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Author: F.F from LBank Labs Research team

Table of Contents

TL; DR
Renaissance of Bitcoin Scaling
Scaling Market Landscape
An Example: Stacks
Nakamoto Upgrade and sBTC
Ecosystem and Stats
Summary

TL; DR

Currently, dApps and Web3 innovation are generating more excitement than Bitcoin. However, we expect this perception to change. Web3 is still in its early stages. Bitcoin, as the largest and strongest cryptocurrency, remains a solid foundation for builders, entrepreneurs, and startups to build on. Its minimalist approach limits functionality to keep the network simple, robust, secure, and trustless. While limited throughput, lack of smart contract capability, and non-turing completeness come at a cost, these trade-offs have allowed Bitcoin to survive ups and downs over the past years.

After the waves of Ordinals, we are looking forward to the renaissance of Bitcoin, with the builder culture leading to the improvement of cryptocurrency. We may see more scaling solutions complementing Bitcoin to create a robust modular network.

Therefore, we are introducing the “Renaissance of Bitcoin Scaling” series. In this series, we will go through the current scaling solutions case by case, exploring the possibilities and finding the most promising solution that inherits Bitcoin and offers greater expressiveness.

In the first essay, we will describe the origin of the scaling demand, the landscape of Bitcoin scaling, and provide our analysis framework and thoughts on the key points of scaling solutions. Then, we will deeply research the most discussed scaling solution, Stacks, as an example, to clarify what matters about Bitcoin scaling.

Renaissance of Bitcoin Scaling

Throughout its long history, the narrative of Bitcoin has undergone significant changes, transitioning from being used for global payments to being regarded as digital gold in the most recent cycle. However, its underlying architecture has remained mostly unchanged. Although many projects have attempted to make Bitcoin more programmable, very few of them have been accepted by the Bitcoin community. This is because the community believes that Bitcoin should remain clean and simple, sticking to its original design. With Ethereum’s increasing overhead and migration to the settlement layer, as well as the rise of modular design, it is clear that Bitcoin has established its role from the very beginning. More computing-intensive work should be delegated to upper layers, similar to how L2s work for Ethereum.

Despite Bitcoin’s scaling problems, few in the community discussed them until the Ordinals inscription this year. During the period of Ordinals and Brc20, the Bitcoin network experienced unprecedented levels of congestion due to pending transactions in the mempool and an increase in transaction fees. Bitcoin users recognized the need for a scaling solution that could efficiently address the backlog without compromising security. Additionally, Bitcoin needs increased demand for blockspace in order for the system to thrive as the block subsidy asymptotes to zero.

Looking back on the early days of DeFi summer, it caused congestion on Ethereum and motivated the community to create alternative Layer 1 and Layer 2 solutions. These notable Layer 2 solutions were built from scratch over the last two years. At present, Layer 2s have a TVL of 10B, which is equivalent to 5% of Ethereum’s market cap. In terms of market cap, the total of Layer 2s has already reached 10%. If we expect Bitcoin’s scaling solutions to be similar to Ethereum’s, that represents a 100B blue-ocean market. However, the notable Lightning Network only reached 5,000 BTC at its all-time high, while other scaling solutions have much less than the Lightning Network. There is still untapped potential for Bitcoin, and as new projects emerge, the case for Bitcoin becomes stronger.

Layer2 Market Cap(Source: CoinGecko)

Scaling Market Landscape

From the above perspective, it appears that the Bitcoin scaling market still has a long way to go before settling down. At the moment, no one entity dominates the market, and there are many interesting avenues to explore in terms of scaling Bitcoin or improving the capital efficiency of BTC. This is why we have decided to delve deeper into this market to determine which solutions may ultimately prevail in the future.

However, it must be acknowledged that Layer2 solutions in Ethereum may not be practical in the context of Bitcoin. While Ethereum is capable of verifying the state transition in Layer 2, Bitcoin can only ensure the validity of the signature. Consequently, scaling solutions for Bitcoin will require more complex innovations and modifications to be tailored to the specific needs of Bitcoin. Therefore, some migrations from Ethereum may not make sense, and the term “Layer2” may not be appropriate in this context.

The Bitcoin landscape below classifies solutions into Meta-protocols, Layer2s, Sidechains, and Cross-Chain Bridges. Additionally, there are other definitions such as sovereign rollups, TAP, zk-rollups, Ark, Drive Chains, Space Chains, Soft Chains, and so on. While this landscape provides a comprehensive overview of what is happening within the Bitcoin community, we acknowledge that its classification may not be entirely accurate, and we do not delve into the technicalities of these terminologies.

Bitcoin Landscape(Source: Twitter)

We should focus on the goals of these solutions, whether they aim to improve the speed of Bitcoin payments, such as Lightning Network; upgrade the efficiency of Bitcoin’s capital, such as wBTC in Ethereum; add more functionality to Bitcoin, such as Ordinals; or implement smart contracts on Bitcoin, such as DLS. In our “Renaissance of Bitcoin Scaling” series, we will study each solution case by case and categorize them based on their scaling purposes, as follows:

1. Adding native functionality to Bitcoin, such as Ordinals.
2. Improving payment speed, such as with Lightning Network.
3. Upgrading the capital efficiency of BTC, such as with wBTC.
4. Implementing smart contract capabilities on Bitcoin, such as with DLS.

Furthermore, some solutions, such as Lightning Network, have expanded their business from payment scaling to issuing tokens on Bitcoin’s native layer, such as Ordinals. As a result, they may fall into multiple categories under our classification.

Once we clarify our classification principles, we’ll focus on the feasibility and security of potential solutions. As we’ve seen before, most Bitcoin users didn’t recognize their scaling solution. There were at least two reasons for this. First, Bitcoin users are the most security-sensitive group in the crypto world. They won’t easily trust a new scaling solution. Second, some scaling protocols rely on a centralized party and aren’t as robust as they claim. In one sense, only a protocol that shows off its security can be trusted by Bitcoin users to bridge their own assets.

From our perspective, all of these solutions need to solve three problems:

1. Trustlessly read the state of Bitcoin
2. Trustlessly write to the state of Bitcoin
3. Self-custody of Bitcoin

Different protocols introduce different security assumptions in dealing with these problems. Many protocols read or write the state of Bitcoin with the help of new layers, and the pegs are generally managed by and entrusted to either a centralized custodian or a federation of trusted entities. According to the cask theory, the weakest layer determines the security level of the solution.

An Example: Stacks

In this article, we will analyze Stacks, which is currently one of the most widely discussed scaling solutions. Stacks is a layer built on top of Bitcoin that is designed to handle the overflow of traffic when the Bitcoin mainnet becomes overwhelmed. It currently leads the market in terms of market cap and TVL. In the following sections, we will cover the architecture, design philosophy, security assumptions, and comprehensive ecosystem of Stacks.

Architecture and Security Assumptions

When it comes to architecture, Stacks relies on the node to run both Bitcoin and Stacks Layer. While Stacks does not use merge-mining like RSK, it has its own miners and mining process, as well as its own economic value and security based on token value. Despite this, Stacks still follows Bitcoin’s finality and maintains a similar pace of block production as Bitcoin.

PoX

To integrate these two layers, Stacks has introduced a new consensus mechanism called Proof of Transfer (PoX), which is similar to Proof of Stake (PoS) but has some vesting design. PoX miners bid by spending BTC and have a bid-weighted random probability of becoming a leader to earn STX tokens from the Stacks layer. After that, miners can stake STX to earn BTC back.

Let’s take a closer look at the benefit-cost analysis of PoX to identify the incentives for miners to maintain the network. According to the statistics from OnStack and Blockchain.com, miners have spent a total of 0.927 BTC in the last 100 blocks and received 111,538 STX in return. In the current market situation, this translates to an input of around 27,161 USD and an earning of 67,592 USD, making it a profitable mining opportunity regardless of the miners’ operational costs.

PoX Stats(Source: OnStack)

The miner SP2DW8DZXJCYDEVX0NN9R1A203GWHCSMGBQS3A64X has earned the most block rewards in the last 100 blocks, spending 3,890,950,000 Sats (38.9 BTC) to mint 2,513,000 STX in total. According to current market conditions, this translates to an input of approximately 1,139,770 USD, with earnings of 1,522,878 USD. These statistics demonstrate that PoX has yielded excellent results in the past, with even better results in recent days, likely due to the limited number of miners on the network.

PoX Miners Stats(Source: OnStack)

Stacking

After the distribution of STX to miners, Stacks makes the circulating STX available to both miners and general users to earn BTC rewards. These rewards are funded by minor payments. Miners benefit by mining STX at a lower cost, while users can earn BTC by staking STX.

As stated by Stacking Club, each staking cycle lasts approximately two weeks. In cycle #63, 339M STX were staked to earn 2.79945 BTC. This translates to an annual percentage yield (APY) of around 9%, making it a viable strategy for earning BTC.

Stacking Stats (Source: Stacking Club)

xBTC

Up until this point, there hasn’t been much discussion about how BTC custody works within Stacks. The truth is, Stacks does not have its own solution for this matter. Instead, they rely on a third-party service provided by Wrapped, which acts as a cross-chain bridge. The wrapped BTC is referred to as xBTC and works similarly to other bridge assets. xBTC will function as the native token on Stacks for various applications, similar to wBTC on Ethereum. Additionally, xBTC will act as a bridge between PoX and Stacking protocols. Currently, there are approximately 156 BTC held in reserve for xBTC.

xBTC Reserve (Source: Wrapped)

Clarity VM

Stacks also introduces a new language to enable smart contract development, claiming to add this capability to Bitcoin. The Clarity VM serves as the execution layer of the virtual machine for Stacks.

However, it’s important to note that this is not a native smart contract layer for Bitcoin. When considering the consensus, staking service, and xBTC, the entire architecture is not dissimilar to Ethereum, which uses Solidity to build contracts.

In the current market, it may not be wise to create a new language. Clarity could potentially be a burden for developers. For example, when examining the sample “Counter” contract, its syntax is quite different from the mainstream language, Solidity. Additionally, there is a lack of educational resources and materials available for Clarity.

Gaia

As previously mentioned, Stacks only stores the hash on Bitcoin. Bitcoin acts more like a data validation layer. However, data availability is not inherited from Bitcoin.

To solve this issue, Stacks utilizes a hybrid DA solution by using Stacks’ native layer and an off-chain DA solution called Gaia, which is a hub service and storage resource on a cloud software provider. Specifically, public transactional metadata and BNS are stored on the Stacks blockchain, while user application data is stored on Gaia. Essentially, Gaia is a cost-effective key-value database that can efficiently and securely store data.

Points

The above text presents the initial version of the Stack operating system that is currently in use. Our analysis framework reveals the following:

• Read: Smart contracts on the Stacks layer can access Bitcoin state and can be activated by standard Bitcoin transactions. This is because Stacks nodes also run Bitcoin nodes as part of consensus, and they eagerly read and index Bitcoin state.
• Write: Stacks only demonstrate that they can store the hash in an anchored block. However, there is still some work to be done before it can be considered a Bitcoin programming layer.
• Custody of Bitcoin: xBTC from Wrapped
• Security Assumption: It is a separate security budget from Bitcoin, with an additional security assumption. The Bitcoin network only serves as a data validity layer, with not much Bitcoin alignment.
  a. The Stacks consensus layer and DA layer have only 5 miners.
  b. The Bridged assets layer may suffer attacks.
  c. The Offchain DA may suffer single-point failure.

Nakamoto Upgrade and sBTC

Nakamoto represents a significant version upgrade for Stacks, addressing some of the problems mentioned previously. It will introduce two major upgrades to the Stacks layer: fast blocks and sBTC.

Fast Blocks

Stacks currently produces blocks at the same rate as Bitcoin, which is one block every 10 minutes. However, this rate is not always consistent. To address this issue, Stacks is developing fast blocks that will produce micro blocks between two Bitcoin blocks. This will result in approximately one new block every 5 seconds.

In addition to the PoX consensus, Stacks will introduce a BFT-style quorum signing mechanism that will allow Stacks miners to select the leader for block production.

The original block under PoX is called the “settlement block,” which will be produced at every Bitcoin block. Settlement blocks do not contain any new transactions, but only settle the recent sequence of fast blocks on the Bitcoin chain. Miners of settlement blocks are incentivized to include the longest sequence of fast blocks for settlement on Bitcoin.

From a user’s perspective, Stacks’ faster block production means faster confirmations, with all transactions on the Stacks layer eventually settling on Bitcoin in the background.

sBTC

Stacks is addressing the issue of bridged assets with their own solution, sBTC. This solution is backed 1:1 by actual BTC held in a multi-sig address on the Bitcoin mainnet.

In Peg-In mode, users can send BTC to a peg wallet (P2SH) on the Bitcoin chain controlled by a threshold fraction of stackers, determined by the fraction of locked STX they represent. In Peg-Out mode, the threshold fraction of Stackers fulfills the peg-out by transferring the requested amount of BTC from the peg wallet/script to the desired Bitcoin address. In emergency situations, a portion of the PoX payouts from miners that would have been received by the stackers is redirected to fulfill peg-out requests, ensuring that all outstanding peg-out requests are eventually fulfilled.

Peg-outs utilize a threshold signature mechanism: Liveness is maintained as long as 70% of stacked STX sign the peg-outs, and safety is maintained (BTC cannot be stolen) as long as at least 31% of the stacked STX do not sign unauthorized peg-outs.

sBTC Mechanism (Source: Stacks)

To encourage original PoX stakers to fulfill the mission, they can lock or “stack” STX and perform peg-out signing and other consensus-critical tasks. In return, they are rewarded in BTC proportionally to the STX they stack.

To improve the capital efficiency of sBTC, Stacks also plans to introduce rollups on the Stacks layer. This will allow users to enjoy the benefits of rollups and fraud proofs (such as privacy and scalability) while using Bitcoin as their asset via sBTC. Rollups on the Stacks layer are much more practical than rollups directly on the Bitcoin L1. However, there is still a long way to go for Layer 3 rollups.

There are also some limitations to the economic mechanism that maintains sBTC. The fully diluted market cap of Stacks is currently around 1 billion, which means sBTC can only hold up to 0.7 billion BTC assets. Once the capacity is above 0.7, the stakers of STX have an incentive to steal BTC and crash the whole system.

Points

• Read: Same as before Nakamoto.
• Write: No further details on threshold signature. This has been a challenging problem in the Bitcoin and cryptocurrency world for years, as it solves a difficult dilemma.
• Custody of Bitcoin: sBTC based on an economic mechanism.
• Security Assumption: Introducing more security assumptions compared to pre-Nakamoto.
  a. BFT consensus layer for fast block production.
  b. 70% shares of stacker are the cornerstone of sBTC.

Ecosystem and Stats

Currently, Stacks boasts the largest and most comprehensive ecosystem of scaling solutions. This includes wallets, DeFi, NFT, staking, and even social platforms. While it’s not feasible to list them all here, we will highlight some representative protocols in each category.

Stacks Ecosystem (Source: Stacks)

Wallets

Hiro Wallet is a widely recognized and trustworthy wallet for Bitcoin and BTC L2s apps, such as Stacks. It can be accessed via a browser extension for Chrome, Firefox, and Brave, as well as a desktop application for MacOS, Windows, and Linux. For Stacks users, Hiro Wallet offers a secure and user-friendly way to connect to Stacks apps, while desktop users can also confidently participate in Stacking by locking STX either individually or in a pool.

Staking

Stacking refers to staking STX in the Stacks system, similar to the popular “LSD”. The key difference between normal staking services on PoS chains and Stacks is that while native token interest is provided in the former, in Stacks, interest is paid in the form of BTC.

The Stacking Club provides basic statistics on Stacking. There are several protocols that offer stacking services, including Planbetter, Xverse Pool, Stacking, and InfStones.

DeFi

DeFi has provided liquidity and helped support the Stack ecosystem. According to DefiLlama, Stacks has achieved a TVL of 23.83M, surpassing many inactive L1s.

Stacks DeFi TVL (Source: DefiLlama)

Among them, ALEX dominates the market with nearly 80% of the share. ALEX serves as a one-stop DeFi hub, offering a bridge, swap, launchpad, lottery, and even a BRC20 orderbook. As previously mentioned, there are 156 circulating xBTC in the Stacks ecosystem, and ALEX controls approximately 100 of them, which amounts to 3 million USD. Another notable protocol is Arkadiko , which not only offers a swap but also lending, contributing 5 million TVL to the ecosystem.

NFT

Prior to the Ordinals trend at the beginning of this year, the focus of the NFT ecosystem was primarily on the native NFT marketplace. However, many platforms, such as Gamma, have now started to support Ordinals inscription and marketplace. This situation may indicate a lack of innovation in the broader NFT industry, including Stacks.

Others

We’ve also come across some interesting protocols on Stacks. CityCoins is an experimental protocol that issues tokens for each city and may garner social consensus in some way. Sigle is a secure and open-source writing platform for content creators in the web3 space, including NFT projects and crypto analysts.

Valuation

According to CoinMarketCap, the price of Stacks was around 0.6059 as of the end of August 2, 2023, which is an 83% drop from its all-time high of 3.61 on November 16, 2021. The future supply of $STX has been predefined to reach approximately 1,818M STX by the year 2050, resulting in a fully diluted market capitalization of around 1.1B. When it comes to token distribution, no entity in space holds more than 10% of the circulating STX supply, with even early investors/entities generally holding less than 5%.

Source: CoinMarketCap

We have included Lightning Network here for comparison purposes only, as other scaling solutions are not yet big enough to be compared to Stacks. Lightning Labs, the company responsible for developing Lightning Network, has secured a total of 82.5 million in funding across five rounds. Their most recent round of funding, Series B, raised 70 million on April 5, 2022. However, the company did not disclose the latest valuation. Based on a conservative estimate of 5% equity sale in Series B, the company could be valued at $1.4 billion.

In April 2022, Lightspark, another company, completed a funding round led by a16z and Paradigm. They raised approximately 173 million at a valuation of nearly 1 billion, which was almost at the same time as Lightning Labs. Suppose Lightning Labs is valued at 2 billion, with a 1 billion premium compared to Lightspark, for the early contribution.

Based on the median value of two hypotheses, it is assumed that the current valuation of Lightning Network is approximately 1.7B.

Additionally, there are approximately 4950 BTC locked in the Lightning Network, using the BTC price at the end of Aug 2, 2023, which is $29479, resulting in a total value locked (TVL) of 145.92M. When comparing Mcap/TVL ratios, it appears that Stacks is nearly three times higher than that of the Lightning Network.

We believe that Stacks’ valuation is higher than anticipated mainly due to the support provided by its economic design — the ability to stack $STX to earn BTC. This feature helps to mitigate sell pressure from miners. After all, there is no alternative solution to provide an attractive option for earning nearly 10% APY on BTC. Additionally, there are some secondary market premiums for Stacks.

Summary

Basically, we define Stacks as a layer for Bitcoin, but it’s not exactly a layer2, sidechain, or cross-chain bridge. This is because it’s difficult to classify Stacks as a layer2 rollup or a sidechain. While all Stacks layer smart contracts and transactions are settled on the Bitcoin blockchain, similar to Ethereum’s state root rollup, they keep their raw data and have a separate security budget in the current version. The Stacks layer doesn’t fit cleanly into the definition of a Sidechain because the consensus runs on Bitcoin L1, follows Bitcoin finality, and publishes data/hashes on L1.

Within our framework, Stacks serves as an enhancement to BTC’s capital efficiency in its current version. Despite Nakamoto’s upgrade, its fundamental nature remains largely unchanged as it continues to build upon new bridged assets. It does not, however, provide smart contract capabilities to Bitcoin.

Stacks also have some flaws when dealing with the key problems of Bitcoin scaling. The most straightforward solution for reading the state is by operating the full node, but it comes at a big cost. Additionally, there are only 5 miners in the Stack currently, and they can easily be crashed by 2 malicious nodes. The “Bitcoin write” problem remains unsolved and ambiguous in the Stacks design. Regarding the custody of bridged assets, the security of sBTC is built upon the economic stability of STX.

The positive aspect of Stacks is that it offers a strong incentive mechanism to encourage miners to maintain the network. Additionally, the profit gained from stacking appeals to general users, who can stake STX to earn BTC.

Based on the findings from Stacks, it appears that the renaissance of Bitcoin scaling requires additional builders to address its technological challenges. It is encouraging to note that the introduction of Ordinals has rekindled the builder culture of Bitcoin. In the subsequent articles, we will explore these protocols to identify the resurgence of old ones or the emergence of new ones.

Reference

• OKX Dev Docs
• Building on Bitcoin: a Comparison of Bitcoin Projects
• Sip-001
• sbtc.pdf
• Stacks Docs
• Stacks Learning Resources
• Stacks — DefiLlama
• Blog
• Onstacks Explorer
• Stacks Explorer by Hiro
• STX Mining Basics | Onstacks Documentation
• Node Operation

Disclaimer: This article is provided for informational purposes only and should not be considered as financial advice. The cryptocurrency market is highly volatile and unpredictable. Always conduct thorough your own research and consult with a qualified financial professional before making any investment decisions.

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