New Journey of Digital Gold Exploring Diversification and Protocol Innovation in the Bitcoin Ecosystem

Embarking on a New Era of Digital Currency Unveiling Diversification and Protocol Innovation within the Bitcoin Ecosystem

Author: @YBBCapital Researcher Ac-Core

Word Count: Over 10,000 Reading Time: 17 minutes

Preface

The concept of Bitcoin was first proposed by Satoshi Nakamoto on November 1, 2008, and Bitcoin was officially born on January 3, 2009. After decades of industry development, Bitcoin has been sprinting on the path of value storage and digital gold, and its value has risen from trading 10,000 bitcoins for a pizza to its current market value of $664.22B. But from the current development of the BTC ecosystem, these are just small attempts. In addition to the value of BTC itself, we still need to explore more patiently for the future. This article will analyze other application ecosystems of BTC.

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Overview of BTC

In 2009, a cryptography expert named Satoshi Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System,” which described an electronic currency system implemented through peer-to-peer technology, allowing online payments to be initiated and paid directly from one party to another, without the need for any financial institution in between. Bitcoin gradually spread worldwide and received widespread attention. It has at least three attributes: technological, sociological, and financial.

• Technological Attributes:

From the perspective of the technical logic of Bitcoin, its network protocol is a decentralized, peer-to-peer transmission protocol. It can be briefly understood as a large public ledger system that is not manipulated by any third parties and cannot be tampered with, relying on blockchain technology to record all transaction behaviors of the entire network database, thereby ensuring that there are no duplicate or false payments;

• Sociological Attributes:

Compared to today’s Internet, blockchain itself adopts distributed ledger technology and has decentralized, tamper-proof, and immutable characteristics through the shared digital transaction records on the network. It is influencing everyone with the trend of information freedom brought by the Internet. Bitcoin, as a completely decentralized digital currency, depends on no single authority to issue it and can transfer value across borders and currencies without going through the banking system. Its information freedom and cross-border payment capabilities give it more sociological attributes;

• Financial Attributes:

From a financial perspective, Bitcoin can be regarded as a digital investment product like digital gold or a standard digital asset with global significance. Compared to gold, because it has a fixed total supply, is easy to carry, has low transaction costs, and appeals to a younger audience, more and more investors and traditional investment institutions believe in its investment value. Because it relies on global circulation through the Internet, it can serve as an efficient and low-cost circulation payment tool and medium of exchange in certain specific scenarios, such as cross-border payments and virtual economic transmission. For example, in January 2015, the New York Stock Exchange and Nasdaq first entered the Bitcoin field, and in recent times, grayscale funds, BlackRock, and others have started to lay out Bitcoin-related ETFs.

Looking at the current development of the entire blockchain, compared to Ethereum, the prosperity of Bitcoin and its ecological projects can be said to be few and far between. The Lightning Network launched in 2019 has shown a new development trend. In addition, Stacks launched in 2021, as well as the recently released Taproot Assets mainnet by Lightning Labs, and Turing-complete Bitcoin contract BitVM have also become a few highlights in the Bitcoin ecosystem.

New Landscape of BTC Bitcoin Ecosystem

BitVM:

Source: BitVM Whitepaper

Recently, Robin Linus, the project leader of ZeroSync, published a whitepaper titled “BitVM: Compute Anything On Bitcoin,” which sparked a heated discussion. BitVM is the abbreviation of “Bitcoin Virtual Machine.” It proposes a Turing-complete Bitcoin contract solution that can be implemented without changing the Bitcoin network consensus, allowing any computable function to be verified on Bitcoin. It allows developers to run complex contracts on Bitcoin without changing the basic Bitcoin rules.

However, we are familiar with the fact that the programmability of Bitcoin is very limited. There is a classical impossible trilemma problem in blockchain: decentralization, security, and scalability. Bitcoin, in its design, only considers decentralization and security, to some extent leaving scalability behind. It only provides three forms of input scripts: Pay to Public Key, Pay to Public Key Hash, and Pay to Script Hash.

Pay to Public Key: This contract is used to send Bitcoin to a Bitcoin address;

Pay to Public Key Hash: This contract is used to send Bitcoin to a Bitcoin address;

Pay to Script Hash: A form of multi-signature script application.

The reason for the very limited programming ability of Bitcoin is that it only supports simple logic and limited opcodes in the Script script. Therefore, it is unable to develop complex smart contracts on the Bitcoin network. It is also because of the Turing incompleteness of Bitcoin scripts that it cannot execute arbitrary calculations or loops to greatly ensure security. Unlike direct computation on Bitcoin, BitVM only verifies the computation (similar to many extension schemes that do not disrupt the native Bitcoin system), and it is mainly achieved through OP-Rollup, fraud proofs, Taproot Leaf, and Bitcoin Script as described in the whitepaper.

Image source: BitVM Whitepaper

Bitcoin had many limitations when it came to complex computing and smart contracts in its initial design, but BitVM uses its unique approach to address these issues. The main roles it includes are:

Prover and Verifier: The former uses information input from a system to create a proof, and the latter verifies the computation result of this proof, without knowing the specific content of the information, ensuring accurate computation;

Off-chain computation and on-chain proof: Without changing the Bitcoin consensus, BitVM undoubtedly needs to move a large amount of computation and extension off-chain to improve flexibility. As for the controversial on-chain proof, a verification method similar to the fraud-proof data validity used by Optimistic Rollup is used to ensure security between severe parties and provers. What makes BitVM special is that it uses Taproot address matrix or Taptree to achieve various program instructions similar to binary circuits, which are combined to complete contract execution [1].

Image source: BitVM Whitepaper

However, the controversy lies in:

BitVM writes “simple proxy” in the Taproot address’s script and executes it as a spending condition instruction for UTXO (explained in the following text). Script is a basic script supported by the Bitcoin network itself. Although it is also an Output, the smart contracts mentioned by BitVM are only parsed in a centralized form after using the custom “script” of Output, with a difference between one being block resolution under the Bitcoin network and the other being who defines and resolves. BitVM can only use Output, not Script, to achieve the normal operation of smart contracts, and whether there exists a centralized mode of operation here is worth considering.

Lightning Network Taproot Assets

Taproot Assets:

On October 18, 2023, Lightning Labs released the mainnet Alpha version of Taproot Assets based on UTXO. With the completion of the mainnet version, the Bitcoin Lightning Network will become a straightforward multi-chain asset network, mainly targeting institutions and asset issuance, enabling the creation of instant, low-cost, and high-capacity transaction application protocols through the Lightning Network.

In the context of El Salvador’s adoption of Bitcoin as a legal currency in 2021, the Lightning community has experienced explosive growth, with users around the world enjoying instant settlement, low fees, and peer-to-peer Bitcoin transactions without financial intermediaries. The Lightning Labs continues to provide services to users, enabling them to integrate stablecoins into their applications using Bitcoin infrastructure. Additionally, developers are also exploring the use of real-world assets such as gold, US Treasury bonds, and corporate bonds for programmable interest payments. Two key factors exist in Taproot Assets: the Lightning Network and Taproot.

Image source: Lightning Labs official website

The Lightning Network:

Currently, the Bitcoin system has a maximum transaction speed limit of one confirmation every 10 minutes, with each confirmation able to handle 2,500 transactions. This quantity was determined through discussions among the Bitcoin community and developers. The main purpose of setting the speed limit is to protect the decentralization and security of the Bitcoin system, sacrificing scalability to a certain extent.

The Lightning Network, initially proposed by Joseph Poon and Thaddeus Dryja in February 2015 and released in March 2018, is a Layer 2 scaling solution for Bitcoin. It allows participants to create smart contracts off-chain, primarily addressing Bitcoin’s scalability and high transaction fees, enabling almost feeless transactions.

The core idea of the Lightning Network is simple: it allows all participants to deposit funds into a shared off-chain wallet address (smart contract) and then instantly send funds to another participant on the same contract after payment completion. Only the final transaction result is confirmed on-chain. The Lightning Network is a significant upgrade to the Bitcoin protocol, but it also brings a new problem, liquidity for the recipients among participants.

Image source: CSDN@mutourend

Taproot

The core reason for Bitcoin’s innovative progress can be attributed to the 2017 Segregated Witness (SegWit) upgrade and the Taproot upgrade in 2021. SegWit introduced a block field to store “proof data,” the signatures and public keys of Bitcoin transactions, to help increase Bitcoin’s throughput. However, potential vulnerabilities forced developers to limit the size of this data. The Taproot upgrade mainly includes two significant changes: MAST+Schnorr signatures, addressing these security concerns and allowing the removal of old SegWit limitations[5].

The core features of Taproot Assets:

1. Stablecoin issuance: LianGuaiyLianGuail, the top global payment application, has issued its own US dollar stablecoin PYUSD. This essentially extends from being a popular payment channel to becoming a value transfer medium itself. Taproot Assets has the same goal of providing stablecoins to users in the borderless financial world, leveraging the value of Bitcoin. For example, it can create a new stablecoin called taUSD and use a single Bitcoin transaction to transfer BTC and taUSD into the Lightning Network channel for DeFi operations. This is the core of Taproot Assets on the Lightning Network.

2. Multi-Universe mode: Universes are repositories that store all the information required for Taproot Asset wallet initialization and synchronization of specific Taproot Asset states. Even if the issuer’s servers crash, the validity and legitimacy of assets can be verified through multiple Universe servers, reducing dependence on third-party data stored off-chain.

3. Asset issuance and redemption API: Similar to corporate bonds, proofs of these redemption transactions can be uploaded to the chain, making it as easy for each user to trade various types of assets on Bitcoin as it is to invest in stocks and bonds in the real world. This allows mapping real-world asset issuance and enables exploration of the RWA track. Multiple sets of assets can be minted at different times, maintaining fungibility, and the asset redemption API facilitates the redemption process for asset issuers.

4. Asynchronous receiving function: Provides developers with a tool to add Uniform Resource Identifiers (URI) to on-chain addresses.

5. Scalability: The new “build-loadtest” command allows developers to stress-test the software. While Lightning may not be the ultimate scaling solution for Bitcoin, the integration with the Lightning Network provides vast possibilities for fast transactions and stablecoin support in the borderless financial world.

RGB Protocol:

The RGB protocol is part of the LNP/BP standards association, which oversees the development of various layers of Bitcoin. It covers Bitcoin Protocol, Lightning Network Protocol, and RGB smart contracts. The RGB protocol is designed for scalable and privacy-preserving Bitcoin and Lightning Network smart contract systems. Its purpose is to run complex smart contracts on UTXOs, integrating them into the Bitcoin ecosystem. The official description states: “A scalable and privacy-preserving smart contract suite for Bitcoin and Lightning Network, for issuing and transferring assets and more generalized rights.” The protocol is based on the concept of client validation and single-use seals proposed by Peter Todd in 2016, operating as a client validation and smart contract system on the second layer or off-chain of Bitcoin. Understanding the RGB protocol requires grasping the following four key points:

Single-use seals:

In simple terms, single-use seals are like literal seals that are applied to objects that need protection, allowing them to be in only two states: open and closed. This ensures that the content is only used once to prevent double spending. In the Bitcoin network, unlike Ethereum accounts, there are only wallet addresses, and Unspent Transaction Outputs (UTXOs) can serve as seals.

So understanding what UTXO is before sealing it in one go, it is a kind of ledger model in which every transaction generates inputs (Input) and outputs (Output). Among them, the output of a transfer transaction is the recipient’s Bitcoin address and the transfer amount, and these outputs are stored in the UTXO set to record unspent transaction outputs. At the same time, an input refers to a specific output of the previous block, so these transactions can be traced. Therefore, the Bitcoin transaction output can be used as a one-time seal.

According to the official documentation of RGB, a UTXO can be viewed as a seal: when it is created, the seal is locked; when it is spent, the seal is opened. According to the consensus rules of Bitcoin, an output can only be spent once. Therefore, if we use it as a seal, the incentive factor that ensures the execution of the Bitcoin consensus rules will also ensure that such a seal can only be opened once.

Image source: RGB Docs Chinese Official

Client-side verification and deterministic Bitcoin commitment:

Client-side verification is a paradigm proposed by Peter Todd in 2016. In the PoW consensus of Bitcoin, state validation does not require all participants in the decentralized protocol to perform global execution, but requires specific transformations to be verified by various aspects. It is transformed into a short deterministic Bitcoin commitment using cryptographic hash functions. This commitment requires some kind of “proof of publication” and has the three main characteristics of proof of receipt, non-disclosure proof, and membership proof. In short, OpenTimeStamps can be viewed as the first protocol in this field, and RGB is the second protocol. Other protocols can also use and integrate these themes, forming a series of client-side verification protocols.

RGB utilizes the Bitcoin blockchain to prevent double spending by committing RGB state transformations to spend the current UTXO that holds the right to be transferred in a specific Bitcoin transaction. This achieves the goal of multiple state transformations that can be committed to a single Bitcoin transaction, and each state transformation can only be committed to a Bitcoin transaction once (otherwise double spending would occur).

Image source: RGB Docs Official (Chinese)

Lightning Network Compatibility:
In the RGB website, when a state transition is promised to a Bitcoin transaction, it does not need to settle immediately on the blockchain because it can become part of a Lightning Network payment channel. It can then obtain security from it and also bring circulation of many digital assets to RGB by borrowing the Lightning Network payment channel.

Image source: RGB Docs Official (Chinese)

Updates in RGB v0.10:
According to Waterdrip Capital’s interpretation, the upgrade mainly focuses on the improvement of flexibility and security, and the following summary is listed:

Image source: Waterdrip Capital

The concept of RGB was proposed as early as 2016, but after several years of development, it has not received widespread attention and application. The main reason may be the relatively limited functionality of early versions and the high learning curve for developers. With the arrival of RGB v0.1, whether RGB can bring us more imagination in the future is worth looking forward to.

Bitcoin’s side chains: Stacks, Liquid, RSK, Drivechain
In 2016, Blockstream proposed the possibility of using tethered side chains to extend Bitcoin. Side chains often refer to trust-minimized blockchains that allow payments with external cryptographic assets (native assets of another blockchain). The most meaningful benefits that can be achieved through side chains are the issuance of user assets, stateful smart contracts that support DeFi solutions, commitment chain extensions, faster settlement finality, and higher privacy.

Stacks:

Image source: Stacks whitepaper

Image source: Stacks Official Website

Basic working principle:

First, let’s introduce Stacks. Although it does not directly refer to itself as a sidechain, there is still controversy over whether it can be classified as one. Its goal is to link itself to the Bitcoin blockchain through its unique “Proof of Transfer” consensus mechanism (PoX), thereby achieving high decentralization and scalability without increasing additional environmental impact.

Stacks is an open-source Layer 2 blockchain for Bitcoin that introduces smart contracts and decentralized applications to Bitcoin. Stacks, originally known as Blockstack, started its foundational work as early as 2013. The technical architecture of Stacks includes the core layer and the subnetwork, and developers and users can choose between the two, with the main difference being that the mainnet is highly decentralized but low throughput, while the subnetwork has less decentralization but higher throughput.

Image source: Stacks white paper

The core layer of Stacks interacts with the Bitcoin layer using the PoX mechanism. PoX is a Staking system similar to PoS and is a variant of Proof of Burn (PoB). It enables Stacks miners to mine blocks by “burning” a portion of their tokens (native assets or other cryptocurrencies). Through this “burning,” Stacks miners can mine more blocks and earn BTC rewards by helping ensure network security. The interaction process is as follows:

In Stacks, Proof of Transfer requires miners to send Bitcoin to other Stacks network participants (on the Bitcoin network, not a burn address). Since Stacks can read the Bitcoin network state, it can verify these Bitcoin transactions. Then, the Stacks protocol randomly selects the winning miner for that block and rewards them with Stacks’ native token, STX.

When interacting with Bitcoin, Stacks does not need to modify its underlying layer protocol because Stacks transactions are bundled together, with Bitcoin acting as the final settlement layer for Stacks, which is then sent to Bitcoin for verification and confirmation. The history of Stacks blocks will always be recorded on the Bitcoin blockchain.

Image source: Stacks Whitepaper

Clarity Smart Contracts:

Stacks uses a coding language called “Clarity” to create smart contracts, which are specifically designed for Stacks to optimize predictability and security. Clarity is intentionally designed to be Turing incomplete, thus avoiding “Turing complexity”. The smart contract code is public and can be accessed directly on the blockchain, allowing developers to test the code before running any smart contracts. This means that developers can build decentralized applications that benefit from the security and stability of Bitcoin while adding new functionality and features. With the support of Clarity, what kind of content can we innovate on Stacks and what are the advantages and disadvantages?

What can be done: 1. Build decentralized applications on Bitcoin and migrate the DeFi sector;

2. Create native assets on Stacks.

Advantages: 1. Security: Integrated with Bitcoin’s powerful security attributes, it has strong security and resistance to attacks;

2. Interoperability: First-layer smart contracts can communicate with other blockchains;

3. Scalability: The PoX consensus mechanism utilizes Bitcoin to achieve faster transaction confirmations and higher scalability.

Disadvantages: 1. Its unique design architecture has a certain learning curve and threshold for developers. It is important to attract more developers from the Ethereum ecosystem and MOVE system to fully tap its potential;

2. The uncertainty brought by STX mining and Stacking to regulation may also affect the development and operation of the second-layer network.

Liquid:

Image source: LBTC official

Now let’s talk about Liquid. It is not only a Bitcoin sidechain but also a settlement network for exchanges, connecting cryptocurrency exchanges and institutions worldwide. Its core functions include fast settlement, strong privacy, digital asset issuance, and anchoring with Bitcoin, enabling faster Bitcoin transactions and digital asset issuance, allowing members to tokenize fiat currencies, securities, and even other cryptocurrencies.

Both Liquid and RSK rely on federated multi-signatures to lock Bitcoin issued in native cryptocurrency form in the sidechain, but their actual peg designs still have significant differences. There are currently 15 operational functionaries for both sidechains, with Liquid requiring 11 signatures to issue Bitcoin and RSK requiring 8. Liquid seems to prioritize security over usability, while RSK prioritizes usability over security.

In general, Liquid is a sidechain platform designed to provide shared liquidity for exchanges, with a focus on protocol simplicity, security, and privacy.

RSK:

Image source: Mt Pelerin official

RSK is also a sidechain with its native token RBTC, aiming to be the foundation of financial inclusiveness and focusing on decentralized finance (DeFi). RSK is a stateful smart contract platform secured by Bitcoin miners, which enhances the value of the Bitcoin ecosystem by expanding the use of Bitcoin as a currency. Decentralized applications can be written using the Solidity compiler and the Web3 standard library, achieving Ethereum compatibility. In addition, it can expand Bitcoin payments through the RIF Lumino payment channel network, offering more on-chain space and off-chain transactions.

The purpose of RSK is to address a broader set of use cases, improving openness and programmability by adopting a stateful VM. It can port Ethereum’s dApps and tools to RSK while maintaining compatibility with Ethereum, while Liquid focuses on becoming an extremely efficient tool.

Drivechain

Drivechain is an open-source sidechain protocol for Bitcoin that allows for customizing different types of sidechains based on specific needs. BIP-300/301 proposed the idea of “adding features and capabilities to the Bitcoin world without actually modifying the Bitcoin core code.” By creating a Bitcoin sidechain secured by Bitcoin miners and relying on the security of Layer 1, various scalability use cases can be implemented in Layer 2. It should be noted that BIP-300’s “Hashrate Escrows” compresses 3-6 months of transaction data into 32 bytes using “Container UTXOs,” and similar to RSK, the network security is maintained through merged mining.

By using sidechains to create blockchain applications that meet their specific needs, Drivechain considers sidechains as a second layer to achieve scalability, avoiding the 1MB size limit of Bitcoin blocks. Currently, seven BIP-300-based sidechains are being developed and continue to attract more Bitcoin communities and enthusiasts. They are, for example (for brevity, only an example, see [6] for details):

• EVM sidechain: EthSide
• Digital asset/colored coin/NFT sidechain: BitAssets
• High transaction throughput sidechain: Thunder Network
• Prediction market sidechain: Hivemind
• Privacy sidechain: zSide
• Distributed DNS sidechain: BitNames
• Storage sidechain: Filecoin

Image Source: LayerTwo Labs Asian Community

Ordinals Protocol and BRC-20:

UniSat Wallet is a popular Chrome extension wallet in the Bitcoin ecosystem that helps users with storage, minting, and transfer of BRC-20 tokens. The Bitcoin ecosystem services offered include buying and selling BTC, NFTs, domain names, and more.

A Brief Introduction to the Origin of BRC-20

As explained in the previous section about UTXO calculations, each transaction generates countless inputs and outputs (changes in balances due to the fact that each Bitcoin consists of the smallest unit: one hundred million satoshis (1 BTC = 10^8), and each of these sats has a unique identifier and cannot be divided. Based on the ordinal of sats in Bitcoin, each sat is given a specific meaning. For example, 50 BTC can be represented as: 4,999,999,999 sats.

Image Source: Fourteen Jun

Although Ordinals Protocol and its self-proclaimed BRC-20 have characteristics that are overly centralized and lack validation mechanisms, it is undeniable that it has attracted more attention to the Bitcoin ecosystem and Layer 2 solutions due to the hot market. To some extent, it has brought the public’s focus back to Bitcoin.

Conclusion:

Bitcoin abandoned the attribute of scalability in its design, in order to greatly enhance the decentralization and security of its network. Regarding related scaling issues, the absolute crushing security brought by Bitcoin as the most successful blockchain network has also brought great imaginative space to many geek developers.

Therefore, supporters of the Bitcoin ecosystem can be roughly divided into two factions: conservatives and radicals. The conservatives believe that Bitcoin must maintain its pure monetary nature, solely used for value storage, and is pure digital gold, without the need for other forms of scalability. The radicals believe that Bitcoin needs to scale to embrace more native applications, maximizing the transactional attributes of Bitcoin, and benefiting the long-term development of Bitcoin. Perhaps we can leave this important question to the future, and time will tell us the answer.

Explanatory references:

【1】https://twitter.com/tmel0211/status/1715627595004543032

【2】https://docs.rgb.info/v/zh/she-ji

【3】https://blackLianGuaiper.rgb.tech/consensus-layer/3.-client-side-validation

【4】https://clarity-lang.org/

【5】https://www.odaily.news/post/5169725

【6】https://layertwolabsasia.medium.com/seven-sidechains-overview-538e76352e6c

Reference articles:

（1）https://www.weiyangx.com/139964.htm

（2）https://research.web3caff.com/zh/archives/11414?ref=0&ref=416

（3）https://blog.rootstock.io/zh-hans/noticia/the-cutting-edge-of-sidechains-liquid-and-rsk/

（4）https://www.bitget.com/zh-CN/news/detail/12560603822363

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