What is Bitcoin?
Bitcoin means different things to different people. To some it is currency, a store of value, a speculative asset, digital property, a decentralized financial ledger and so on. That is the versatile nature of a permissionless and open-sourced protocol.
Therefore, Bitcoin must be a base layer which hosts all these functions on top of its foundation. To understand this statement, you must understand the layers of protocols that make all this possible. The blog you are reading right now sits on top of many layers of the “Internet”, which itself sits on two other layers before that, Networks and Computers. The Bitcoin protocol operates similarly with many layers built upon its sturdy substratum. As Michael Saylor puts it, Bitcoin is the bedrock on which all of Manhattan is built upon. If you refer to the key layers of the Internet as seen in Figure 1, you can see the many layers of the internet and how each technology is built upon the previous one. This bodes well for a visual representation of Bitcoin’s network. Of course, this analogy may be loose and not directly comparable, but I think the internet is a suitable metaphor to represent the layers of Bitcoin in relation to a technology that everyone already uses.
Miners
The Bitcoin Network operates on two types of computers: mining computers and node computers. When you hear that Bitcoin is “mined”, this is referring to mining computers “discovering” new bitcoins and adding them into the circulating supply. The process of mining can be complex, and we won’t get too technical in this blog, but I will write another one dedicated to purely the mining process of Bitcoin as it is integral to the entire Network. To put it simply: mining computers deploy a process called Proof of Work (PoW) to solve a difficult mathematical problem based on a cryptographic hash algorithm. Stay with me – in non-alien language – people compete with other people at a guessing game, and whoever guesses the correct answer wins the bitcoin reward. This guessing game is done on specialized computers called Application-Specific Integrated Circuits, or ASICs. This guessing game is measured in two ways: the performance of the computers and the cost of the electricity used. Back in the early days of Bitcoin, you could mine bitcoin on your laptop. Now, as more miners join the worldwide guessing game, a stronger and stronger computer is needed to compete with the increasing amount of people playing the same guessing game.
As figure 2 depicts, the hash rate, which is like the horsepower of the Bitcoin network, is at an all-time high and climbing. This represents the aggregate computer power of all the miners securing the Network. Currently this number sits at around 605 exahash per second. Exa means quintillion, which is 18 zeros. One might be inclined to attempt to compare this hash rate to other networks or servers to size up Bitcoin, but unfortunately hash rate is specific to the ASICs that are exclusively using the PoW algorithm. However, energy consumption can be used for comparison to other sectors. With the immense compute of the Bitcoin network, it indeed does use a significant amount of energy. Something to the tune of 173.94 Terawatts per hour, annualized, according to University of Cambridge. In comparison to countries, this amount of energy could power the Netherlands by 117% and would cover 44.4% of Australia’s energy usage. Many Bitcoin pundits denigrate this side of Bitcoin even though miners are incentivized to harness renewable, isolated, or otherwise wasted energy sources. Furthermore, the higher the hash rate, the more secure the network is, thereby protecting the entire protocol with a massive shield of energy and economic power.
Nodes
Nodes are like points of connections that have multiple connections to other nodes, and so on. This group of connections constitute the next layer above the mining computers of Bitcoin, and they are called nodes. Just as a group of computers form a network in the layers of the Internet, a group of nodes form Bitcoin’s network. Bitcoin’s network of nodes plays several critical roles in securing the protocol. As you will learn in
the next section, they ensure that no coins were double-spent, that all transactions are properly signed and that the blocks have the correct proof-of-work ledger. To run the Bitcoin software, these nodes must have the entire blockchain downloaded onto them, and then constantly check with every other single node in the network if it matches what they got. This doesn’t require special computers like ASICs for mining. A node can be downloaded onto a 1 terabyte hard drive as Bitcoin’s blockchain is around 560 GB in size currently. This isn’t very big at all considering Call of Duty MW2 is 125 GB in size. That’s 15 years of hundreds of billions of dollars in global monetary final settlements without failure recorded on a hard drive 4.5 times bigger than CoD.
There are also lightweight nodes that don’t require the full blockchain to be downloaded and can still verify the network and serve specialized roles, but of course the full nodes are what keeps the protocol the most secure. When miners add new blocks to the ledger, the nodes verify with every other node the validity of the block.
Did you know Satoshi never used the word blockchain in their whitepaper? They referred to the blockchain as a timestamp server. And as such, if there’s a discrepancy between two histories of the timestamp server, the ledger with the longest (chain of) history (blocks) is the true ledger. When there’s an intentional discrepancy by a group of developers, they would “hardfork” or copy the original Bitcoin Core code to a new timestamp server with a major rule altered. This rule that they alter always compromises some part of Bitcoin’s perfectly weighted trinity; security, scalability and decentralization. This is called the blockchain trilemma.
Adam Back, an early developer in Bitcoin’s history and creator of the 1990s digital protocol Hashcash (which Satoshi Nakamoto cited in the Bitcoin whitepaper), has stated that despite his extensive efforts to tweak Bitcoin’s core code, any changes always compromised its trinity in some way. Satoshi’s original Bitcoin has been working flawlessly for the past 15 years and has retained most node operators and users. All other versions of it have trended towards zero against Bitcoin in terms of price, network effect and security.
Layer 2s
As noted in the introduction, Bitcoin is a sturdy substratum that is being built upon. Its foundation consists of the Bitcoin Core code that is open-sourced and can be found on GitHub. Just as the browser Mosaic and then later Google was built on top of HTTPS, HTTPS was first built on top of TCP/IP. In quick summary, the Transmission Control Protocol (TCP) ensures that data is sent and received correctly and in order, and the Internet Protocol (IP) instills correct destinations to these data packets. HyperText Transfer Protocol (HTTP and then later HTTPS; S meaning secure) ensures that these data packets are encrypted between clients like a web browser (Google) and a web server (Apache). From this description and from figure 1, I am sure you can see the pattern. The entire internet as we know it is built in layers and each subsequent layer relies on some sort of technical aspect of the preceding one. Bitcoin is built in much the same way. It resembles its own “internet” in that if you extrapolate the layers to the existing facets of Bitcoin, you can see some semblance. For example, the computer layer of the internet could be akin to the ASIC machines used to mine Bitcoin. The internet’s network layer is like the node network of Bitcoin. Of course, this is incorrect as Bitcoin itself relies on the very layers of the internet to communicate its peer-to-peer network of miners, nodes, transactions, etc. Yet it is still a noteworthy and even perhaps fun observation.
So, what kind of layers does Bitcoin have? As this is a new technology the defining applications and protocols on top of Bitcoin are still being categorized but for the most part there is some agreement in the community. Layer 2 is characterized as utilizing and interacting with the Bitcoin blockchain directly for very specific purposes like improving transaction speeds and costs. It doesn’t use layer 1 for every action, but eventually must settle and finalize on layer 1 for it to be considered truly valid. An example of this is the Lightning Network (LN).
As you can see in Figure 5, the Lightning Network (LN) allows for fast and cheap payments between two parties within an opened channel. To open a Lightning channel, you must pay a Bitcoin transaction fee and fund the channel. Once the channel is open, the two parties can conduct numerous transactions off-chain. These transactions are nearly instantaneous and incur minimal fees compared to on-chain transactions.
But what happens if the channel runs out of funds? When a channel runs out of funds on one side, it means that one party has sent all their allocated Bitcoin to the other party. In this situation, the channel can't facilitate further transactions in that direction without intervention. One way to handle this is by rebalancing the channel. This involves sending Bitcoin back to the original party through another route on the Lightning Network, essentially restoring the balance. There are also automated services and tools available that can help rebalance your channels without manual intervention.
Another option is to add more funds to the channel. This typically requires closing the current channel and opening a new one with a higher balance, which incurs additional on-chain transaction fees. However, the latest updates in the Lightning Network protocol are introducing dual-funded channels, where both parties can add funds to an existing channel without closing it, making it easier to maintain liquidity.
Alternatively, users can open multiple channels with different parties to avoid running out of funds in a single channel. This way, if one channel depletes, transactions can still be routed through other open channels. The primary purpose of the Lightning Network is to enhance Bitcoin's scalability. By conducting transactions off-chain, the Lightning Network reduces the load on the Bitcoin blockchain, decreasing congestion and lowering transaction fees. This is particularly important as Bitcoin's popularity grows and more users join the network. Transactions on the Lightning Network are almost instantaneous, a significant improvement over on-chain transactions, which can take several minutes to confirm. For everyday use, such as buying a coffee or paying for services, the speed of Lightning transactions makes Bitcoin much more practical.
Opening and funding lightning channels may seem inconvenient for everyday users, especially between strangers with no trust. However, there are innovative and retail centric LN wallets like Wallet of Satoshi and Strike, which use a centralized custodial model to fund the channels themselves so users can interact and send lightning payments to anyone in the world without funding a channel.
The Lightning Network also makes it feasible to conduct microtransactions, which are small payments that would be impractical on the main Bitcoin blockchain due to high fees. With Lightning, users can send very small amounts of Bitcoin with negligible fees, opening up possibilities for new business models and applications, such as pay-per-article journalism, tipping content creators, or IoT payments. Additionally, in inevitable coming age of super-intelligent AIs, these AIs will be using decentralized digital currencies like Bitcoin and the LN for micropayments between each other. Sentient digital beings won’t have an account at your local bank. They will have their own wallets and there will be an entire economy between these beings.
Since most transactions on the Lightning Network are conducted off-chain, they are not immediately visible on the public blockchain, providing an additional layer of privacy for users. Only the opening and closing transactions are recorded on the blockchain, making it harder to trace individual lightning payments.
Lightning Network Capacity has been growing steadily over the last 6 years. It’s impressive that it’s maintained an uptrend even during the 2022 bear market. This goes to show that the interest and development of the LN is increasing. El Salvador, after instantiating Bitcoin as legal tender in their country, uses the LN in their government-issued Chivo wallet for fast and cheap transactions suitable for everyday citizens. According to Forbes, President Nayib Bukele announced that 3 million people have downloaded the Chivo bitcoin wallet, amounting to 46% of the population.
Layer 3s and beyond
The third layer consists of more complex applications and services that leverage the foundational capabilities of Bitcoin while providing a user-friendly interface. The categories of these applications can range from messaging, decentralized finance (DeFi), tokenization, smart contracts, security and authentication.
Bitcoin’s Layer 3 is where things start to get really interesting. Think of it as the application layer, similar to how we use various apps on the internet that are built on foundational protocols. Layer 3 solutions leverage both the security of Bitcoin’s base layer (Layer 1) and the scalability enhancements of Layer 2 solutions like the Lightning Network. This layer is all about adding complex functionality and making Bitcoin more user-friendly and versatile. Let’s dive into some examples.
Application-Specific Protocols
Sphinx Chat is a perfect illustration of a Layer 3 application. It’s an encrypted messaging platform that uses the Lightning Network for payments. Imagine being able to send a message and money in one go, all seamlessly integrated. Another example is Impervious.ai, which provides a suite of tools for developers to build applications on top of Bitcoin and the Lightning Network. This includes features for identity, data storage, and communication, creating a rich ecosystem for developers to tap into.
Tokenization Platforms
Tokenization is another exciting area. The RGB Protocol allows for the creation and management of digital assets on Bitcoin and Lightning. This means you can issue tokens that represent anything from real estate to digital collectibles, all secured by Bitcoin’s robust infrastructure. Similarly, the Taro protocol enables the issuance of assets and tokens on Bitcoin and Lightning, allowing users to transact these tokens quickly and cheaply.
Decentralized Finance (DeFi)
DeFi on Bitcoin is still in its early stages, but it’s gaining traction. Imagine lending, borrowing, and trading using Bitcoin without needing a traditional bank. Some projects are working on bringing these DeFi capabilities to Bitcoin, leveraging Layer 2 solutions for efficiency and Layer 3 applications for more complex financial operations.
What Defines Layer 3?
Layer 3 is essentially about creating user-friendly applications that make Bitcoin more accessible and practical for everyday use. Whether it’s through tokenizing assets, enabling microtransactions, or providing new financial services, Layer 3 solutions are pushing the boundaries of what’s possible with Bitcoin. They’re taking the sturdy, secure foundation of Bitcoin and building on it, making it more versatile and useful for a wide range of applications. This layer of innovation is what will help drive broader adoption and open up new possibilities for Bitcoin and its ecosystem.
LockChain
In the evolving landscape of Bitcoin and its layers, LockChain is the newest cat on the street. It leverages Bitcoin’s robust security to transform digital identity and data authentication. The app uses Android’s built-in biometric verification system and public-private key cryptography to create a secure digital identity. Users enroll by generating a keypair and broadcasting their public key via Bitcoin transactions, ensuring their identity is uniquely and immutably tied to the blockchain.
LockChain combats the rising threats of deepfake and AI-based scams by providing a foolproof method for humans to verify each other. By integrating QR codes linked to social media or government IDs, it ensures seamless and trustworthy identity verification. Moreover, LockChain’s user-friendly interface makes it easy to manage and authenticate identities, bridging the gap between advanced blockchain technology and everyday usability.
So, is LockChain a Layer 3 solution? Not exactly. LockChain primarily interacts with Bitcoin’s Layer 1 for its core security features, securing identities onto the blockchain’s decentralized immutable ledger using OP_RETURN. However, the additional functionalities and enhanced user interactions it provides, such as tamper-proof QR codes verified by a public key embedded on Bitcoin align it with the principles of Layer 3 applications. It showcases how sophisticated blockchain technology can be made accessible and practical for everyday users.
Beyond
According to Techopedia, there are an estimated 219 million global Bitcoin owners in 2024. Constituting merely 2.74% of the entire world, it’s easy to see that Bitcoin is still early in its adoption curve. Although I hold the notion that the adoption rate will increase exponentially in a ‘gradually, then suddenly’ fashion, it’s extremely exciting to see all the unique applications already built this early in Bitcoin’s history. Figure 7 depicts the number of people using the internet. As you can see, the entire world is more than halfway past Internet adoption, in terms of usage in the past 3 months. Using this model, Bitcoin’s 219 million users is akin to the number of users the Internet had pre-2000. This is the truly exciting times. How could anyone have predicted things like the Apple App store, Instagram, AirBnB, Uber, or Facebook in the year 1998? I was about to write Amazon, but Bezos already had a vision of Amazon being the “everything store” pre-2000s. He truly was visionary. I think a few notable “Jeff Bezo”s in our current Bitcoin adoption curve are Jack Mallers from Strike and Jack Dorsey of Square, and the late and great Hal Finney who personally worked online with Satoshi Nakamoto and received the first Bitcoin transaction. Other notable names are Andreas Antonopoulos, one of Bitcoin’s greatest educators and Adam Back, CEO of Blockstream and an early core Bitcoin developer, who inspired Satoshi to incorporate proof-of-work mining into Bitcoin.
Bitcoin has a long journey ahead. It’s exciting to dream about the possibilities this liberating and revolutionary technology can do for humankind. It’s an honor to be apart of the community, to build on Bitcoin and to serve humanity as a medium for users to interact with this network to protect digital identity and file immutability. LockChain, like the many other great applications in this industry, has a long way to go and it’s never a dull moment in the vast Bitcoin galaxy. If you made it this far, congratulations dear reader. You are no longer a hitchhiker. You have the means to define your own end, a choice to opt out of the old, corrupt system and to join a new one. One that protects your property rights by a mountain of economic power and the very laws of physics. One where every single peer isn’t above or below the other, but equal to all users of the network. One where the powerful cannot create more of and where the weak cannot be coerced by. Keep stackin’ and hodl on. A hitchhiker's guide to the bitcoin protocol
Don’t trust. Verify.