There is a better way – Cointelegraph magazine

Rising venture capital interest in Bitcoin Layer-2 projects has focused attention on whether the new scaling solutions really deserve the classification.

A survey from Spartan Group in December found that most Bitcoin layer-2 transactions are attributed to Stack, Lightning, RSK, and Liquidity.

According to BTCL data, Bitcoin Scale has now grown beyond those four projects, with 73 Bitcoin Scale solutions being developed as of June 7 with a total value of $3.61 billion locked in.

But even though the Bitcoin Layer 2s and influencers talk about “Bitcoin L2s” as a hot new narrative, the label is controversial.

This is because the structure of most Bitcoin layer 2s is similar to the sidechain of the blockchain, which parallels the native chain and does not inherit its security. Real L2s must run on top of the local chain and inherit the security.

The head of the CKB Ecosystem Fund – an investor in Bitcoin scalability and interoperability projects – argues that the term “L2” for sidechains is simply a marketing method.

“A true L2 should operate on the underlying layer of security, while a sidechain is a separate blockchain with its own security model,” Yu says.

“Using the term L2 for Gonchen can be really misleading and may be driven by market considerations rather than technical accuracy.”

And according to Mikko Otama, co-founder of Algorithmic Investment Protocol Trading Strategy, the real test of a true L2 is “Can you get your money back without someone else's consent?”

Bridges and native properties

Sidechains do not automatically support the parent chain's native property. Instead, Bitcoin (or any native asset for that matter) is transferred through pecking mechanisms that lock their assets at their origin and are represented by tokens of equivalent value in the side chain.

The Ethereum scaler Optimism, widely considered the true Layer 2, also requires native ETH to be locked on the native chain. The difference is optimistic wraparound, which means transaction data is periodically sent back to Ethereum and its security is tied to the main chain.

The security of the attached sidechain assets depends on the new chain rules and may be compromised during the attack.

There is no official consensus on what a true L2 definition is for Bitcoin, but Ethereum has a record of arguments to cite from the long debate over whether Polygon's PoS should be allowed in the Layer-2 club.

The Ethereum community describes Layer 2 as: “a separate blockchain that extends Ethereum and inherits Ethereum's security guarantees.

Does it matter if they are “real” Bitcoin L2s or not?

Therefore, most of the 73 Bitcoin Layer-2 projects listed on BTCL2 do not generally meet the criteria to be considered Layer 2. Does it make a difference?

“The Dejans don't care; They just want to make money,” Bob Bodley, founder and CEO of regular marketplace Bionic, told the magazine.

But many in the space care deeply and are working their way up the ranks. [and] Definitions to make it clearer,” he added.

David Schwedt, chief operating officer of blockchain security firm Halborn, told the magazine that there is “no consensus on the actual technical requirements” for a protocol to be considered layer 2, other than solutions that address scaling issues for the first layers.

“I think most of these Layer 2 users don't really understand the technical difference between these terms, so the difference is not that important.”

The complexities of what happens in the background may not be important to many end users, whose main goal may be to send and receive bitcoins quickly.

But this perception may change if the security of their funds is challenged by new vulnerabilities that do not exist on the new Bitcoin chain, which is believed to be the most secure, decentralized and bomb-proof blockchain.

“These networks can introduce additional points of vulnerability and potential centralization that are not present in the main chain,” says Schwed.

Schwede explained that sidechains often use oracles or cross-chain communication tools to maintain consistency with assets on the main blockchain.

Oracles are systems used to feed data from external sources into the blockchain. These tools add complexity and bring their own risks.

For example, if verbal communication is corrupted or there is a flaw in the communication protocol, it can cause incorrect information to be used, affecting transactions and the integrity of assets on the sidechain.

This makes the entire system more vulnerable to attacks or errors that could result in financial loss to users.

Sidechains do not have native Bitcoin

Spartan Group researchers say that the launch of ordinals on Bitcoin led to the era of “building on Bitcoin” and revolutionized the development of infrastructure and scaling surfaces for Bitcoin.

“Most Bitcoin Layer-2 solutions use some form of [multisignature] Cross-chain bridge to facilitate Bitcoin conversion between [native chain] and L2,” Cipher Wang, CEO and co-founder of the Bitcoin Layer-2 project UTXO Stack, tells the magazine.

A multi-signature wallet structure, or multisig, is when a group of parties controls the process of locking and unlocking assets between chains, adding a layer of control, which comes as a package deal with other trusts and permissions.

“Exit requests from users are completely unauthorized and require authentication from nodes,” says Wang.

But the multisig structure doesn't disqualify the projects from being true layer 2, because the bridges between those on Ethereum, like Optimism, are also controlled by multisigs. The difference comes in whether these assets are secured by Bitcoin.

Another critical point is verifying assets on transactions, such as Punk3700, the anonymous developer behind the Bitcoin-scale project BVM.

“On Ethereum, you can verify it with a smart contract. On Bitcoin, there is no smart contract,” Punk3700 said in the newsletter.

“So, it's like, ‘Trust me, bro.'”

In a multi-sig structure, when users use the smart contract of the second layer in the second layer, they can obtain an asset that holds the same value as Bitcoin in the second layer for purposes such as accessing DeFi services. Childhood compared to Ethereum or Solana.

Sidechains do not necessarily use the parent chain's native token (or its assigned equivalent) to pay for transactions. However, popular Ethereum layer 2s like Arbitrum and Optimism use Bridged Ether, which is recorded and secured by the main chain.

L2s ensure you get funds back – you don't get a sidechain.

These are Ethereum balance sheets, which means that transactions happen outside of the Ethereum blockchain but are later recorded there. Since the data is stored on Ethereum, even if the second layer has problems, users still have the opportunity to withdraw their Ethereum from the main chain.

This is not the case for Bitcoin, as its scripting language limits the network's ability to support advanced smart contracts and operations such as packages.

Developers have found ways to get around this limitation to enable more sophisticated applications, such as soft forks, and even a more flexible programming language.

A popular solution to scaling the network and increasing the capacity of smart contracts is to launch sidechains, which are new blockchains that have their own characteristics, consensus mechanisms and often transaction fees as their own native tokens.

If a sidechain is blocked for any reason, there is a chance that the user will not be able to withdraw their assets on the first layer, although those who control the multisig wallet can help recover.

Aidan Yago, head of strategy at Bitcoin DeFi platform Sovryn, said funds in most Bitcoin layer-2 projects are disqualified from being considered true layer 2s as they are not secured by the Bitcoin proof-of-work network.

Lightning is L2, and ZK-rollups may happen in the future.

There are exceptions, the most famous example being the Lightning Network, Bitcoin's layer 2 that uses a system of channels to enable off-chain transactions. Opening and closing these channels requires onchain transactions that are transmitted through the Bitcoin network and verified by Proof of Work.

It is also adding support for re-enabling the operation code “OP_CAT” that enhances Bitcoin's scripting capabilities. This was removed by Bitcoin creator Satoshi Nakamoto in 2010 due to security concerns.

Israel-based StarkWare, the company behind Ethereum's Layer 2 Starknet, recently announced a $1-million research fund to use OP_CAT and zero-knowledge (ZK) proof-of-concept technology to help scale Bitcoin.

For now, Bitcoin cannot use ZK standards such as ZK-rollups due to scripting limitations, but some projects rely on a simple client to do so.

“Right now we're using ZK Light clients for validation, but we can easily replace them with OP_CAT or BitVM when ZK Light clients are ready in the future,” says Punk, adding that the 3700 could be a year away from such developments.

Turns and runes emphasize the importance of size

Following last year's mainstreaming process, the launch of the Funnel token protocol Runes in April boosted demand for Bitcoin's scalable infrastructure due to a flurry of transactions.

According to data from IntoTheBlock, the seven-day average of Bitcoin transactions reached an all-time high on May 20.

According to GeniiData, a Bitcoin data platform, Runes dominated 61% of Bitcoin transactions on June 6, while ordinary took 8.5% of its own. This leaves only 30% of transactions and other miscellaneous requests.

The apparent need for scale has seen VCs chasing “L2s” as they wave more money around.

In the first quarter, VCs invested $2.49 billion into crypto companies, Galaxy Digital reported. Tier-2 projects are the fourth most popular investment category, accounting for 7% of the total.

Alex Thorne, head of research at Galaxy Digital, told the magazine that the company has pursued 13 fundraising rounds in Bitcoin Layer-2 projects. Of these, eight did not disclose the amount of funding, while the remaining five raised at least $34.7 million combined. While that's a small portion of the total reported by Galaxy Digital, Tor notes that the Galaxy Report's price is based solely on publicly available data, and the actual amount could be much higher.

“We expect the actual amount raised by Bitcoin L2s to be over $100 million,” Thorne says.

“We are personally aware of several deals that have not been reported or made public, but the amount has not been disclosed, so $34.7 million is the lower limit,” Thorne says.

Lightning Network sets the standard for L2s.

Sovrin Yago calls the Lightning Network a “true” Layer 2, while Ohtama calls it “the strongest Bitcoin innovation of the last decade.”

Although it is one of the oldest and most widely supported Bitcoin Layer-2 projects, it has faced adoption challenges. According to BTCL2, a total value of $320 million has been locked and surpassed by new Bitcoin sidechains such as Merlin Chain and BounceBit.

Sidechains can handle the most complex smart contracts and decentralized applications.

But Ohtamaa argues that such protocols have nothing to do with Bitcoin, its inherent wealth or security.

“In this dispute, we already have the best Bitcoin sidechain in the world and it's called Ethereum,” says Ohtamaa.

“If you want to use Bitcoin DeFi, just use your (wrapped) Bitcoin on Ethereum, and it will be better than any other sidechain.”

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John Yun

Yohan Yun is a multimedia journalist who has been reporting on blockchain since 2017. He has contributed as an editor to the crypto media outlet Forkast and covered Asian tech stories as an assistant reporter for Bloomberg BNA and Forbes. He spends his free time cooking and experimenting with new recipes.