cross-chain functionality, leveraging their previous experience building them to achieve substantial growth. However, this surge has also raised concerns about the potential for fragmented liquidity in L2 solutions, as seen with Ethereum.

Instead, there is an opportunity to expand the use of Bitcoin assets and get more Bitcoin users involved in these new platforms. Despite the similarities between many of these products, the future of Bitcoin L2 remains uncertain and dynamic, awaiting further development.