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Use Case
The base L1 Bitcoin layer was not designed for optimal composability, making it bulky and inefficient for complex applications. Instead, building on an L2 while securing value on an L1 is a more sensible approach. There are three main L2 solutions on Bitcoin: Lightning, RSK, and Stacks. These differ from Ethereum L2s, and we will discuss these differences briefly. For simplicity, we will use the L2 term here.
Each L2 has different goals and is complimentary, but Stacks is the furthest along in terms of developing an ecosystem for traditional crypto applications (NFTs, DeFi, Name Services, etc.). It has the most advanced NFT ecosystem, the BTC naming service operates on STX, and further DeFi applications will be enabled with their next upgrade this year. Moreover, it is the only one of the three with a token.
DeFi on Bitcoin
Before analyzing Bitcoin-based protocols, it's essential to address the question, "Why not build directly on the base layer?"
First, the scripting language of Bitcoin lacks support for loops and intricate flows, making it challenging to develop smart contract logic and general-purpose applications directly on its base layer. These limitations, however, also contribute to its strengths. Bitcoin is not highly programmable, and it deliberately lacks the smart contract capabilities seen in other ecosystems. This design choice ensures security and reliability for Bitcoin as a decentralized store of value.
To address these challenges, developers have attempted to create Bitcoin-based assets that necessitate centralized intermediaries or rely on separate blockchains with wrapped BTC. However, wrapped BTC is not the same as Bitcoin, and many Bitcoin enthusiasts remain skeptical about the security and decentralization offered by independent blockchains or single-party custody solutions.
Second, Bitcoin's 10-minute block time is comparatively lengthy when contrasted with Ethereum and other L1 blockchains. Although block time is just one of several factors that influence a blockchain's settlement time and settlement assurance quality, Bitcoin's extended block time hinders its use in applications that demand faster transaction confirmations, such as buying a cup of coffee.
Lastly, individual transaction fees on Bitcoin are relatively high – the average fee for a Bitcoin transaction was around $10 in 2021. In contrast, many competing networks offer transaction fees as low as a fraction of a cent.
Stacks is designed to bring smart contracts and decentralized applications (dApps) to the Bitcoin ecosystem, thereby enhancing its capabilities and utility. The native token of the Stacks ecosystem is STX, which plays a crucial role in the platform's functionality, including fueling smart contract execution, participating in the network consensus, and earning rewards through a mechanism called "Stacking."
Overall, the STX token has three primary use cases:
- Utility: STX tokens are used to pay for the execution of smart contracts on the Stacks network, effectively functioning as 'gas' fees similar to Ethereum's Ether (ETH). This creates a demand for STX tokens as the Stacks ecosystem grows and sees increased smart contract and dApp usage.
- Consensus Participation: STX token holders can actively participate in the Proof-of-Transfer (PoX) consensus mechanism that underpins the Stacks network. By locking up or "Stacking" their tokens, users can support network security and earn rewards in the form of Bitcoin (BTC).
- Ecosystem Growth: The STX token is also designed to incentivize developers, users, and other stakeholders to contribute to the growth and development of the Stacks ecosystem, thus ensuring its long-term success and sustainability.
Smart contracts can unleash more productive uses for the billions of dollars stored in Bitcoin's market cap. To illustrate, just look at Ethereum’s market cap thanks to the proliferation of DeFi applications. This figure doesn't even include NFTs, Web3 gaming, and other innovations. Smart contracts not only attract more value to blockchain ecosystems but also create value.
In contrast, Bitcoin has a market cap of over $1 trillion, but only $2.8 billion is recorded in its TVL through Bitcoin-native applications. Interestingly, more than $10.5 billion is bridged for use on Ethereum through Wrapped BTC (wBTC), clearly indicating the pent-up demand for Bitcoin applications.
Over the years, numerous attempts have been made to make Bitcoin more programmable, enabling smart contract development and, consequently, the development of Web3 apps and dApps for Bitcoin. As early as 2013, Bitcoin forums hosted discussions regarding proposals to make Bitcoin programmable with smart contracts. Covenants, a type of smart contract functionality, extend the functionality of Bitcoin Script to create conditional statements around how a coin can be spent, sent, or used.
However, the base layer of Bitcoin was never designed to optimize for speed and scalability. As a blockchain, Bitcoin sacrifices these qualities in favor of optimum security and decentralization. Because of this, Bitcoin features a hefty ~10-minute block time, while modern blockchains like Solana have a block time of mere seconds.
This is where L2 Bitcoin solutions come into play. Lightning Network, Ark, RSK, Liquid, and Stacks are all developed solutions to bypass the extreme inefficiencies of the Bitcoin base layer, allowing modern DeFi applications, projects, and assets to be developed and launched on Bitcoin. Stacks, as of 2024, feature the highest rate of adoption.
Stacks enables true Web3 to be implemented onto the Bitcoin chain, adding to Bitcoin's arguably unmatched decentralization and security guarantees. This infrastructure stack can be thought of like this: miners secure the Bitcoin network, the base layer. Stacks, being on top of Bitcoin, offers much higher scalability and implement smart contract programmability. Lastly, several different kinds of Web3 utilities (DeFi, NFTs, marketplaces, etc.) can be built in a third layer on Stacks - opening up Bitcoin’s $1 trillion valuation for true economic use.
