Bitcoin Taproot upgrade countdown three days! Learn what impact it will have in one article

Note: Most of the information in this article comes from Kraken Intelligence and bitcoinops.org.

It is reported that the Taproot upgrade of the Bitcoin network will be implemented on the afternoon of November 14th, Beijing time (when the block height reaches 709,632). This historic upgrade will enhance Bitcoin's privacy, scalability and the flexibility of smart contracts.

So what exactly is Taproot? Let’s take a quick look at its development history:

Taproot is the first soft fork upgrade to Bitcoin since SegWit was implemented in 2017. This soft fork includes three BIPs that work together to enhance important properties of Bitcoin and pave the way for great innovation in Bitcoin:

1. Schnorr signatures;

2. Taproot;

3. Tapscript;

Detailed explanation of the three major BIPs of Taproot upgrade

BIP340 (Schnorr Signatures) introduces a more secure, lightweight, and flexible cryptographic signature that supports “key aggregation,” a technique that ensures single-signature transactions, multi-signature transactions, and complex smart contracts are indistinguishable on the blockchain.

Schnorr’s key aggregation feature allows parties to a multi-signature transaction to collaboratively combine their public keys and produce a signature that is valid for the sum of their public keys.

This saves block space, improves privacy, and enables faster transaction verification.

BIP341 (taproot) specifies rules for the new Pay-to-Taproot (P2TR) output type, which upgrades #SegWit v0 to v1 to accept Schnorr signatures.

The purpose of this BIP is to improve the privacy, efficiency, and flexibility of Bitcoin scripting functionality without reducing security.

Bip-taproot leverages Schnorr signatures to encompass more complex transaction types, making them identical to single-signature transactions on the blockchain.

This includes opening/closing Lightning Network channels, atomic swaps, and other complex smart contract protocols.

More importantly, Bip-taproot implements Merkelized Abstract Syntax Trees (MAST), a privacy solution that uses Merkle trees to submit only the execution conditions of a transaction to the blockchain, rather than the full details of all other possible outcomes.

By only publishing the details of executed transactions, thereby recording less data on the blockchain, Taproot provides greater privacy and scalability for Bitcoin users.

BIP342 (Tapscript) updates the script coding language used to write BTC transaction parameters to provide Schnorr and Taproot technologies to users who choose to upgrade. In addition, Tapscript also makes future opcode updates for Bitcoin easier to implement.

Many people also believe that the implementation of Taproot also lays the technical foundation for DeFi on Bitcoin.

Once activated, Bitcoin will enable large-scale smart contracts with tens of thousands of signatures while hiding all participants and keeping the size of single-signature transactions small.

What impact will the Taproot upgrade have on Bitcoin?

However, the magic of Taproot may not be immediately apparent, as most wallet service providers will continue to use the ECDSA signature scheme after Schnorr signatures are activated. In addition, Bitcoin blocks will continue to have both Schnorr signatures and ECDSA signatures, which limits the benefits of batch verification in the short term.

In due time, the crypto community will widely adopt the technology so that most transactions are conducted through Taproot (even if Bitcoin users are not aware of it). Still, full adoption will not happen overnight, and some individual users are more likely to adopt Taproot before businesses.

On the other hand, since preparations for the Taproot upgrade have been underway for many years, some market participants believe that Taproot’s positive impact on Bitcoin has already been reflected in its price.

These skeptics might point out that Bitcoin’s market cap has grown nearly 10x since March 2020, in part because of the Taproot upgrade, as it has been on the industry’s radar for quite some time. Others would argue that the impact of Taproot will not be reflected in Bitcoin’s price until after it is activated, as evidenced by the 50% surge in Bitcoin’s market cap in the week following SegWit’s activation.

Price impact aside, this technological upgrade makes the Bitcoin network more attractive for building DeFi protocols, which could attract incremental user demand for Bitcoin.

Specifically, key aggregation allows Bitcoin to compete with higher throughput blockchains such as Ethereum, and some speculate that Taproot enables Bitcoin sidechain networks such as Sovryn, Thorchain, and Portal to create large-scale multi-signature vaults that lock up Bitcoin for use on the sidechain at the same cost as a single-signature transaction. Prior to Taproot’s implementation, the high cost of large numbers of signatures was prohibitive.

Due to the high cost of large multi-signature smart contracts with hundreds or even thousands of signatories, DeFi protocols have not been very interested in Bitcoin. According to data from DeFi Prime, DeFi projects on the Ethereum platform account for 64%, while Bitcoin's DeFi protocols only account for about 7.5% (exponential amount).

Additionally, Segregated Witness (SegWit) transactions and Lightning Network channels will also become more common, as there will be a significantly better alternative. Still, this growth may be difficult to measure after Taproot activates, as creating and closing Taproot-compatible LN channels will look like standard transactions.

Taproot also has the potential to create a strong fee market for miners once all 21 million bitcoins are in circulation. The theory assumes that if users have a substantial need for privacy, they may want to passively participate in CoinJoin transactions, where their wallet balances are combined into a single transaction between multiple senders. If this demand is large, the increase in on-chain fees may incentivize miners to continue working even after the last bitcoin has entered circulation.

Either way, Taproot could improve Bitcoin’s viability as a store of value and medium of exchange.