Layer-2s Promise to Bring DeFi Solutions to Bitcoin Despite Security Challenges

Designed to operate on top of the Bitcoin blockchain, layer-2s are emerging rapidly, fueled by years of innovation in the Ethereum ecosystem.

Several protocols are now onboarding hundreds of developers to the Bitcoin network with the aim of making the BTC blockchain ecosystem more useful over time. These protocols are designed to operate on top of the Bitcoin blockchain, promising to bring decentralized finance (DeFi) solutions to the original chain.

Despite locking millions in value on-chain in a few months, Bitcoin layer-2s are still in their infancy and face challenges such as security issues and user experience concerns.

At the Bitcoin 2024 conference in Nashville, Tennessee, the Cointelegraph team spoke with some of these protocols about their visions and the challenges they face.

Investment manager Franklin Templeton is one of the issuers of Bitcoin exchange-traded funds, but the company is also backing emerging layer-2 protocols, such as Bitlayer.

According to Bitlayer co-founder Charlie Hu, the asset manager is now eyeing alternatives to unlock yield for its clients through digital assets, specifically via the Bitcoin network. He told Cointelegraph:

“We are working with Franklin Templeton, one of the largest asset managers in the world, and they are looking at ways to put their clients'資金 into the crypto markets. But they want to do it in a safe and sound way, and they are looking at alternatives to putting clients'資金 directly on centralized exchanges.”

In July, Bitlayer closed an $11 million Series A round led by Templeton and ABCDE. The startup offers a more scalable way to transact on the Bitcoin network, like an additional road for transactions on the blockchain. For developers, this opens up the possibility of building applications on the BTC network instead of using Ethereum.

In the nearly three months since its mainnet went live, the protocol has amassed $409 million in value locked on its chain, according to DefiLlama. The demand, according to Hu, mainly comes from institutional clients seeking additional income from crypto markets.

“The demand is coming from institutions that want to put their clients'資金 in the crypto markets. But they want to do it in a safe and sound way. So they are looking at alternatives to putting clients'資金 directly on centralized exchanges. And this is where Bitlayer comes in,” he added.

While Ethereum layer-2s and bridges have become a target for hackers and bad actors over the past few years, Bitcoin layer-2s may also take some time to evolve on this front.

“The big question at the core of this whole security model is how do I get it [tokens] out?,” said Build On Bitcoin (BOB) co-founder Alexei Zamyatin in reference to concerns about wrapping tokens on another layer while maintaining the security of the Bitcoin blockchain.

To address this issue, BOB's team contributes to the development of BitVM, a virtual machine designed to execute smart contracts directly on the Bitcoin blockchain. According to Zamyatin, the BitVM system could enable realistic rollups that inherit Bitcoin security:

“The idea is to have a smart contract that can be deployed on Bitcoin and will accept a batch of transactions, like a mini-block, and then generate a proof of the validity of these transactions. And this proof will be included in a Bitcoin transaction, and then anyone can verify it.”

Working on Bitcoin research since 2015, Zamyatin co-founded BOB to create a hybrid solution that combines features of the Bitcoin and Ethereum blockchains. Since then, the protocol has raised over $11 million from several investors.

In Zamyatin's view, layer-2s will allow innovation to return to Bitcoin in an era when centralized institutions are becoming more prevalent:

“I find it a bit weird and strange that we're all cheering for the centralized platforms,” he said. “It's good for the price [...] but I think we shouldn't forget that [...] we will have to innovate [Bitcoin] now to make sure we have an alternative.”

Protocols working on the Bitcoin network have a clear goal: to close the utility gap between the first cryptocurrency and other layer-1 blockchains, such as Ethereum. In other words, build an alternative for crypto-based games, non-fungible tokens (NFTs), and protocols that currently exist elsewhere on-chain.

“I think Bitcoin is the entry point for the non-crypto world, right? Everyone hears Bitcoin first of Ethereum. I think Bitcoin can be the entry point, so everyone will buy Bitcoin or USDT first, not Ethereum,” B² network co-founder, known as Calvin, told Cointelegraph.

The protocol offers a data availability layer on the Bitcoin blockchain, a critical component for the security of decentralized applications. This layer ensures that the data necessary to validate transactions is available to all nodes in a network. In a blockchain-based game, for instance, this data layer could ensure that player interactions and in-game asset movements are stored in a decentralized manner.

Having a dedicated layer for NFT transactions could have avoided the network congestion seen in 2023