The original authors and contributors: Kyle Ellicott, Yan Ma, Darius Tan, Melody He

Original source: Spartan Group

Translated by: 0xNirvana

"Bitcoin Ecosystem: Unveiling the Era of Trustless Finance" is a research report on the various aspects of the development of the Bitcoin ecosystem. The report was jointly written by the Spartan Group team, Kyle Ellicott, and several experts who provided feedback and insights and generously spent time reviewing the final version of this article. This report was drafted in December 2023, and the data contained herein is accurate as of the time of writing. This is the second article in a series of four. For the first article, please visit "Bitcoin Ecosystem: Unveiling the Era of Trustless Finance".

Continuous Evolution of Bitcoin Debate

Since its birth in January 2009, the role and potential of Bitcoin have undergone significant evolution. Initially, many people viewed Bitcoin as a tool for hedging against inflation, a means of storing value (SoV), and a hope for democratizing the financial system. It wasn't until recently, the fifteenth year since the birth of Bitcoin, that the network effect of Bitcoin was once again brought to attention - that is, the platform for shaping decentralized applications (dApps) in the future. This evolution is particularly noteworthy at this stage for several reasons, including: Ethereum has achieved remarkable achievements in application development, Bitcoin's dominance as an asset has never weakened relative to Ethereum, and its influence is growing, which undoubtedly affects people's expectations of the Bitcoin network. Inspired by this, developers have introduced many infrastructure "layers" on top of the Bitcoin core network (Layer-1 or L1). These Bitcoin ecosystem layers fully utilize the stability and security of Bitcoin, while increasing scalability and programmability without changing the foundation of L1, aiming to release over $850 billion in assets that have not yet generated revenue and are constantly growing. Today, we are all witnesses and participants in the significant progress of the Bitcoin ecosystem layers, hoping that these layers can act on BTC assets, fully inherit Bitcoin's reorganization security and finality, and overcome its limitations in programmability and performance. Looking to the future, these unique infrastructure layers attached to the Bitcoin ecosystem will become the cornerstone on which many application entrepreneurs rely.

Despite the progress mentioned above, many necessary infrastructures are still in the development and testing stage. It is worth noting that the journey that the Bitcoin ecosystem is going through is not unprecedented. In 2017, early NFT and token projects flooded the Ethereum network, causing transaction speeds to slow down and transaction fees to skyrocket. This phenomenon inspired the developer community to build more powerful infrastructure, even if their efforts could only support a small portion of the potential application demands of the Ethereum network. Developers hoped to provide the necessary scalability and flexibility for the network. At that time, the Ethereum community discussed and experimented with various methods, and ultimately decided to adopt a layered approach to improve its performance and scalability. This led to the widely used and accepted Ethereum Layer-2 (L2) that we see today, with its on-chain locked assets (TVL) reaching billions of dollars. Therefore, Ethereum's experience in scalability, ecosystem growth, decentralized applications, and underlying network can serve as a reference for Bitcoin.

Similar to the key moment of Ethereum in 2017, the introduction of Ordinals in 2023 became a significant cultural turning point for "building on the Bitcoin ecosystem". This transformation has sparked a developer revolution, namely the development of infrastructure and extension layers on top of Bitcoin L1. We now not only see the emergence of new protocols and token standards (such as BRC-20), but also the development of new Bitcoin L2, which are beginning to unleash the potential of the Bitcoin economy and allow us to glimpse the dormant capital worth over $850 billion that may be unlocked, relying on the most stable and tested technology in the industry so far. Therefore, the Bitcoin proposition is being redefined: Bitcoin is no longer just a store of value or an asset, but is realizing the significance of infrastructure in its expanding economy.

Compared to the growth trajectory of Ethereum, the Bitcoin ecosystem is likely to experience a surge in user adoption, driven by viral use cases that can activate growth engines. This will in turn attract more developers and increase the TVL of the ecosystem applications. Considering that the market value of Bitcoin is approximately 850 billion US dollars, which is 3.15 times that of Ethereum's market value of 270 billion US dollars, the current Bitcoin application TVL is only 320 million US dollars, while Ethereum's application TVL is 76 billion US dollars. In other words, these data indicate a potential 740-fold growth opportunity for the Bitcoin ecosystem to achieve a similar level of maturity as Ethereum in terms of application. In addition, we also need to consider the possibility of additional liquidity influx once the ecosystem gains momentum.

The huge market potential of Bitcoin smart contracts

"Network" vs. "Asset" Battle

In order to gain a deeper understanding of the constantly evolving new narrative, we need to distinguish between Bitcoin digital assets (BTC) and the Bitcoin network (i.e. Bitcoin Core, Bitcoin L1, Bitcoin blockchain) as two separate concepts. Many people are confused about the meaning of the term "Bitcoin" because it can refer to both the network and the currency. Although these two are closely related, they are actually quite different. To avoid confusion, this report uses "Bitcoin" when referring to the network and "BTC" when discussing tokens or digital assets.

· The famous white paper of Bitcoin the Network, "Bitcoin: A Peer-to-Peer Electronic Cash System" by Satoshi Nakamoto, was released on October 31, 2008, introducing a peer-to-peer electronic cash system to the world. Shortly after, the Bitcoin network went live and its genesis block was mined on January 3, 2009. Since its release, the network has maintained stable operation, while other networks have experienced various problems such as downtime and attacks, proving the feasibility of Bitcoin as the ultimate L1 network. Bitcoin demonstrates its ability to provide trust in a decentralized intermediary-free environment and serves as the ultimate decentralized settlement layer for transactions, assets, and future applications. However, due to the lack of flexible programmability and the inability to write to the network without trust, developing applications other than BTC assets themselves on Bitcoin has been difficult. Compared to Ethereum, a significant difference of Bitcoin is that it does not natively support smart contracts. Without smart contracts, developing anything based on the Bitcoin network requires more tools to achieve similar functionality. Smart contracts are a key feature that enables decentralized applications to use BTC as assets or settle transactions on the Bitcoin L1.

· BTC (digital asset) has always been regarded as a means of value storage in the traditional sense, as well as a hedge against inflation in the turbulent global financial market. The emergence of BTC for the first time provided the world with a digital, permissionless, censorship-resistant, and scarce global asset. The top position of BTC as a premier cryptocurrency has never been shaken, and its market value has now exceeded $850 billion, reaching a peak of $1.25 trillion in November 2021. However, even today, more than a decade later, the general public still only sees the value of BTC as a means of value storage. Unless BTC undergoes further evolution and innovation, it will be difficult for us to see BTC gain more practicality, and the public's judgment of its value will be difficult to surpass the current cognition.

And the Bitcoin ecosystem provides a solution to this problem. BTC assets are the initial use case of Bitcoin L1. If the Bitcoin ecosystem, such as Bitcoin L2, can run smart contracts that use BTC as assets, then Bitcoin L1 can retain its key advantages (such as security, durability, and decentralization) while allowing unlimited experiments on other Bitcoin ecosystems. Applications can use BTC as their assets, run on the L2 track, and settle transactions on L1. These L2 tracks can provide faster and more scalable transactions while gradually inheriting security from L1. This makes "Building on Bitcoin" possible and redefines the Bitcoin proposition as the infrastructure for a truly valuable and growing Bitcoin economy.

Building in the Bitcoin ecosystem

In the past few years, the market has proven that "building on the Bitcoin blockchain" can bring unique opportunities and challenges. Unlike other blockchains, Bitcoin was created with the intention of being seen as an asset or "currency", rather than as an application platform. Other blockchains have entered the public eye with a clear positioning as application platforms. Why is Bitcoin's process of maturing slower than other ecosystems? To better understand this issue, it is important to review its initial state.

· The Bitcoin network is open to everyone, regardless of their background or technical knowledge. The Bitcoin code is open source and can be copied and modified. This openness fosters a culture of experimentation, where no single group or individual can have a decisive impact on the direction of blockchain development.

· The interoperability of the Bitcoin network is limited, which leads to the creation of its unique derivative products. The derivative network of Bitcoin is completely independent, has its own assets, and does not have "backward compatibility" with the original Bitcoin network. Therefore, in the current state, BTC assets are restricted to the Bitcoin network and cannot be directly removed or transferred to other blockchain networks.

· The lack of programmability will pose significant obstacles to development. Due to the lack of support for smart contracts, Bitcoin does not have flexible programming capabilities, which constrains its use as an application development platform. Coupled with its severe performance limitations, if Bitcoin is viewed as a construction platform, this is a major challenge that must be faced.

· Bitcoin L1 still needs help in terms of speed and scalability. The speed at which the Bitcoin network confirms transactions and its ability to process large amounts of transaction data in a short period of time are both very limited. In order to meet the critical need for decentralization, the size and frequency of records (also known as blocks) in the Bitcoin blockchain are restricted. With an average of one block produced every 10 minutes and an original block size of 1 megabyte, the on-chain transaction processing capacity of the Bitcoin network is affected, resulting in an average transaction confirmation time of 10 to 30 minutes, which is far from meeting the needs of most applications.

In order to address or improve several characteristics of Bitcoin, it is necessary to first understand the Blockchain Trilemma. When looking at Bitcoin L1 through this concept, we can see that it is decentralized (a) and secure (b), but lacks scalability (c), with transaction processing speeds of only about 3 to 7.8 transactions per second. This limitation highlights the need to find alternative solutions or additional ecosystem layers to compensate for the inherent deficiencies of the blockchain network.

The urgent need for scalable solutions gave birth to the Ethereum network in its early days. Although Ethereum lacks the security and decentralization compared to Bitcoin, it has achieved significant growth by providing scalability solutions required for application development, such as Layer 2 networks (e.g., Arbitrum, OP Mainnet, etc.) and subnets (e.g., Avalanche's Evergreen). Throughout the industry, similar trade-off solutions have emerged, sparking a wave of development focused on scalability solutions, including sharding, nested blockchains, state channels, supernets (e.g., Polygon Edge), app-chains, and Layer 2 networks (also known as sidechains).

For years, people's attention has mainly focused on the Ethereum and its compatible Ethereum Virtual Machine (EVM) ecosystem. However, by 2023, with the latest upgrade of Bitcoin L1 and the emergence of Ordinals, we are witnessing a shift in the entire industry's focus. Developers are redirecting their attention to Bitcoin, especially to solve its scalability issues - an important component of the impossible triangle problem (security, decentralization, and scalability) of Bitcoin L1.

Bitcoin Scaling: Key L1 Upgrades

The significant progress of Bitcoin in terms of scalability began with the Segregated Witness (SegWit) update in July 2017. This upgrade marked an important change by separating unlocking code into a dedicated part of each Bitcoin transaction, shortening transaction times, and expanding block capacity beyond the 1MB limit set by Satoshi Nakamoto in 2010.

SegWit introduced a revised block size measurement method using "weight units" (Weight Units, wu), later known as vsize/vbyte, allowing up to 4 million weight units (4wu) per block, effectively expanding the block size to approximately 4MB. This change aimed to be backward compatible with all previous Bitcoin Core versions and significantly improved transaction efficiency.

Bitcoin: 1MB block size capacity factor. Source: Glassnode

SegWit achieves this goal by splitting the data structure. It separates the "witness data" (including signatures and scripts) from the "transaction data" in a new section of the Bitcoin block, which contains detailed information such as sender and receiver. The introduction of this structure divides the new 4wu (weighted unit) block size into the following two parts:

· Witnessing each virtual byte (vbyte) of data is calculated as 1 weight unit (wu), which is only 25% of the weight of each virtual byte compared to transaction data.

· Each virtual byte (vbyte) of transaction data is calculated as 4 weight units (wu), which is four times the weight of each virtual byte of witness data.

SegWit 有何不同？来源： Cointelegraph

What is the difference with SegWit? Source: Cointelegraph

Taproot follows SegWit as another major upgrade to Bitcoin, which was activated in November 2021. Taproot is a soft fork that removes the maximum limit on witness data for each transaction, resulting in faster transaction speeds, enhanced privacy protection through Merkelized Alternative Script Trees (MAST), and more efficient key signatures through Schnorr signatures. Taproot also facilitates asset transactions on Bitcoin L1, introducing protocols such as Pay-to-Taproot (P2TR) and Taproot Asset Representation Overlay (Taro).

· Taro is a protocol based on Taproot technology, which supports the issuance, sending, and receiving of assets on Bitcoin L1 and Lightning Network. The protocol will launch its mainnet Alpha version in October 2023.

· The Schnorr signature achieves key aggregation by introducing the ability to merge multiple public keys and signatures into one. In short, multiple signatures are combined for verification instead of individually aggregating each signature, thereby improving transaction efficiency.

· MAST increases privacy by hiding preset conditions related to transactions and does not publish unused results on the chain. This not only enhances privacy but also reduces transaction volume, thereby lowering data usage.

The Renaissance of Bitcoin Builders Triggered by Inscriptions

The average transaction fee of Bitcoin will reach its peak in May 2023 due to Ordinals. Source: ycharts

The phenomenon-level inscriptions have reignited developers' interest in Bitcoin, but this has also further magnified the limitations of Bitcoin. In particular, due to the lack of support for fully expressive smart contracts, developers have turned their attention to other platforms. This highlights the need for more complex scaling solutions within the Bitcoin ecosystem to ensure its practicality and relevance in a wider range of blockchain and financial fields.

Update by the author (February 8, 2024)

Some of the latest developments in Bitcoin L1 infrastructure aim to simulate smart contract functionality without the need for a dedicated smart contract layer. Innovations such as Recursive Smelting (BRC-420) and OrdiFi, as well as discussions about re-enabling the "OP_CAT" function through a soft fork, are all aimed at facilitating complex transactions similar to DeFi, bypassing traditional smart contracts.

It is worth emphasizing again that, unlike Ethereum's virtual machine (EVM) compatible chains that achieve composability through a general-purpose virtual machine, Bitcoin's framework lacks such smart contract mechanisms. This fundamental difference requires additional tools and more complex integration strategies to be deployed in the Bitcoin project to provide a user experience comparable to Ethereum. This may lead to similar scalability challenges for experiments and the underlying network on L1. At this point, there are already smart contract applications of varying degrees emerging in the ecosystem, and it is likely to further expand.

For example, the team behind BRC-420 recently launched Merlin Chain, a Bitcoin-native L2 solution aimed at addressing scalability issues. In addition, Ordz Games released the first-ever Bitcoin-based game last year, using the BRC-20 token OG. The token was decentralizedly traded on ALEX Lab's Launchpad earlier this year in the form of an IDO, achieving 81x oversubscription in ORDG. In the following parts of this series, we will delve into these innovations and outline the continuous evolution of the Bitcoin ecosystem.

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