The Bitcoin Ecosystem
and the State of Layer-2 Networks
Last updated: 11.04.2024
Author: Amir A.
Executive Summary
The launch of Ordinals has brought excitement and enthusiasm from users and builders to get involved in the Bitcoin ecosystem
- Average transaction fees have drastically increased from around USD 1 to USD 3 and above.
- Over 50 Layer 2 projects have launched or are in the process of launching on the Bitcoin protocol.
The growth potential of Bitcoin’s ecosystem remains largely untapped
- BTC’s TVL to market cap ratio is 0.0056%. In sharp comparison to Ethereum which has a 12% ratio.
- In particular, yield-generating mechanisms could unlock tremendous value for long-term holders, who for the most part just “hodl” Bitcoin.
The case for Bitcoin Layer 2s is particularly strong due to the following
- Inherent scalability and programmability limitations of Bitcoin
- Bitcoin is the optimal base layer for important asides to reside on due to its robust security
This opportunity has not gone unnoticed as the Layer 2 market is growing rapidly
- More than 50 layer-2 projects have launched or are in the process of launching since the start of 2023, making the market highly competitive.
- Different architectures are being explored: ZK-rollups, sidechains, rollup as a service, and state channels
- Currently, Stacks has positioned itself strongly as the leader in this space, and looks to retain this position thanks to significant growth over the last few months, and a robust ecosystem that has been built over the last few years.
- Several new entrants appear to have strong potential: Merlin Chain, Botanix, BEVM, Bitlayer
The Bitcoin Renaissance
Despite being the largest cryptocurrency by market cap, the development and usage of applications on Bitcoin have never caught on the same scale as Ethereum. However, since the inception of Ordinals, there has been a renaissance within the Bitcoin community as development and usage of applications on Bitcoin have grown significantly. The current phase in which Bitcoin is in shows similarities to Ethereum in 2017 as early NFT projects and token launches flooded the network.
This can be seen by all the new inscription and token standards and infrastructure projects built on Bitcoin over the past 15 months.
Leading inscription standards: Ordinals, Atomicals, Bitcoin Stamps, Tap protocol
Leading token standards: BRC-20, ARC-20, BRC-100, ORC-20, Runes (to be released)
Runes in particular is highly anticipated as it was developed by Casey (inventor of Ordinals), as a more efficient alternative to BRC-20s). It is expected to launch on Bitcoin halving which is estimated on April 19th.
Infrastructure projects:
- Mubi: bridge for Ordinals to Ethereum
- Ordiswap: AMM dex for ordinals
- Unisat: originally a Bitcoin wallet to have adopted Ordinals early and now also has a marketplace
- Ordiscan: blockchain explorer for ordinal-related transactions
- BeFi Labs: L2 trading terminal for Ordinals
The demand to own and interact with these protocols is clear judging by the high valuations of these projects: The total market cap for BRC-20 tokens alone currently sits at over USD 2.7bn, while infrastructure projects such as Ordiscan and Mubi are ranging have valuations of USD 40m and USD 90m respectively.
Furthermore, the demand to use and build on Bitcoin is evident by the increase in the average transaction fees over the last year:
Average transaction fees on Bitcoin (USD)
Source: Ycharts
The Case for Layer 2 Protocols on Bitcoin
Bitcoin as the base layer
As Bitcoin looks to become a globally adopted cryptocurrency and is arguably the most secure blockchain due to its robust proof of work consensus mechanism and mining power, there is a strong case that it makes the most sense for all important blockchain-related assets to be stored on and secured by Bitcoin.
Limited programmability of Bitcoin
Bitcoin on its base layer is not an ideal platform to build complex applications as its UTXO and scripting model limits the complexity of applications that can be built. It can be argued that the current inscription standards built on Bitcoin are not efficient and have been ‘shoehorned’ in. For Bitcoin to become a hub for decentralised applications, Layer-2 protocols are needed to accommodate use cases that are currently difficult to achieve.
Limited scalability
Like Ethereum, Bitcoin has limited scaling capacity, which is a core argument as to why Layer-2s are needed for Bitcoin to grow its user base. This was seen during the last Ordinal craze as there was a backlog of 120k unconfirmed transactions and mining fees spiked so high, that for the first time, miners made more through transactions than daily block rewards.
Making use of unproductive capital
With Bitcoin being a USD 1.4 trillion asset, and the leading crypto asset on a long list of metrics, it is clear that there is a lot of idle money held by long-term investors that can potentially be used productively through applications on top of Bitcoin. With the newly found interest to build on and interact with Bitcoin, a big opportunity presents itself for Bitcoin Layer-2 protocols to gain traction.
Market Opportunity
Currently, according to Defillama, the TVL on Bitcoin is 1.3B, which is a fraction of Ethereum’s current 54.8B TVL. When comparing the current TVLs to the respective market capitalizations of Bitcoin and Ethereum, it is clear how big the opportunity is for Bitcoin to catch up.
- BTC TVL to market cap: 0.056%
- ETH TVL to market cap: 12%
Furthermore, when comparing the top 10 Layer 2 protocols on Bitcoin and Ethereum by valuation shows that the market currently perceives Ethereum Layer-2 protocols to be of much higher value:
Ethereum ecosystem top 10 L2s
Bitcoin ecosystem top 10 L2s
Source: CoinGecko
An important point to highlight is that nearly half of the Bitcoin Layer-2s listed here, namely, Elastos, SYS, Nervos, Conflux, and Sovryn recently pivoted to create a Bitcoin Layer-2 during the last year and a half.
Current State of the Layer 2 Market
The current state of the market
The opportunity to capture a piece of the potentially massive Layer 2 market for Bitcoin has not gone unnoticed as over 50 Layer 2 projects are in the process of launching or have already launched since the start of Ordinals.
The kinds of Layer 2s in the market can be split according to the categories below according to the following categories: Rollup, Rollup infrastructure, side-chains, and State Channels.
Rollups
An argument against rollups is that Bitcoin’s inherent scalability limitations may hinder its potential to scale for a large user base. However, with ZK technology rapidly progressing and lowering in cost, this may not be a huge obstacle in the future. Most rollups being launched have a ZK architecture.
The following are some rollups that have launched or plan to launch on Bitcoin:
ZK-rollups
- Merlin Chain
- B² Network
- Rollux (from SYS)
- Bitlayer
- Citrea
- Lumibit
- ZKSats
Optimistic rollups
- BEL2 (from Elastos)
- Bitlayer
- Beet Network
Rollup as a Service
This includes two categories: modular rollups and a network of interoperable rollups, similar to Optimism’s superchain concept. Projects offering rollup infrastructure:
- Rollkit: modular
- BVM: modular
- Soveryn: non-modular, Super Chain approach
- LayerTwoLabs: Drive Chains
- BitVM: open source rollup infrastructure adopted by numerous L2s launching
Side Chains
Sidechains have the advantage of having higher scaling potential over rollups, as they do not require to post transactions onto the main chain. However, it does also mean they can be considered less secure than rollups that inherit security from Bitcoin.
Regarding the consensus mechanism used by sidechains, there is an argument that proof of stake side chains built on Bitcoin have a high potential to capture TVL, as proof of stake built on top of Bitcoin’s proof of work creates a mechanism to derive yield for idle Bitcoin while contributing to the Layer 2s security.
List of Bitcoin sidechains
- Stacks
- Dovi
- SatoshiVM
- Botanix
- Rosetta Network
- Conflux
- Bitfinity
- Mint Layer
- Liquid Network
- BL2
- Rootstock
- Bouncebit
- Gelios
- TronDAO
State-channels
State channels are a strong solution for payments as they enable a fast and cheap way to transfer Bitcoin. However, their limited programmability makes them a weak solution for more complex applications.
State channel solutions:
- Lighting network
- Mercury Layer
Other Layer 2s
Apart from the categories above, some other Layer 2s fall under different categories. These include:
- Nervos Network: modular L2 with RGB++ primitive (can be a sidechain to many networks)
- RGB: smart contract system for Bitcoin (client-side validation)
- BiHelix: development infrastructure built with RGB
- BitLight Labs: development infrastructure built with RGB
- Bool: data availability layer
- BOB (Build on Bitcoin): hybrid L2 powered by Bitcoin and Ethereum
- Bison labs: sovereign rollup
- TunaChain: hybrid ZK-OP rollup
- Naka chain: OPtimistic rollup powered by BVM
- Eternal AI: Optimistic rollup powered by BVM
- Core: delegated proof of work (secured by BTC mining pools)
- Bouncebit: staking blockchain
- Eastblue: abstraction layer powered by NEAR protocol
Important attributes of a Layer 2
As the market is highly saturated with new entrants it is difficult to predict which Layer 2 protocols will win over the long term. However apart from the different architectures reviewed above, the following criteria can also used to assess and compare Layer 2 protocols on Bitcoin:
- Codebase: EVM compatibility
- Native support for Bitcoin
- Security: bridging structure and leveraging Bitcoin to validate/secure transactions
High-value Prospects
Stacks
Native currency: STX, soon to implement BTC
As one of the first movers in this sector, Stacks has built a robust ecosystem with over 90 projects in their ecosystem. Although they previously struggled to gain traction in terms of TVL and users, this appears to be changing quickly as their TVL has grown by over 200% since early February and now sits at over USD 160m.
Furthermore, Stack’s Nakamoto upgrade coming in April will improve scalability and speed and the expected introduction of sBTC onto their chain will bring native support to Bitcoin for Stacks. At the moment, Stacks are the market leaders in market cap at a valuation of USD 4.98bn and are strongly positioned to retain this spot.
Merlin Chain
Native currency: BTC
Merlin Chain is an EVM-compatible ZKrollup that launched in February 2022 after a successful staking campaign that attracted over 2bn in TVL.
Their launch has been successful, as it has attracted numerous users and projects as well as a quickly growing TVL which currently sits at USD 92m.
Projects that have adopted or are building on Merlin Chain:
- Pyth Network: Oracle
- Merlin swap: DEX
- DragonVerse: MMO game
- Uni cross: cross-chain inscription minting platform
- Surf Protocol: Lending/borrowing protocol
Botanix
Native currency: BTC
Botanix is an EVM-compatible sidechain that is currently in test mode. Botanix’s key differentiator to competitors is their ‘spider chain’ which they claim will be the most decentralized two-way pegg / bridging solution available.
BEVM
Native currency: BTC
BEVM is a highly anticipated EVM-compatible Layer 2 sidechain that recently launched its main net. BEVM raised capital from VCs such as RockTree Capital, Waterdrip Capital, and ArkStream Capital at a post-money valuation of USD 200m.
Bitlayer
Native currency: BTC
Bitlayer is an Optimistic rollup on Bitcoin, aiming to launch this year. Bitlayer stands out from competitors due to its developer friendliness as it supports numerous virtual machines: EVM, SolVM, CairoVM, MoveVM.
Potential risks for this sector
Centralized control of Bitcoin locked-in bridges
If Layer 2s on Bitcoin gain significant adoption, it would mean a significant portion of Bitcoin’s supply would be locked in bridges to respective Layer 2 protocols. Although most Layer 2 protocols claim to have a safe and decentralized bridging solution, this remains a large risk factor.
Detracting value away from Bitcoin
An argument from Paul Sztorc, a Bitcoin Maxi, the founder of LayerTwoLabs and key advocate for the Drivechains proposal is that any Layer 2 built on top of Bitcoin should benefit miners. The reasoning is that if Layer 2s on Bitcoin are contributing fees for Bitcoin miners, they are driving traffic away from miners and are detrimental to the security of Bitcoin.
Lack of reliance on Bitcoin for security
Many of the solutions being built now are perhaps not ‘’true’’ Layer 2s, due many of the solutions do not fully rely on Bitcoin for consensus and/or validation of transaction. . On the flip side, should a Layer 2 fully relies on Bitcoin for its security, its scalability and throughput would be limited by Bitcoin’s lack of sustainable infrastructure for it.
Disclaimer
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