There are now three active solutions for transferring Bitcoin not on the Bitcoin blockchain, but on another blockchain or offchain: Blockstream’s Liquid sidechain, WBTC moved to the Ethereum blockchain, and the Lightning network. Each of the solutions appeals to a different audience, but Ethereum surprisingly attracts the most Bitcoins.
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For Bitcoin (BTC), it has long been a foregone conclusion that the blockchain itself is merely a so-called “settlement layer.” It is not there to be used by users directly, but rather to serve as an anchor for various higher layers on which actual transactions then take place. Bitcoin is not meant to scale “onchain,” but at different layers.
Meanwhile, three of these “second layers” are ready for the market and also register some users: the Sidechain Liquid by Blocksteam (L-BTC), the Wrapped BTC (WBTC), which is brought to the Ethereum blockchain by BitGo, and the Lightning network, where Bitcoins flow “off” the blockchain. So it gets complicated, because Bitcoin is no longer Bitcoin. Instead, there are four types of Bitcoin that mean the same coin but handle it at a different technical level.
Each of these levels attempts to solve a different problem using a different method. We present them below, and then compare how much they are used.
Blockstream’s Liquid sidechain has the purpose of improving exchange-to-exchange Bitcoin transfers. Read more about it at https://blockstream.com/liquid/. While normal Bitcoin transactions can get expensive quickly in some cases – fees of five or more euros are unfortunately not all that uncommon – Liquid transactions only cost a few cents. And while Bitcoin transactions usually take an hour before exchanges consider them finalized – namely when they have six confirmations – Liquid transactions are finalized within minutes. Finally, Liquid transactions can optionally disguise the amount sent, which allows traders to expect more privacy.
Technically, Liquid uses a type of anchor transaction on the Bitcoin blockchain, through which Bitcoins are frozen to subsequently emerge on the Liquid sidechain. The keys for the anchor addresses are held by the Liquid consortium, which includes Blockstream as well as a number of exchanges such as Bitfinex and the hardware wallet manufacturer Ledger. Only members of the consortium can create new Liquid blocks, while anyone can run a full node to form transactions and verify the blockchain.
In addition to faster confirmations, Liquid also allows tokens to be formed. One example is the L-USDt, tethered dollars on the Liquid blockchain. However, with around 450 “assets” on the Liquid blockchain so far, there seems to be little prospect of competing with Ethereum or even Simple Ledger on Bitcoin Cash here.
Liquid’s target audience is primarily traders who want to skim arbitrage profits between exchanges. For example, if the Bitcoin price is higher there than there, or if there are better lending rates on one exchange than the other. Such opportunities often close within minutes. By the time a normal bitcoin transaction arrives, it’s often too late.
The wallet BitGo started putting Bitcoins on the Ethereum blockchain as “wrapped BTC” (WBTC) in late 2018. To do this, the company locks away Bitcoins on its cold wallet and creates an ERC token on Ethereum that represents Bitcoins.
Users thus enjoy the value and scarcity of Bitcoins, but the technical features of the Ethereum blockchain. For example, transactions with WBTC receive the first confirmation after only about 15 seconds. Since some exchanges only require 5-10 confirmations to credit Ethereum-based tokens, transactions with WBTC are just as fast as with Liquid. Ethereum fees are currently in the low double-digit cents, but were mostly in single digits in the weeks and months prior. Unlike Liquid, Ethereum is an extremely heavily used blockchain that is currently already operating at capacity. Unless Ethereum 2.0 becomes a reality relatively soon, Ethereum – and by extension WBTC tokens – will run into scaling issues.
However, faster and cheaper transactions are more of a side benefit for WBTC. Their biggest advantage is that they bring Bitcoins into the world of smart contracts. A WBTC, like any other token on Ethereum, can interact with a variety of smart contracts. It can be exchanged for other tokens on decentralized exchanges (DEX) – making Bitcoins the unit of trade on DEX – and it can be deposited with the Maker DAO, for example, to borrow DAI dollars. This allows Bitcoins to be hodled at the same time as Onchain dollars are borrowed and spent or interest is paid. In addition, it should be possible to lend WBTC through a smart contract, allowing one to earn interest on bitcoins in a decentralized manner.
The trust relationships are different for Liquid and WBTC. On the one hand, WBTC is completely centralized at BitGo. The company is almost solely responsible for WBTC maintaining its value relationship with Bitcoin. It is the floodgate through which anyone who wants to create a WBTC must pass. The WBTC tokens themselves, however, move as freely as any others on the Ethereum blockchain. You can freely acquire them, freely sell them, and freely transfer them, and BitGo can’t stop you. With the Liquid sidechain, on the other hand, there is no central authority, as there is with WBTC, just a consortium. However, a third of the members can also prevent and censor transactions, so they can exercise more power than BitGo.
The Lightning Network
We’ve already written a lot about the Lightning network here. Thanks to a multisig smart contract, the network’s participants thereby form so-called payment channels, which form a network through which one can transfer Bitcoins in real time without them seeing the blockchain.
The Lightning network has been live since the beginning of 2018. There are now numerous wallets for Lightning, hackdays, conferences, community projects, and the first payment service providers already accept Lightning transactions. If the Bitcoin community has its way, Lightning should be THE second layer. The network is decentralized, transactions are very private, take place in real time, cost virtually no fees, and are more or less endlessly scalable. Both ideologically and technically, Lightning is by far the best solution.
However, Lightning is a completely new concept. While Liquid and WBTC merely transfer the existing principle – the blockchain transaction – from the Bitcoin blockchain to another, Lightning takes a completely new approach. This means that the infrastructure effort for Lightning is significantly higher and the user experience currently leaves a lot to be desired. Lightning is the thicker board to drill.
User statistics on Lightning are generally incomplete. There is no data on the number of transactions, and even the data on the number of Bitcoins locked in is incomplete because not all payment channels are public. Therefore, it is almost impossible to give concrete data on how much the offchain network is used. But if we go by the values that are available, Lightning lags behind the other two solutions despite a head start of about half a year and the great enthusiasm of the community.
Notes on how to use the second-layer solutions
Bitcoins get to these second-degree layers by being frozen on the blockchain itself. One metric to evaluate the success of such a layer is the number of bitcoins that are deposited. In this regard, WBTC are by far the most successful: more Bitcoins circulate on Ethereum than in Lightning and Liquid combined.
Another metric would be the number of transactions. After all, the higher tiers are there for Bitcoin to be used. For Lightning, the number of transactions is unknown because they are sent around the network in a decentralized and obfuscated manner. For WBTC, the number of transactions is known, and it totals 190,000. For Liquid, I have not found it out. There is a Liquid page, liquid.horse, but it has been out of date for more than a year.
Blockstream’s Liquid page only reveals that Liquid processed just over 1,700 transactions in the last 24 hours. For WBTC, etherscan.io shows between 500 and 800 daily transactions in the last week, up from 1,000 to 3,500 in the weeks prior, so it’s hard to say which of the two projects records more transactions. However, both account for only a tiny fraction of transactions on the bitcoin chain, one percent at most.
What Liquid-Bitcoin is used for exactly is difficult to say. On Bisq, you can trade L-BTC for BTC in a decentralized way. But the trading volume is vanishingly small. Otherwise, although some exchanges are members of the Liquid network