Bitcoin Ecosystem Development and Challenges: Unlocking Trillion Market Potential

As discussions around the Bitcoin ecosystem heat up in the crypto market, industry insiders look forward to the next cycle of exponential blockchain growth stemming from the large-scale application of Bitcoin. Utilizing client verification solutions to build smart contracts on Bitcoin scripts, while being compatible with the Lightning Network that offers unlimited scalability for channel transactions, could become a large-scale application solution for blockchain that simultaneously ensures "security, decentralization, and scalability".

This article will provide popular science explanations of some basic concepts of the Bitcoin ecosystem. From the "Blockchain Trilemma" that hinders large-scale applications, to the "Bitcoin Lightning Network" that overcomes the "Trilemma", and to the current solutions for Bitcoin scripts and the principles of the UTXO model.

Obstacles to Large-scale Applications of Blockchain

Industry insiders have suggested that "blockchain networks cannot simultaneously achieve security, decentralization, and scalability," also known as the "Blockchain Trilemma." This dilemma has long hindered the large-scale application of blockchain.

Over the past decade, certain public chains have focused on developing decentralization while ensuring security, continuously innovating at the infrastructure layer of the underlying public chain to expand its scalability. To achieve this goal, various technologies such as algorithms, sharding, and Rollup have also been iterated.

However, regarding the scalability problem, based on the attempts of certain public chains and their Layer 2 solutions, it seems that as long as the solutions are limited to the blockchain, performance will have an upper limit. Even the currently visible most powerful blockchain still struggles to break through the upper limit of TPS ( transactions per second ), and there is still a huge gap from the requirements for large-scale commercial applications at the million-level TPS and the goal of achieving hundreds of millions of TPS in global industrial applications. For mainstream public chains, regardless of which type, they all face a bottleneck—"How to solve scalability?"

The Operation Mechanism of the Lightning Network

The Lightning Network utilizes off-chain computation, namely "payment channel (Payment Channel)", to completely solve the scalability problem of the "impossible triangle"—as long as enough channels are built, any number of concurrent transactions can be processed.

Lightning Network Principles

• Using the banking system as a metaphor, if person A and person B open accounts and transfer money. When both individuals are at the same bank, the settlement occurs internally within that bank. However, when person A and person B are not at the same bank, a cross-bank settlement operation needs to be executed through the central bank.

• The Lightning Network mimics the way banks settle: User A and B open a Lightning channel between them through the Lightning Network. When the channel is opened, A and B settle directly on the Lightning Network using the channel, without the need to settle on the Bitcoin blockchain. Only when the channel is closed do A and B need to cross the Lightning Network to settle on the Bitcoin blockchain.

Lightning Channel Operation Process

1. Deposit Reserve: Similar to the traditional scenario where opening a bank account requires a deposit, opening a Lightning Network channel also requires a Bitcoin reserve.
2. Off-chain transaction accounting: Each transaction is recorded individually through the Lightning Network, and each record must be accompanied by a penalty agreement.
3. On-chain settlement records: After closing the lightning channel, the historical transaction data is packaged and settled all at once, and ultimately sent to the Bitcoin blockchain.

How does the Lightning Network prevent on-chain fraud

If during the channel trading process, A commits fraud by prematurely closing the channel to settle Bitcoin. Then at the time the channel closes, a fraudulent transaction will immediately occur on the Bitcoin chain. Based on the openness of the Bitcoin chain, B can observe this in a timely manner and punish A using the pre-signed penalty agreement. The penalty content is to confiscate all of A's reserves.

The bottleneck of large-scale applications of the Lightning Network

The Lightning Network theoretically achieves infinite scalability, overcoming the blockchain trilemma. However, the most critical issue hindering the large-scale application of the Lightning Network is that it uses the same script as Bitcoin, and the Bitcoin chain does not have smart contracts, only simple scripts that cannot support complex applications. This means that the Bitcoin chain is Turing incomplete; Turing completeness means that any computational problem can theoretically be solved. Using a Turing complete scripting language allows for logical compatibility with other programming languages and theoretically enables the realization of any logic that other languages can achieve, as well as replicating real-world business logic to the maximum extent. There are no smart contracts on the Bitcoin blockchain, let alone applications built on smart contracts. Therefore, the biggest problem that the Lightning Network needs to overcome is "how to implement smart contracts on Bitcoin."

Existing solutions to enhance the "function" of the Bitcoin blockchain

1. Side Chain

A sidechain refers to a chain that has smart contract functionality, which is linked bidirectionally to the Bitcoin main chain, allowing Bitcoin assets to migrate seamlessly between the main chain and the sidechain, thus enabling smart contracts. However, there is currently no sufficiently decentralized bidirectional linking technology. The replication of the main chain and asset migration on the sidechain requires third-party centralized service providers, and currently, only semi-centralized solutions exist. The sidechain solutions have not received support from the Bitcoin core developer community due to issues of centralization from third-party issuance.

2. Colored Coins

In 2012, the president of the Bitcoin Association published a paper titled "Overview of Colored Coins," which introduced a mechanism utilizing the "fungibility" of Bitcoin to separate specific tokens from others by "coloring" certain coins, thereby creating applications suitable for these coins. The specific method involves using the OP_RETURN instruction in Bitcoin scripts to add 80 bytes of arbitrary characters, designing strings in a specified format within those 80 bytes, marking the meaning of the strings as "colored coins" through human specification, and enabling more complex smart contracts. However, the 80-byte space is too small to achieve complex functionalities.

The subsequent "Colored Coins" scheme has also introduced new technologies. For example, the "Ordinals" inscription technology utilizes the 3 MB "Segregated Witness" space within a Bitcoin block to embed small images, issuing NFTs. For instance, BRC-20 expresses more complex content than 80 bytes with a string of code. However, these Colored Coins will create additional severe problems—occupying the "Segregated Witness" space, which was originally used to store Bitcoin transaction signatures, squeezing the "Segregated Witness" space will lead to a decrease in the number of executable transactions on Bitcoin, resulting in a decline in Bitcoin's performance. The Colored Coins scheme has also faced strong opposition from Bitcoin core developers, as Colored Coins pollute the native Bitcoin, and the artificially designated format still requires a centralized third party for server parsing.

3. Client-Validation

In 2016, Bitcoin core developers published a paper proposing the client-side verification paradigm, which ensures the privacy premise that only both parties know the contract content by simulating the traditional contract signing method without any third-party involvement, achieving complete decentralization. At the same time, during the execution of the transaction, it adopts a method where the transaction initiator provides the necessary complete transaction history data, and the other party verifies it independently to prevent fraud issues. This eliminates the troubles of centralization and features off-chain verification that is not performance-limited, leading most people to currently consider it the 'optimal' solution to the insufficient Turing completeness of the Bitcoin blockchain.

Traditional Contract Signing vs Blockchain Smart Contract Signing

• Traditional Contract Signing: There is a transaction between A and B, a contract is signed first, and both parties confirm the content of the contract before signing. The contract cannot be altered at the time of signing. Any transactions during the future execution of the contract are transactions between A and B, without the need for third-party intervention.

• Blockchain smart contract signing: The transaction process is announced to the entire network, and all miners execute and verify it. The entire execution process has no privacy, and due to the need to be published to the entire network for consensus, performance is limited.

Is the client validation flawless?

Upon seeing this, it seems that some may have questions. The decentralized Bitcoin blockchain itself addresses security issues in traditional commerce, but with the introduction of client-side validation, the solution returns to off-chain. Even if it resolves the fraud issue, how can we effectively prevent double-spending problems from arising?

Introduce "one-time seal"

Since client-side validation does not inherently include a double-spending prevention mechanism, we have to introduce third-party assistance to solve this problem. To achieve this goal, we will bind each state of every contract that needs to be verified in client-side validation to a specific Bitcoin unspent transaction output (UTXO). Since UTXOs exist in only two forms, "spent" and "unspent", once we need to change the state of the verification contract, we must spend the bound UTXO (any amount is fine) to have the transaction that spends it confirmed by the blockchain. In addition, the Bitcoin transaction that spends it must also provide proof of the state transition content (which functions similarly to a hash value). In simple terms, the bound UTXO can be seen as the wax seal of this state "envelope"—to open the envelope, you must break the seal.

Supplementary Explanation of the UTXO Model

Unlike the account model of some public chains, the unspent transaction output (UTXO) is the total amount of cryptocurrency sent from one address to another but not yet redeemed by the recipient, so that funds can be sent to others in subsequent transactions.

• For example, if Alice sends 1 Bitcoin to Bob, as long as Bob has not spent the BTC received from Alice, he owns a UTXO. Once Bob spends 1 BTC, the lifecycle of the UTXO ends.

• Suppose Bob's wallet has only participated in one transaction, in which Bob received 1 Bitcoin from Alice. The transaction validators know that Bob's UTXO balance is 1 Bitcoin. If Bob then sends 1 Bitcoin to Carol, his UTXO immediately becomes 0 Bitcoin. If Bob then attempts to double spend his coin in a second outgoing transaction, the validators will find that his UTXO balance is insufficient to serve as an input for the second transaction, and honest validators will not propagate or confirm his double spend transaction.

The Next Exponential Growth: Bitcoin Ecosystem Fully Explodes

In the evolution of Bitcoin, the design of client validation cleverly avoids the centralization issues of sidechains and colored coins, and introduces a one-time sealing mechanism, further enhancing its security. At this moment, the Bitcoin ecosystem is witnessing the birth of a series of brand new protocols, among which, the RGB protocol not only inherits the above concepts but also proposes compatibility with the Lightning Network, laying the foundation for unlimited scalability. Although the compatibility of the RGB protocol with the Lightning Network is not yet perfect, we are confident about the future, believing that the infrastructure helping to continuously optimize the protocol will overcome the long-standing "blockchain trilemma" limitations.

We have more reasons to expect that the next cycle of blockchain exponential growth will be driven by the explosion of the Bitcoin ecosystem leading to large-scale adoption of blockchain. I believe Bitcoin will break through its original single value storage, highlighting its monetary attributes while continuously integrating more applications into the Bitcoin ecosystem through diversified solutions, promoting ecological scalability and sustainable development, and continuing to bring unlimited possibilities to the blockchain world.