Original title: UNDERSTANDING THE"BITCOIN L2 TRILEMMA"》
Original author: Trevor Owens
Original compilation: Frank, Foresight News
As a venture capitalist, I am token agnostic. Since we invest in the early stages of new technology development, we invest in equity rather than tokens, so we only receive the corresponding tokens proportionally. We firmly believe that for a token to be effective, it should play a vital role.
In essence, removing a token should undermine the core value proposition and underlying architecture. Using a token just for the sake of it, or avoiding using a token for no reason, is a red flag, but in most cases In the Web3 project, there are a large number of tokens launched just for the sake of owning one token.
Projects that might have been successful failed due to the unsustainability of their token economies and caused significant financial losses to investors. In contrast, in the Bitcoin community, you will find developers wasting countless hours on unsolvable technical problems, solutions that I call tokens without token mechanisms - I call this This method is likened to trying to have sex without having sex. Both methods appear unreasonable.
Now, let’s delve into the three aspects of this impossible triangle:
1. OFF-CHAIN NETWORK
Examples include Lightning Network and RGB.
None of these solutions are blockchains, but networks that keep data off-chain (stored by users) without a common public ledger, making data and smart contracts much less accessible and interactive. As a result, users cannot experience the full functionality that smart contract blockchains like Ethereum or Solana can provide.
They also require users to run their own nodes or infrastructure in order to be fully decentralized, which leads to significant user experience barriers to adoption. Nonetheless, this approach offers scalability and privacy benefits that go far beyond what blockchain technology can offer, making it the best choice for specific application use cases, especially large-scale payments.
2. Decentralized side chain
For example, solutions such as Stacks, Interlay, and Layer-0.
Decentralized sidechains allow anyone to participate in consensus (i.e. mining) as they replenish their security budget with new tokens issued by the protocol, which creates a competitive market for miners - who spend resources The native tokens competing for the blockchain network are then used by users to pay for gas fees when executing smart contracts.
It is expected that as usage and network effects increase, demand for the token will increase and make it economically sustainable. However, introducing additional tokens may complicate the user experience. Additionally, Bitcoin maximalists generally attack this, calling it a scam, as these coins are considered competitors to Bitcoin.
This situation tends to make life harder for developers, and on the positive side, owning a token can foster community building and facilitate the raising of funds to fund the vast amount of research and development efforts.
3. Combined side chains
Solutions such as Liquid, RSK, Botanix, etc.
In this case, without tokens, the only compensation for miners (or validators) is paid by the company behind the development work, or by user fees generated by the blockchain network, although these fees are usually within the first few years. It was insignificant during the years until the network was used on a large scale.
This compensation for miners is necessary because in a proof-of-work consensus model, mining costs money, and in proof-of-stake, there is also the risk of funds being cut. Even Bitcoin and Ethereum, each with over 100 million users, fund their network security primarily through token reward subsidies.
To solve this problem, federated sidechains do not open mining to everyone. Taking Liquid as an example, it has established a group of 15 crypto business service providers, including exchanges, OTC merchants and infrastructure providers. Although this approach can work well, it requires trust in the chosen one. entity.
At the same time, in order to become more decentralized over time, an age-old conundrum arises: How to attract a large number of users and generate significant fees while running a trusted community? There are also ongoing efforts to design hardware solutions to automate and democratize membership, transferring trust to the hardware used.
So what are the advantages of federated sidechains? A simpler user experience because these sidechains use a BTC-pegged token to pay network fees, thus avoiding the possibility of new tokens facing opposition from Bitcoin maximalists. Although it is currently unknown whether this group of Bitcoin users will actually participate in the Web3 use cases enabled by these sidechains.
Other Insights: Mining VS Cross-chain
The key is to recognize the difference between RSK and Liquid. The former uses federated mining, and as of February 2022, it has obtained an impressive 64% of BTC’s hash rate, but RSK uses federated mining and a hardware-centric approach to build a cross-chain bridge.
In contrast, token-based sidechains are building decentralized cross-chain bridges and using their native tokens as collateral. Examples of this include Stack’s ongoing advancement of sBTC, as well as Interlay and several Layer-0 sidechains. alternatives. By leveraging the native token as collateral, the design provides an incentive model to maintain open membership in the BTC asset cross-chain protocol.
Newly launched via a white paper this month, BitVM may propose a solution that makes federated cross-chain bridges more trust-minimizing and eliminates the need for hardware-based solutions.
Three potential solutions to the impossible triangle
Many potential solutions require a Bitcoin soft fork, which could take quite some time to gain support. Drivechains is a recent controversial example, originally proposed in 2017 and now in its prime, Validity Rollup (or ZK Rollup) has brought hope and gained more positive reception from several Bitcoin Core developers feedback.
However, effective implementation remains a challenge and may even be a distant reality. Federated mining is interesting, especially RSK proving that even without compelling incentives there will be mass adoption by Bitcoin miners, however the lack of tokens still means reliance on trusted cross-chain bridges or advanced hardware configurations awaiting market validation .
In the coming years, BitVM may revolutionize federated cross-chain bridges along with federated mining and potentially solve the dilemma of decentralization.
EVM issues (another topic)
It is worth emphasizing that many sidechains choose EVM, with RSK, Botanix and many Layer 0 solutions adopting this approach. This decision accelerates market expansion and ensures integration with exchanges and EVM-centric blockchains. Infrastructure compatibility.
Instead, Stacks and Starkware (ZK Rollup) designed their own virtual machines that aimed to improve the EVM in specific areas such as decidability and ZK compatibility, a double-edged sword that meant they could lose network effects, But may provide developers with a platform to make better applications and differentiate themselves from the market-leading Ethereum applications.
Destroy all tokens
For most builders, decisions about tokens should be rooted in practical considerations. Due to its support for smart contracts on Layer 1, Layer 2 Rollup solutions do not require tokens, but leading projects like Optimism and Arbitrum also have tokens.
They use these tokens to strengthen community ties and fund development, and this market-based evidence further complicates the question of whether tokens are needed. Base, the Layer 2 network launched by Coinbase, has recently gained huge traction without launching a token. However, Coinbase stated that launching a token in the future is still an option.
Based on my past experience as a corporate innovation executive and entrepreneur, I liken the token vs. tokenless debate to the startup equity vs. corporate equity conundrum. In my book, The Lean Enterprise, I highlight many examples of internal innovation attempts that failed due to a lack of incentives proportional to the high risk and extensive RD required by these projects.
Even Google, known for its innovation-focused corporate culture, has seen its employees give up huge stock options to start their own businesses, giving birth to giants such as Twitter, Instagram, Niantic, Pinterest, etc., resulting in a potential loss of more than $100 billion in market value. .
Layer 2 projects come with huge risks, most are doomed to fail, the amount of money required to develop them is huge, while offering less security benefits than Validity Rollup solutions (such as Optimism, Arbitrum, and Base), nor the ability to create new bits coins to fund the security budget or developer community of a new blockchain.
Polygon is an Ethereum sidechain that still dominates by market capitalization and developer engagement among all Ethereum scaling solutions. Now its moving to a ZK-based strategy, so even if the zk-rollup itself doesnt require a token, having a native token may provide a competitive advantage. Like all things business-related, theres no clear answer.
final thoughts
The Bitcoin L2 space is fascinating, and competition is growing as protocols like Ordinals, BRC-20, and Runes attract more Web3 developers to build on Bitcoin. As Web3 investors, our focus remains on applications and infrastructure, and we try to avoid token trading.
Our current interest lies in off-chain networks and decentralized sidechains with unique application advantages, mainly because of their open member consensus model, community building and capital acquisition advantages. If BitVM successfully introduces a joint cross-chain bridge, For a more trust-minimizing approach, we are also optimistic about joint mining.
Importantly, both mortgage-driven cross-chain bridges such as sBTC and the BitVM approach are still in the development stage. BitVM was just announced via a white paper this month and has attracted strong interest from developers, while sBTC has been in development for more than a year and has A lot of resources have been invested. Ultimately, in addition to investing in Bitcoin L1 applications and infrastructure, the Bitcoin Frontier Fund aims to strategically expand into these three areas.
