Layers 2 Bitcoin: Analysis of its secondary layer projects

Why this "layers 2" trend on Bitcoin?

Bitcoin is recognised as the most decentralised and secure blockchain. In addition, BTC's capitalisation represents 54% of the total capitalisation of the crypto sector. Because of these factors, many projects want to build around the Bitcoin network to take advantage of its security, large capitalisation and prestige.

Recently, we have seen an acceleration of this phenomenon with the launch of many projects presenting themselves as "layers 2" of Bitcoin. This trend is partly due to the success of ordinals, which are a kind of NFT on Bitcoin, as well as the announcement of BitVM, which promises to multiply Bitcoin's possibilities (see below).

General introduction 🧬

It is crucial to define certain terms for better understanding, especially in a field where the misuse of buzz words for marketing purposes is common.

By Layer 2, we mean a network from which we can withdraw unilaterally, without the permission of other players, to return to Layer 1, in our case, Bitcoin.

We can define three main functions of a blockchain:

Execution: Managing the execution of transactions and updating the state of a chain

Settlement: Dispute resolution

Data availability: Checking that transaction data is public and accessible

The purpose of a Layer 2 is to execute transactions outside its Layer 1, primarily to increase throughput and reduce cost.

A Layer 2 is always dependent on its Layer 1 for its settlement function, and so must prove that the transactions it has executed are correct. There are two models of proof.

The optimistic model assumes by default that transactions are correctly executed. If someone notices an anomaly in the execution of the transactions, they can submit a proof of fraud which will invalidate those transactions. This model works as long as at least one actor is honest.

The other model relies on proofs of validity that Layer 2 regularly publishes on its Layer 1, mathematically attesting that the transactions have been correctly executed.

Finally, a Layer 2 has several ways of managing the availability of the data for the transactions it performs. It can publish them on its own network or on a specialist blockchain such as Celestia. The most secure method is to publish them on its Layer 1, but this limits transaction throughput and increases their cost.

There are 4 main categories of Layer 2:

In addition to the projects that fall into this classification, there are also forms of layer 2 with architectures specific to the Bitcoin network.

We will also look at sidechains, which are layer 1s connected to Bitcoin by a bridge.

Risks and trade-offs 🥵

When a project claims to "inherit Bitcoin security", it is crucial to understand what properties are at stake. One key aspect is the security of the bridge that connects it to the Bitcoin network.

A rollup is an ideal layer 2 in terms of security because it inherits all the properties of its layer 1: transaction history and validity are guaranteed by layer 1 and it is always possible to unilaterally revert to layer 1.

An optimistic rollup is simple to set up, but there is a 7-day delay before you can return to layer 1, whereas a zk rollup has no such constraint.

A validium also inherits Bitcoin's properties for transaction validity and transaction history. However, to return its funds to layer 1, it must rely on the honesty of at least one actor in the network where the data is published.

An optimium only partially inherits Bitcoin's security and requires at least one actor in the network where the data is published to be honest to ensure the validity of transactions and their history, as well as to be able to return to layer 1.

A well-designed sidechain can offer a level of security equivalent to an optimium.

What we have described is correct only for projects in their final phase. Unfortunately, the structures are still considered to be in the experimental phase and the teams have enormous control over the security of their project.

Bitcoin's challenge and BitVM's hope 💪

Traditional layer 2s all rely on proofs that they publish on their layer 1, which are then verified by the layer 1. However, the Bitcoin network cannot directly verify these proofs because it is only capable of rudimentary operations, unlike most other blockchains that can perform any function.

On 9 October 2023, Robin Linus announced BitVM, a protocol that could make any function on the Bitcoin network verifiable. In a simplified way, BitVM allows operations similar to smart contracts to be carried out, and if these operations are executed dishonestly it is possible to submit some sort of proof of fraud to recover one's funds and punish the malicious actor.

Since then, several projects have decided to build layers 2 of Bitcoin, whose proofs would be verified using BitVM.

However, BitVM is still in development and has its limitations. Salvatore Ingala, firmware engineer at Ledger, notes that applications built on BitVM can only accommodate a limited number of actors capable of submitting proof of fraud, whereas the ideal would be to allow anyone to do so.

"The aim of projects relying on BitVM seems to be to design a "minimal trust" bridge. For example, a system where just one honest operator out of 100 is enough to prevent loss of funds. This is of course better than a federation based solely on a multisig," he tells The Big Whale.

Théo Pantamis, developer of LN Markets, also expresses doubts about BitVM's effectiveness in terms of scaling. "BitVM brings real innovation to Bitcoin, but as is often the case in the crypto sector, we're crying miracle before we've seen the practical implementation of the solution. BitVM consumes a huge amount of data to perform simple operations which represents an obstacle to scalability."

Salvatore Ingala has developed MATT, another solution for deploying forms of smart contracts on Bitcoin. However, MATT cannot run on the current Bitcoin network because it requires the implementation of covenants.

Bitcoin covenants are spending conditions that introduce new options for managing transactions, opening up the possibility of new applications on Bitcoin. Adding covenants would require an update to the Bitcoin network via a soft fork, but the Bitcoin network is known for its willingness to evolve as little as possible in order to maintain its simplicity and security.

Fanis Michalakis, developer at LN Markets, points out that "there are different types of covenants that add more or less flexibility to development on Bitcoin, but the community remains divided on the type of covenants that should be implemented."

It therefore appears that there are no plans to add any changes in the near future and that BitVM currently remains the most satisfactory solution for developing layers 2.

Early layers 2

The Lightning Network is the first true layer 2 on Bitcoin. It is designed for daily payments and allows users to return unilaterally to the main network. However, it is difficult to develop other types of large-scale applications. In addition, it relies on payment channels that encounter liquidity fragmentation problems.

"For several years, Bitcoin layers 2 that support smart contracts have been in development, but they have no tokens to sell, which makes them less attractive to investors and users," says Fanis Michalakis.

RGB falls into this category. Its development is rather laborious, especially as it is not easy to create applications on it. "RGB is based on the AluVM runtime environment and there is little documentation or tools for developing on it," explains Théo Pantamis.

The new wave of "layers 2"

These projects have raised significant funds, giving them more resources to develop and communicate. What's more, most organise airdrop campaigns to attract liquidity and attract attention. Here's a selection of the most relevant.

Stacks (STX)

Stacks is one of the most popular projects among Bitcoin's new "layers 2". The project is in the process of rolling out its "Nakamoto" update, which will anchor its block creation with Bitcoin's, making it impossible to reorganise the history of its blockchain.

However, the Bitcoin network cannot guarantee that transactions made on Stacks are valid. Furthermore, it is not possible to unilaterally transfer one's funds from Stacks to Bitcoin.

Stacks therefore resembles a sidechain.

The Stacks blockchain has a locked value of $110 million and a native token called STX with a total valuation of $3.6 billion. We bring you a market analysis of its token as it is the most highly valued.

Market analysis of STX by Chadi El Adnani, Head of Content & Research at SUN ZU Lab 📈

STX has very strong liquidity levels, with a market capitalisation of $2.9 billion and daily trading volumes of between $40 million and $120 million on the main centralised exchanges. Average market depth at 50 bps exceeds $1 million on Binance.

The relationship between Stacks and Bitcoin is often compared to that between Polygon (MATIC) and Ethereum (ETH). Indeed, Stacks extends Bitcoin's capabilities by enabling a wider range of applications. However, an analysis of the financial markets reveals many disparities: MATIC's market capitalisation and daily trading volumes are twice those of STX. Even in relative terms, STX represents only 0.2% of Bitcoin's market capitalisation, compared with 1.6% for MATIC/ETH. This partly reflects the importance of Layer 2 to Ethereum and the different philosophies of the two cryptocurrency leaders.

Like many other altcoins, STX's performance reached almost 150% at the end of March 2024, far outperforming BTC and ETH. However, it has lost momentum and currently stands at 30%, compared with around 60% for BTC and ETH.

Merlin (MERL)

Merlin is a recent blockchain based on the EVM (Ethereum Virtual Machine) that enables the creation of smart contracts. It also supports the use of Bitcoin wallets thanks to Particle Network, a project focused on chain abstraction.

Merlin presents itself as a Bitcoin zk-rollup. However, as we have seen, this type of layer 2 is not possible on Bitcoin without the support of BitVM, which is not mentioned in its documentation. Furthermore, the latter does not specify whether the available data is actually published on the Bitcoin network.

Despite this, the project has attracted more than $1.2 billion in locked value on its network during its various airdrop campaigns for its MERL token, with a total valuation of $920 million.

BOB (Build On Bitcoin)

Bob is a recent EVM-based blockchain. Currently, it is an Optimism rollup on Ethereum as part of the Optimism Superchain. The project's evolution plan is divided into three phases:

- Integrate the computing power of Bitcoin network miners to secure BOB, inspired by the "merge mining" concept.
- Become an optimistic rollup based on BitVM.
- Evolve into a Bitcoin zk-rollup, if an update to Bitcoin allows it.

For full functionality, merge mining would require updates to the Bitcoin network allowing miners to validate multiple blockchains simultaneously.

Théo Pantamis explains why these updates are open to debate: "Allowing merge mining offers additional rewards to miners, but encourages them to use increasingly sophisticated hardware, which puts small miners at a disadvantage and hampers decentralisation."

Fanis Michalakis added: "Ideally, a layer 2 should not impose more constraints on the various players in the Bitcoin network."

BOB is currently running an airdrop campaign, which involves blocking value on the network's various protocols to collect "spices". At present, $50 million of value is locked on the network.

B² Network

B² Network is a project in the launch phase that describes itself as a Bitcoin zk-rollup. However, like Merlin, the attributes of a true zk-rollup are not present in the documentation.

This project has launched a campaign allowing bitcoins to be deposited on the network's smart contracts to accumulate points ahead of launch.

Mezo

Mezo bills itself as the "economic layer of Bitcoin" and at least seems to have the intellectual honesty not to describe itself as a true layer 2 of Bitcoin or inherit all of its security.

Mezo is one of the projects that has raised one of the largest amounts of funding ($21 million) within the Bitcoin ecosystem.

It is a sidechain based on Proof of Hold, which seems to be similar to Proof of Stake. The network hasn't launched yet, but it's possible to lock bitcoins into it for a set period of time in order to accumulate points.

Alpen and Citrea

Alpen and Citrea are two projects in development that want to launch as BitVM-based zk-rollups.

Their documentation is clearer and indicates an approach that tries to really inherit as much of Bitcoin's security as possible.

It remains to be seen how successful these projects will be in dealing with the security and scalability issues caused by the current limitations of BitVM that we mentioned earlier.

Ark

Ark is another layer 2 whose development is worth following. Its unique architecture is partly inspired by that of the Lightning Network, while addressing two of the latter's major problems: the fragmentation of liquidity and the anonymity of transactions.

"Ark has a very interesting approach because it is initially built without requiring the implementation of covenants (therefore changes to the Bitcoin network), but will then be able to integrate them, particularly to improve its scalability," Théo Pantamis points out.

The Big Whale's opinion 🐳

The concept of Bitcoin's "layer 2" is often used loosely by projects for marketing purposes.

Besides the Lightning Network, which specialises in payments, there is no really used "layer 2" that allows a unilateral reversion of the Bitcoin network. Some upcoming projects could change the game, but their implementation remains uncertain.

Most of these Bitcoin projects only work with synthetic bitcoins, notably wBTC, which relies on a group of centralised players, and tBTC, which opts for a more decentralised but still imperfect approach, as evidenced by its very low adoption ($240 million in capitalisation).

The use of Bitcoin "layers 2" with synthetic bitcoins multiplies the risks. While it may be tempting to monetise your bitcoins by depositing them on these networks, it is important to understand the associated risks.

The main advantage of building on Bitcoin is to benefit from its security. However, most of the projects presented are currently far less secure than other major blockchains such as Ethereum and Solana.

The most promising projects that really seem to prioritise inheriting as much of the Bitcoin network's security as possible are therefore Ark, Alpen and Citrea. They are all still in the development stage.

"It's not clear that improving scalability is the only priority for Bitcoin. For example, it's possible that protecting privacy makes more sense at the moment, but these are tasks that can be carried out at the same time, and sometimes feed off each other," concludes Fanis Michalakis.

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