Now that we have established that DeFi is critical to Bitcoin’s success, the next logical question is, do we build Bitcoin DeFi on the main Bitcoin chain or on a Layer 2 (L2)?
In order to build Bitcoin based financial services that offer a user experience capable of mass adoption (high network effects) we need the following six ingredients:
- A way to digitally represent money, as well as fungible and non-fungible assets
- A high degree of confidence that transactions cannot be reversed (otherwise known as “finality”)
- A virtual machine to perform computations via trustless computer programs (aka “smart contracts”)
- A trust-minimized way to move assets from the mainchain into smart contracts
- Fast confirmation times to unlock a user experience akin to the current norm offered by existing financial services
- Cheap transaction costs to enable services for a broad user base
The Bitcoin mainchain brings two of the six ingredients to the table: BTC is digital money and with Ordinals and BRC-20 the protocol has recently added primitives that allow us to represent NFTs and tokens. Additionally, the Bitcoin mainchain offers excellent finality through the immense energy and computing power that ensures its tamper-resistance.
Conversely, the Bitcoin mainchain lacks smart contract expressibility (Bitcoin script is very limited), and the user experience is tolerable at best with long confirmation times (minutes to hours) and high transaction costs.
L2s (or sidechains), on the other hand, excel at smart contracting and offer a superior user experience with fast and cheap transactions.
The optimal solution is a system that takes full advantage of the finality of the mainchain while simultaneously leveraging the user experience of L2s. Put more simply, the optimal Bitcoin based financial system transacts on L2s and settles into the mainchain.
Luckily we stand on the cusp of this exact infrastructure coming online.
A myriad of L2s like Stacks, Rootstock, Liquid, Spiderchains, BitVM, and many others have thrown their hat in the ring to make this vision become reality — a world where we can leverage the foundation of the Bitcoin mainchain to build a financial system that is highly secure, decentralized, and permissionless while offering a best-in-class user experience with fast and cheap transactions and fully expressible smart contracts.
Only L2s unlock Bitcoin DeFi with a user experience that can lead to mass adoption. Therefore, it is only with L2s that we have the ability to achieve high enough network effects to make Bitcoin the dominant financial system.