The Bankless Guide to Bitcoin L2s

Bitcoin's network is evolving with the introduction of Layer 2 solutions designed to improve scalability and functionality.

These innovations are vital as they help reduce high fees and slow transaction speeds, allowing Bitcoin to support new use cases like smart contracts, potentially enabling a vibrant dApp network on top of the chain.

In this guide, we'll delve into how Bitcoin Layer 2s work, their benefits, and their potential impact on the Bitcoin ecosystem.

Key Takeaways

• Scalability and Efficiency: Bitcoin Layer 2s process transactions offchain, reducing congestion and fees on the main network, making transactions faster and cheaper.
• Enhanced Functionality: These solutions bring new capabilities to Bitcoin, enabling support for smart contracts and decentralized applications, which were previously challenging to implement.
• Scaling Methods: Bitcoin Layer 2s can take multiple different approaches to scaling. Examples of these are State Channels, like those used by the Lightning Network, which facilitate offchain payments; Rollups, which consolidate multiple transactions offchain before adding them to the main blockchain; and Sidechains, which connect to Bitcoin via two-way bridges, expanding its capabilities.
• Market Trends: Recent developments like Ordinals, Runes, and BRC-20s have increased demand for Bitcoin’s block space, highlighting the need for scalable solutions.
• Top Projects: Notable Bitcoin Layer 2 projects include Bison Network, Stacks, BitVM, Botanix, Chainway, Kasar Labs, Merlin Chain, and Ark, each offering unique approaches to enhancing Bitcoin’s scalability and functionality.

What is a Bitcoin Layer 2?

Bitcoin Layer 2s are blockchains built on BTC to enhance scalability and increase functionality. By processing transactions off the main blockchain, these Layer 2s alleviate congestion and reduce fees on the main Bitcoin network. Further, they provide functionality like enhanced programmability and expanded capabilities to support various decentralized applications. Despite operating offchain, these Layer 2 solutions remain secure and decentralized by ultimately settling transactions on the Bitcoin blockchain.

How do Bitcoin Layer 2s work?

Bitcoin Layer 2 solutions enhance Bitcoin’s scalability and efficiency by processing transactions offchain, reducing the load on the main blockchain, and lowering fees. They then periodically settle the main chain to ensure security and immutability. These solutions integrate seamlessly with the Bitcoin network, allowing easy fund transfers between the Layer 1 and a Layer 2. Additionally, mechanisms like state channels, rollups, and sidechains improve performance and expand Bitcoin's capabilities.

• State Channels: Used by protocols like the Lightning Network, state channels enable end-to-end encrypted channels for payments. Transactions within these channels occur offchain, with only the opening and closing balances reported to the main network, reducing congestion and improving efficiency.
• Blockchain Rollups: Like Ethereum scaling solutions, both optimistic and zk-rollups play a role in Bitcoin Layer 2s, consolidating multiple transactions offchain into a single piece of data before adding it to the Bitcoin blockchain. 
• Sidechains: Independent blockchains with their own consensus mechanisms, sidechains connect to Layer 1s like Bitcoin via a two-way bridge. This connection allows the transfer of assets between chains, supports additional Layer 2 solutions, and expands the capabilities of the Bitcoin network.

Why Bitcoin L2s?

The design of Bitcoin's network prioritizes security and decentralization, making tradeoffs around scalability. This has led to high transaction fees and congestion during peak times. With the growing demand for Bitcoin’s block space, driven by developments like Ordinals, Runes, and BRC-20s, the need for scalable solutions is evident.

Bitcoin has experienced significant development recently, with new primitives like Ordinals (Bitcoin NFTs), Runes (Bitcoin meme coins), and BRC-20s (Bitcoin tokens) taking center stage. This marks a big shift in the Bitcoin ecosystem, from focusing solely on BTC as the asset to a more dynamic ecosystem with multiple applications for users, builders, and speculators.

For nearly a decade, the Bitcoin community has grappled with scalability issues, with transaction costs rising significantly during peak network traffic. Today, experiments like Ordinals, Runes, and BRC-20s drive new heights in demand for Bitcoin’s block space:

• Ordinals caused Bitcoin fees to rise by up to 280% year-to-date in December 2023.
• Runes transactions comprise 68% of Bitcoin's total transactions since inception.
• BRC-20s have caused Bitcoin transaction fees to spike, making up 74% of the block reward on occasion.

To become universally accessible and adopted, Bitcoin must scale to handle more traffic without high transaction costs. Layer 2s address these issues, expanding Bitcoin’s use cases to support everything from everyday transactions to complex smart contracts. As a result, Bitcoin L2s have become a dominant narrative in crypto this cycle, one we explore in-depth here.

How to Invest in Bitcoin Layer 2s?

Investing in Bitcoin Layer 2s can involve directly buying and/or staking the tokens of these networks like STX or BVM, or even building dApps on them. Before investing, it’s essential to understand the specific Layer 2 solution, its advantages, and its potential risks.

Top Bitcoin Layer 2 projects

Several Layer 2 solutions have emerged in the Bitcoin ecosystem, enhancing scalability and introducing new functionalities.

• Bison Network: Bison Network uses zero-knowledge (zk) rollups to increase transaction throughput and reduce fees. It leverages Ordinals for data storage and includes Bison OS for managing transactions and Bison Prover for generating zero-knowledge proofs.
• Stacks: This Layer 2 integrates smart contracts with Bitcoin using Proof of Transfer (PoX) consensus. This mechanism allows users to stake STX tokens to earn BTC, enhancing the functionality and security of the Bitcoin network.
• BitVM: BitVM introduces smart contracts on Bitcoin by verifying computations rather than executing them. This system enables advanced functionalities without requiring changes to Bitcoin's existing rules.
• Botanix: Botanix utilizes the Spiderchain design to create seamless two-way pegged sidechains with Bitcoin. It integrates with the Ethereum Virtual Machine (EVM) to combine Bitcoin's robustness with Ethereum's smart contract capabilities.
• Chainway: Chainway is developing Citrea, a zk-rollup solution for Bitcoin that ensures transaction validity with zero-knowledge proofs. This approach enhances scalability and security for Bitcoin transactions.
• Kasar Labs: Kasar Labs integrates Starknet's zk-rollup capabilities with Bitcoin, enabling advanced cryptographic proofs and data availability. Their work includes Barknet, leveraging Starknet’s Madara sequencer and Cairo VM.
• Merlin Chain: Merlin Chain is an EVM-compatible zk-rollup designed to scale Bitcoin-native protocols like Atomicals, Bitmaps, and BRC-20s. It recently added $2B in TVL, demonstrating significant growth and adoption.
• Ark: Ark uses virtual transaction outputs (VTXO) for anonymous, offchain payments without the need to manage liquidity. This unique approach facilitates private and efficient transactions.

For an in-depth analysis of the top Bitcoin Layer 2 projects, including detailed insights and potential investment opportunities, check out our post here. 

By providing solutions that increase transaction speed and lower fees, Bitcoin Layer 2s can unlock new functionalities like smart contracts and dApps for Bitcoin, ushering in an era of expanded activity.

These prospects add to the excitement about Bitcoin's future, from the launch of the Bitcoin spot ETF to the rise of Ordinals, BRC-20s, and Runes, though they still have a ways to go before becoming fully operational. With the breadth of different approaches projects are taking to scaling Bitcoin with L2s, it will be important to watch how each performs to see if a particular scaling method stands out as better for Bitcoin going forward.