The Importance of Bitcoin Upgrades and Layer Two Applications

As a financial advisor with clients interested in bitcoin, it’s crucial to understand upgrades to its network and their potential impact on bitcoin’s investment thesis.

CoinDesk Insights
Sep 30, 2021 at 12:50 p.m. UTC
Updated Sep 30, 2021 at 12:50 p.m. UTC

Jackson Wood is a financial advisor at Freedom Day Solutions.

It’s no secret that the crypto community is divided around the support of bitcoin and alt coins, a term given to any coin that is an alternative to bitcoin. Some are in the camp that bitcoin, along with future technical improvements, will be the main – if not the only – coin that will survive. While others view this as impossible, it’s important to understand why these pro-bitcoin believers remain so convinced.

Crucial to the advancement of bitcoin are the Bitcoin Core Developers. This is an international team of developers, often called “maintainers,” that is constantly monitoring, improving and working on bitcoin and its blockchain. This group, due to its decentralized nature, is funded by companies, such as Square, Coinbase, Gemini and others, and the community to maintain Bitcoin’s open-source and secure network.

Bitcoin Improvement Proposals (BIPs)

Often, these core developers will propose changes to the Bitcoin network. These changes are referred to as Bitcoin Improvement Proposals (BIPs) and, if implemented, create a formal change to Bitcoin. True to Bitcoin’s decentralized nature, anyone can propose a BIP. The community will discuss each BIP until it is ultimately accepted or rejected.

Upon acceptance, each BIP is assigned a number and officially published on the Bitcoin Core GitHub. When this happens, the Bitcoin Core Developers really get to work. They test the upgrade and make sure it is safe to implement on Bitcoin. Once satisfactory due diligence is done on the BIP (often this is referred to as reaching consensus), the activation plan is created. Upon the network approving the BIP and the activation plan, the code is changed and the upgrade is implemented.

SegWit and Taproot

A notable BIP on Bitcoin was SegWit (BIP 141), which was activated in 2017. This upgrade modified the Bitcoin code and effectively increased the block size by removing signature data from Bitcoin transactions. In short, the BIP 141 upgrade allowed more transactions to be included in each Bitcoin block and therefore increased the Bitcoin transaction volume.

This November, Bitcoin will undergo the biggest upgrade to its code since SegWit. Taproot (discussed in BIP 340, 341 and 342) introduces what are called Schnorr signatures to Bitcoin. To avoid a very technical discussion, Taproot will improve privacy, scalability and finally implement smart contract functions on Bitcoin.

One of the major benefits of Taproot activation is the fact that multi-signature transactions will become much less data heavy, which blazes a Bitcoin path for smart contract implementation. Many alt coins were designed from the ground up with these improvements in place and therefore drew attention and investment away from Bitcoin. The Bitcoin developers took plenty of time to ensure this upgrade was safe before implementation. Many, including myself, view this as a monumental move for Bitcoin, and it certainly levels the playing field in the smart-contract competition.

As a financial advisor with clients interested in bitcoin, it’s important to understand these upgrades and their potential impact on the investment thesis of bitcoin. BIPs can have positive effects or negative effects when implemented on Bitcoin. Just as an advisor would listen to quarterly calls of companies whose stocks they hold for clients in order to determine future outlooks, the same applies to Bitcoin, and an advisor must remain aware of any future changes.

Layer two applications

Another component of Bitcoin is what is called layer two applications. Very early in the history of Bitcoin, the community noticed scaling problems. If bitcoin were to ever become a global currency, or even compete with companies like Western Union, Visa or others, developers would need to create solutions that allow for cheap and fast transactions to always occur. The Bitcoin blocks would become too crowded, transaction times would be too long, and fees too high if a solution wasn’t presented and implemented. The Bitcoin mainchain can handle approximately three to seven transactions per second, a far cry from the 20,000 transactions per second that occur on credit card networks.

Bitcoin Lightning Network

Along came the Bitcoin Lightning Network. The Lightning Network is a second layer protocol that operates on top of the Bitcoin blockchain. Lightning takes transactions “off-chain.” Basically, bitcoin is removed from the main network and placed into a two-party, multi-signature “channel.” This channel is created between two parties and allows each party to send nearly an unlimited amount of transactions at a very low cost. These transactions happen specifically on the Lightning Network and not on the Bitcoin blockchain. Because these transactions are not approved by Bitcoin nodes or miners, the Bitcoin network is not affected. Upon terminating or closing the Lightning channel, all of the information included in the history of the channel is consolidated and included in a transaction that is then sent to the main Bitcoin blockchain (mainnet) to be recorded.

Twitter recently announced tipping for all iOS users. For this to be possible, Twitter will rely on third-party companies such as Strike that provide the ability to link a Twitter account to a Bitcoin address and a Lightning Network address. The Lightning Network allows tiny amounts of money to be sent instantly to anyone with an address. Twitter CEO Jack Dorsey has been a longtime proponent of Bitcoin and the Lightning Network. Many view this as an elegant solution to many problems faced in the global payment’s ecosystem. Many pro-Bitcoin investors are encouraged to see that such a large social media company is exclusively building on Bitcoin, and this adds to their Bitcoin-only conviction.

What is clear is that Bitcoin Core developers are focused exclusively on improving Bitcoin. Through BIP implementations, layer 2 advancements, and the continued focus on Bitcoin, the largest cryptocurrency is constantly able to compete with newer projects and continues to demand the majority of market share in the cryptosphere. Taproot and Lightning Network will allow bitcoin to remain competitive with other alt coins in terms of functionality, speed and security. Not only is bitcoin the largest cryptocurrency based on market cap, but the upgrades and core developers are working to ensure that bitcoin remains preeminent.

DISCLOSURE

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