The Off-Chain Bitcoin Bull Market – Bitcoin Magazine

by James · August 31, 2022

This is an opinion editorial by Zack Voell, a bitcoin mining and market researcher.

One of the more interesting and controversial developments in the Bitcoin ecosystem is off-chain use cases. Many of these applications are not technologically identical, but they nevertheless expand the list of potential use cases aside from the Bitcoin base for a given bitcoin holder. And some of these products are completely outside the Bitcoin economy.

This article does not take a position on the unique benefits of any particular off-chain use for Bitcoin, but it does summarize some growth trends and supply data that show growth and adoption across Layer 2 protocols, bitcoin-backed tokens, and more. Using bitcoin in these ways is not suitable for all investors, but anyone who cares about the broad scope of Bitcoin adopters should pay attention to these trends to better understand where and how bitcoin is moving.

Table of Contents

Defining ‘Off-Chain Bitcoin’

Before examining any data, this section will hopefully reduce some of the potential mental blocks or preconceived criticisms readers may have about these applications that may color their objective interpretation of data in the following sections.

The catch-all category of “off-chain” bitcoin is not intended to equate or conflate all of the later-mentioned protocols as identical or even broadly equivalent. But there is a sufficiently usable label for these tools that offer uses for bitcoin that are not directly on the base later. Some of these applications share characteristics of simply holding assets on a custodial exchange, but a key difference is that almost all of these protocols are not permissioned, closed source, or as centralized as exchanges. The following data focuses on these open financial tools for alternative bitcoin use.

Overview of Layer 2 Bitcoin Capacity

Protocols built in layers of the Bitcoin technology stack above the base layer blockchain are often criticized for their lean usage. Usually, this criticism comes from supporters of alternative blockchains. But the data show that growth is nevertheless steady, even if it is relatively slower.

The colored area chart below shows bitcoin supplies on the Lightning Network, Liquid Network and RSK over the past two years. It is clear that of these three, some see the supply growing faster than others. But the overall growth trajectory is markedly opposite to bitcoin’s current price action. Despite the bear market, adoption continues.

However, these three “built-on-bitcoin” protocols are not alone. Other Bitcoin-adjacent networks such as Stacks also support a type of synthetic bitcoin asset. Built with the motto “unleashing Bitcoin’s full potential,” Stacks announced its offering of a form of packaged bitcoin in January 2021. The asset uses the ticker symbol xBTC.

Data overview of tokenized Bitcoins

It’s no secret that synthetic bitcoin products on other blockchains are often mocked on Twitter and not universally used or welcomed by the wider Bitcoin community. But data shows that a non-trivial amount of bitcoin investors are increasingly using bitcoin-backed tokens.

The best example is the growth of Wrapped Bitcoin (WBTC), an ERC-20 token launched by BitGo. The chart below taken from The Block shows the extraordinary growth in WBTC supply over the past two years regardless of downward bitcoin price action:

BitGo’s bitcoin-backed token is not the only asset of its kind on Ethereum. Six other teams have launched similar assets, including tBTC, pBTC, renBTC and more. Each one offers slightly different features and protocol architectures to serve different user demographics.

Ethereum is also not alone in supporting synthetic bitcoin products apart from the Bitcoin blockchain. Other chains later launched these products as gimmicks (eg Tron) or to try to emulate the success of Ethereum’s bitcoin-backed tokens (eg Solana and Avalanche). But Ethereum is by far the network with the largest amount of synthetic bitcoin assets, thanks in large part to the craze of “DeFi Summer” in 2020.

The bar chart below shows current supplies of synthetic bitcoin on alternative blockchains:

Are these Bitcoin products “good”?

Mention tokenized bitcoin products in a crowd and reactions are bound to be polarized. In orthodox Bitcoin communities, Layer 2 protocols (e.g. Lightning and Liquid) are easy favorites and their adoption is steady, although relatively slow.

So, are these products “good”? All of these off-chain uses for bitcoin present different trade-offs, but the idiosyncratic utility of each cannot be ignored. Whether everyone should choose one way to use the coins is not the point. Because becoming a reserve asset—for the global fiat economy or the internet-based “crypto” economy—is bitcoin’s most widely accepted purpose, generally speaking, products that achieve this goal should be encouraged. Lightning pushes utility into the native Bitcoin economy in the same way that tokenized bitcoin has a clear and direct effect on bitcoin acting as a form of reserve asset for non-Bitcoin native sectors of the broader cryptocurrency market.

Remortgaging is another popular concern with most bitcoin financial products. Importantly, this concern does not apply to these products outside the chain. The lack of rehypothecation for Lightning products is evident. And in fact, almost all of these products are built on and apart from the Bitcoin protocol itself designed to serve a one-to-one bitcoin-backed or exchanged asset, whether it’s a simple transfer of bitcoin from the base layer to the Lightning Network or an exchange of “real” bitcoin for a bitcoin token used on other blockchains. One of the leading tokenized bitcoin products maintained by BitGo, for example, publishes proof of the reserves backing the bitcoin tokens it issues.