The Next Era of Bitcoin Layer-2 Networks

The emergence of Bitcoin layer-two networks (“Bitcoin L2s”) marks the beginning of a new era of innovation and development for the leading cryptocurrency.

output: Bitcoin Layer 2 solutions are enhancing the utility and programmability of Bitcoin, heralding the beginning of a new era of innovation and development for the leading cryptocurrency.

A dominant theme that has been gaining steam this crypto bull cycle is the emergence of Bitcoin layer-two networks (“Bitcoin L2s”). Bitcoin is commonly known as the largest, most decentralized and most secure crypto asset with a global holder base of over 100 million people and market cap of $1.2 trillion.

However, as a technology platform, it suffers from limitations such as slow transaction speed (~10-30 minute block confirmation times), low scalability (can only process about 7 transactions per second) and limited programmability (its scripting language and smart contract functionality are limited).

Historically, the most successful technology networks were built and scaled in layers, which is especially true for the development of the internet. The internet’s layered approach is called the Open Systems Interconnection model and consists of seven layers: physical, data link, network, transport, session, presentation, application layers. Every time an end user accesses her email or posts a comment on X, all of these technologies function and interplay in the background, unbeknownst to the user.

OSI Model outlining layers of the internet stack

Similarly, to address Bitcoin’s limitations, while still inheriting its invaluable properties of network security and decentralization, the Bitcoin ecosystem has seen a rush of development to launch Bitcoin L2 networks. These projects have ushered a renaissance of development and programmability, bringing DeFi, NFTs, gaming and other use cases proliferating on competing blockchain ecosystems to Bitcoin.

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This layered approach is in stark contrast to integrated blockchains that aim to provide all of the core functions of a blockchain (consensus, data availability, execution) on the base layer. Blockchains such as Solana, Near and Algorand aim to scale and deliver high performance computation without the need to offload data availability or execution to other networks, different from the “modular” approach taken by Bitcoin and Ethereum.

Total-value locked (TVL) serves as the main metric tracking the growth of DeFi for particular ecosystems. It represents capital that is deployed in various ways, such as lending assets to earn yield, providing liquidity in a pool, serving as collateral to access on-chain credit, etc. The development of Bitcoin layers enabled DeFi use cases to flourish on Bitcoin, although their growth is limited compared to more mature ecosystems such as Ethereum.

Bitcoin L2 TVL

Current total DeFi TVL across the leading Bitcoin layers is ~$1.5 billion. This may seem like a large figure, but it is only 2% of Ethereum’s TVL which currently stands at $81.3 billion. Furthermore, if you look at the ratio of TVL to network market cap, Bitcoin’s is a paltry 0.13% compared to Ethereum’s 27%.

Given the amount of latent value stored in Bitcoin which is in excess of $1 trillion, there is an enormous market opportunity for the leading Bitcoin layers to unlock this value for various financial use cases. Assuming Bitcoin DeFi grows to the percentage on par with Ethereum, this represents $300 billion in deployable capital, at current market prices.

Meta-Protocols Versus Layer-Two Solutions

Ordinals and Runes are meta-protocols that emerged on Bitcoin and launched in January 2023 and April 2024 respectively. The Ordinals protocol, in particular, catalyzed greater interest in Bitcoin development and is often attributed to have kicked off “Bitcoin Season 2”.

Meta-protocols such as Ordinals and Runes operate directly on Bitcoin’s base layer without changing the core protocol. They embed additional functionality within Bitcoin transactions and are suitable for applications that can be built directly with Bitcoin’s existing scripting framework (i.e. NFTs and memecoins inscribed on individual satoshis).

Alternatively, Bitcoin L2 solutions operate on separate blockchains that are anchored to Bitcoin. They often use Bitcoin’s security for finality but provide more complex capabilities through their own consensus mechanisms. L2 solutions enable smart contracts, dApps and cross-chain interactions, often with their own tokens (i.e. DeFi, gaming, social media and other apps requiring more complex logic).

Both the meta-protocol and L2 solution approaches aim to enhance Bitcoin’s utility by enabling new use cases and applications, which will drive up demand for Bitcoin block space. This increased demand will in turn increase transaction fees on the Bitcoin base layer, playing an important part to sustain Bitcoin’s security model, especially as the block subsidy declines every four years due to the Halving.

Ordinal Inscription Fees (USD)

Periodically, Ordinals have caused transaction

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