Will Bitcoin’s Taproot upgrade create a “DeFi rain”?

On November 14th, the Taproot upgrade from Bitcoin to block 709.632 was activated, with the aim of creating a de-fi and decentralized application (dApp) ecosystem around the decentralized cryptocurrency, giving it a function more like Ethereum.

But while Taproot has almost complete support from the Bitcoin community – unlike the divisive SegWit upgrade that happened in 2017 – it hasn’t resulted in any significant changes in price or volume.

While the Taproot upgrade is transforming Bitcoin into the future with a number of privacy and efficiency upgrades, it will remain a relatively conservative force in the crypto space, primarily as a warehouse to store value for the future.

Bitcoin price and volume unchanged after Taproot upgrade | Source: Footprint Analytics

ETH price breaks USD 2,800 and trading volume above USD 30,000 after London upgrade on August 6, 2021 | Source: Footprint Analytics

What is taproot?

The Bitcoin community updates Bitcoin every 4 years through soft forks, where new features are introduced primarily through Bitcoin Improvement Proposals (BIPs).

Unlike previous upgrades, Taproot is not a single feature extension to the Bitcoin network, but rather a larger upgrade with three proposed improvements (BIP340, BIP341, and BIP342).

Greg Maxwell proposed this upgrade in 2018. Since then, three BIPs, written by Pieter Wuille, Tim Ruffing, AJ Townes and Jonas Nick, have been aggregated into Taproot and merged into Bitcoin Core in October 2020.

The Taproot upgrade aims to improve the privacy of transactions and the efficiency of the Bitcoin network.

Content of the offer:

• The BIP340 adds a Schnorr multiple signature approach that is also compatible with previous Elliptic Curve digital signatures.
• BIP341 proposes a new network payment method called “Pay-to-Taproot” (P2TR), which uses the MAST data structure (Merkle Tree) and uses the functions of synthetic signatures.
• BIP342 enhances the Bitcoin network by adding a new scripting language called Tapescript to verify Schnorr’s synthetic signatures and pay-to-taproot payment pipeline, enhancing the inclusiveness and flexibility of the P2TR coin smart contracts.

Effects on Bitcoin

Lower transaction costs

• One of the main advantages of Schnorr signatures is the ability to capture multiple keys and generate unique signatures in complex Bitcoin transactions. In this way, signatures from several parties can be “aggregated” into a single Schnorr signature.
• It is hailed as the most important technical update since Segwit.
• Schnorr signatures reduce the amount of data required for multi-signature transactions. This makes it cheaper to process transactions, which leads to lower transaction fees.

Better security

• The MAST data structure, based on the Schnorr multi-signature approach, can contain complex transaction information. It allows transactions with multiple signatures or transactions with multiple addresses to appear as a single standard transaction.
• Multi-signature transactions are indistinguishable from simple transactions, which means that addresses that participate in multi-signature transactions have a higher level of anonymity and privacy.

Smart contracts support

• Since the Taproot upgrade reduces the output of transactions on the network, it opens up the possibility of implementing complex smart contracts.
• At the same time, Taproot offers a comprehensive set of tools for developers to further develop Bitcoin.

In short: the heart of the Taproot upgrade are Schnorr signatures. It brings a whole new combination of performance, data protection and even smart contract features to Bitcoin.

Can Taproot Enhance Bitcoin’s Competitive Edge?

Although both Bitcoin and the Ethereum network are based on the concept of a distributed ledger and encryption, they differ in technical properties.

For example, Bitcoin acts as a digital currency that is equivalent to gold and is used to store values. Ether powers applications and generates revenue by supporting the network.

One of the main differences between Bitcoin and Ether is that Ether supports and works with smart contracts, giving developers the ability to create new applications.

Today, Ether is establishing itself as the preferred blockchain for these applications, also known as dApps.

The number of DeFi protocols on Ethereum is growing every month | Source: Footprint Analytics

Most dApps and NFTs are based on an Ethernet network. As the use of Ether in DeFi and NFT grows in popularity, Ether has established itself as a leader in the adoption of crypto.

Top 10 Ethereum Burning Projects, including DeFi & NFT | Source: Footprint Analytics

While Ethereum has a larger transaction volume, Bitcoin’s superior network security and capacity can also attract liquidity in the long run.

Similar to gold, Bitcoin is stable and capped at 21 million BTC and the potential of digital gold is increasingly being confirmed.

Taproot is making the Bitcoin network more attractive for building DeFi protocols to capture growing user demand. Many Bitcoin watchers see this upgrade as a godsend for DeFi on the Bitcoin network.

However, many analysts don’t believe that Taproot will be able to turn Bitcoin into a smart contract ecosystem.

Positioned as a peer-to-peer cryptocurrency system, Bitcoin lacks a mature “virtual machine” EVM (Smart Contract Runtime Environment) to execute smart contracts to aid in the storage, execution and review of smart contracts.

Therefore, it is difficult to get more dApp or DeFi projects to program and build projects in your chain. There is still a long way to go before Bitcoin becomes a programmable platform with the DeFi ecosystem.

To be fair, Bitcoin’s development is very slow.

One reason for this is its Proof-of-Work (PoW) consensus mechanism, which requires up to 50% of the consensus of the Bitcoin nodes for each modification. Even Taproot is unlikely to have caught up with DeFi’s rapid growth.

In addition, only half of the known Bitcoin nodes support the upgrade, the rest are still running with legacy software. That means they haven’t implemented Taproot’s new rules yet.

Taproot’s actual operations, including Schorr, will not begin until next year.

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