Portal Ventures: Current status and potential areas of BTC ecosystem

Author: Catrina Wang Source: Portal Ventures Translation: Shan Ouba, Golden Finance

In May 2023, we launched a three-month research project assuming that the Bitcoin ecosystem will recover. This led to our paper "Panda Renaissance" published in November 2023. Since then, market interest and capital investment in this paper have grown exponentially. In this post, we will share updated thoughts and reflections from about a year ago.

1. Current state of BTC ecosystem: observations and comments

2. How our thinking has evolved

• Our firm beliefs

• Areas where our views have shifted

3. BTC’s new chapter: What’s next

• Prediction

• Blank space: Sectors and verticals that excite us

For the sake of brevity, we will present our observations, opinions, suspicions, and predictions in bullet point form.

The State of Bitcoin: Observations and Comments on the Industry

1.Intense Competition Between EVM L2s/Sidechains, Indistinguishable Value Propositions: Competition has shifted from “who is the least trustworthy” to who can 1. execute the most complex airdrop games, and 2. access the deepest liquidity via Bitcoin “whales”. This shift also explains the geographic concentration of L2s emerging from the Asia-Pacific region.

2. Intense Fragmentation

• Liquidity and Scaling Solutions: Over 80 sidechains/rollups, and 5+ meta-protocols.

• Token Standards: There is a duopoly between BRC20 and RUNE, followed by a long tail of other meta-protocols such as ARC, CRBC, RGB, etc.

• Indexers: Each token standard requires its own indexer.

3. Sidechains and Rollups The expectation for BitVM is to trustlessly re-anchor them to L1: I am quite skeptical of “L2s” that are initially positioned as sidechains and claim to become “trustless” after integrating with BitVM. My skepticism is two-fold:

Technical feasibility: The process of implementing “optimistic rollup” style validation on-chain involves developing millions or even billions of logic gates. This process is not only expensive due to operating on the base layer, but also slow due to the BTC block time limit. In addition, it may take quite a long time to complete this process. As far as I know (please correct me if I am wrong), BitVM has become a community project and faces the usual challenges of decentralization: no single entity is responsible for its development timeline, milestones, quality and overall success.

GTM Timing: According to various sources, BitVM will not be ready for the next 18-24 months. Even if everything goes well with BitVM and they deliver on their promises, this means these L2s will remain centralized via multisig for the foreseeable future. So what will they rely on to compete in the meantime?

4. Broad Trust Assumptions Between L2s (Sidechains + Rollups) and Meta-Protocols

It may be worth clarifying what the taxonomy of sidechains vs rollups is. Below is a table detailing the differences based on conversations we’ve had over the past few months - feedback welcome.

Trust assumptions of sidechains:

• The anchoring between the BTC base layer and the second-layer solution is mainly managed by the multi-signature centralized management controlled by the core team.

• The status and transaction finality are not verified by the BTC base layer, but by the project team.

Trust Assumptions for ZK Rollups:

• Currently, there is no way to perform zk verification on Bitcoin. The sorter needs to be centralized (similar to ETH L2s), and there is a trust assumption that the decentralized network of validators will correctly verify the transactions checked by the prover.

Rollups are limited in the number of transactions they can process due to the need to transmit data back to Bitcoin.

Trust Assumptions for BitVM (Optimistic Rollup):

The main use of BitVM is to promise a trustless bridge. The high-level step is that the BitVM code can be broken down into logic gates for fraud provers to binary search and find points where the execution is inaccurate.
While anyone can provide a fault proof to seize an operator's collateral (if the operator behaves maliciously), BitVM presents an economic challenge. Operators need to match the amount of liquidity that is collateralized. For example, if I bridge 10BTC through BitVM, the operator of BitVM needs to put up 10BTC as collateral for this single transaction, which is difficult to scale economically.

Trust Assumptions of Meta-Protocols: Indexers

BRC20, RUNE, PIPE, Trac, etc., all need their own indexers to convert the "state" of the account-based model from BTC's native UTXO model or vice versa. Ethereum has internalized indexing because its virtual machine can calculate state, and BTC's indexer is similar to Ethereum's GETH.

To understand the concept of an indexer, imagine all UTXO transactions are like raw Excel data, where there are thousands of addresses transacting with each other. To understand who owns what and the final balance (account state), the indexer acts like a pivot table. They calculate additions and subtractions and determine the final balance by address. Currently, indexers like BestInSlots, GeniiData, and ALEX Labs Oracle provide APIs for developers to directly pull balances or "account states" of meta-protocols such as BRC20.

Discrete Logarithm Contracts (DLCs): Dependence on External Oracles

DLCs in Bitcoin rely on external oracles to determine the outcome of the contract. In a DLC, the role of the oracle is to sign a message indicating the outcome of an event. This signature is then used by the contracting parties to construct and broadcast a transaction that settles the contract on the Bitcoin blockchain. The security and trustworthiness of the DLC relies heavily on the reliability and honesty of the oracle, as its data directly affects the settlement of the contract.

5. Continued skepticism of VCs in the Western Hemisphere: I have had several discussions with other investors about the value of BTC L2s. While we agree that most Bitcoin “L2s” are considered “fake” as they do not necessarily inherit BTC’s security and many will most likely disappear in the coming months, we believe there is still value in this vertical because

Flawed, nascent, and inevitable: the segment of BTC holders who want to put their BTC into a hard wallet and bury it in their backyard has been saturated over the past 10 years. While BTC’s second layer solutions are inferior to its Ethereum counterparts in terms of security and trustlessness, the past year has only been the beginning of scaling and programmability solutions on Bitcoin.

The trend towards Bitcoin becoming more versatile and programmable, in addition to its existing identity as a store of value, has been evident. This trend is evidenced by the public’s enthusiasm for staking, trading, and the exponential growth of Bitcoin’s on-chain fees since 2023 (up to $40 per transaction in December). With the emergence of OP_CAT, various rollups and sidechain solutions, use cases that were previously only the domain of Ethereum and Solana are now being explored on Bitcoin.

Making BTC Capital Efficient: BTC remains one of the most highly valued assets among institutions. More financial instruments built on or derived from Bitcoin are needed. However, limitations in base-layer design make such products difficult to implement. This highlights the need for second-layer programmable solutions.

This trend solves BTC’s existential crisis: More programmability creates demand for Bitcoin block space, which results in more fees as a net new incentive for miners to secure the network. This is especially critical at each halving. This is discussed in more depth in a previous article.

6. Increasingly creative ways to utilize Bitcoin block space

• As a way to burn data in witness and transaction blocks

• As permanent on-chain data storage (this is an excellent product-market fit for luxury/collectibles use cases)

Reviewing the paper from a year ago: How our thinking has evolved or continues

Where we got it right: The overall trends, timing, and demand are related to issuing digital assets on top of Bitcoin (meta-protocols), programmability solutions (second layers, Rollups), and efforts to make BTC more capital efficient (Babylon, Lorenzo).

The jury is still out: The future of BTC may be native vs. xVM. While this is not a consensus view, we maintain that BTC should develop its own native ecosystem rather than adopting the seemingly “convenient” Ethereum Virtual Machine (EVM) approach. While we fully recognize the benefits of the EVM approach (such as interoperability with the existing defi ecosystem, easy onboarding for Solidity developers, and Solidity being the most battle-tested language, etc.), having a BTC second-layer token exist in the ERC-20 format, just as Arbitrum is launching its token as Solana SPL, seems contradictory.

Changes in our stance: In the original article “Panda Renaissance”, two paths were proposed: making BTC more “programmable” like a general-purpose L1, or making it more “capital efficient” to expand its functionality and become a more productive financial asset.

At the time, I leaned toward the latter. BTC’s inherent limitations from the Script language make it unsuitable for complex programmability. However, my view has changed over the past year. The market has shown demand for Bitcoin block space, transforming it from a dormant “digital gold” chain to a programmable, general-purpose chain. Ethereum is now effectively a “sandbox”: the Bitcoin community has learned from Ethereum’s DeFi development over the past 7 years to innovate on Bitcoin.

Ecosystem Chapter 2: Predictions and Blank Areas

1. Each approach will have 1-2 winners. This means there will be 1-2 winners on EVM (such as Botanix), meta-protocols (likely BRC20 or Rune), bridge-less base layer approaches (such as Arch), ZK rollup, and STX (already a pioneer). There will be a total of 5-6 major players in the next cycle, each with a valuation of over $50 billion at its peak.

2. Safety-hedging: Currently, scaling solutions are competing for attention and liquidity access. However, over time, especially after security-related incidents, liquidity will tend to favor the most secure L2/rollup with the least trust assumptions.

3. Most other Layer 2 solutions, sidechains, and rollups will not survive. Until this happens, the best airdrop programs, access to high-signal investors, and connections to Bitcoin whales will continue to be fiercely competitive.

4. Developers will gradually wake up from the BitVM dream, realizing that the trust-minimization needs it provides to builders came too late, too slow, and too costly.

5.BTC DeFi will surpass ETH: I have long believed that Ethereum is a testing ground for BTC. Everything since 2017 has been based on the false belief that “BTC can’t do it”. However, this is no longer the case. If I were to take risk on my tokens (stake, farm, leverage), would I rather earn yield in a lower valued currency or in BTC? I fully expect BTC to have an equally, if not more robust, DeFi and infrastructure ecosystem than Ethereum in the future.

6. A Bitcoin-native “ERC-20” token standard will emerge: Bitcoin needs its own ERC20-like token standard that can operate on different L2s and base layers. One way to achieve this is a partnership between Arch, a bridgeless layer programmability solution, and Auran, a native Bitcoin TSS (Threshold Signature Scheme) based interoperability solution. Such a standard will be the primary solution where the winners eventually emerge in stablecoins, institutional adoption, on-chain yield products, etc.

White Space Verticals We’re Interested In

1. Bridgeless Experience (Use Cases Better for Base Layer): It’s unlikely that full trustlessness will be achieved on any scalable/programmable layer — and frankly, it’s not something most users care about, unless a hack occurs. While keeping trust assumptions constant in most rollups/L2s, there will be a range of low-velocity use cases (like high-value collectibles exchange, lending, native yield, staking, etc.) where users and developers would prefer to achieve the same level of programmability on the base layer (via solutions like Arch Network) without bridging to another L2.

Of course, the tradeoff here is speed, as transactions will be limited by BTC block times. However, not all operations need to be extremely fast on-chain. Bridgeless solutions will unlock new “slow and steady” use case segments on the base layer, like stablecoins, lending, prediction markets, etc.

2. Unify infrastructure by orchestrating state across various L2s (better suited for second-layer use cases): Provide a "one-stop" developer/consumer experience to solve the liquidity and functional fragmentation issues rampant in today's Bitcoin ecosystem. Auran Network is a pioneer in this field and we are excited about it.

"The formula for startup success: find a large and highly fragmented industry with low NPS; vertically integrate solutions to simplify value products" - Keith Rabois, Founders Fund

3. BTC liquidity output to other L1: Many high-profile new/existing other L1s are exploring using BTC's liquidity to promote their own ecosystem growth. Solutions like Zeus Network that create a messaging layer between Solana and BTC may gain attention.

4. Stablecoin winners: There are already more than 10 stablecoin projects. Deep collaboration with mainstream programmability and interoperability solutions will be key to market dominance.

5.OP CAT: OP_CAT (BIP-347) is a Bitcoin Improvement Proposal that aims to simplify and extend Bitcoin's functionality to enable logical loops and conditional statements. It will allow the creation of rules or conditions on how Bitcoin can be spent, opening the door to many development possibilities including second layers, smart contracts, etc. The expected timeline is more than 12 months.

6. Native Ordinals Trading Platform: If history repeats itself, as we have seen on SOL and ETH, most of the trading volume will be dominated by native professional trading platforms like Blur or Tensor. So far, most of the Ordinals trading activity has been on Magic Eden and OKX. As the NFT winter subsides, we expect native Ordinals trading platforms like Ordinal Hive to flourish.

7. BitVM alternatives to enable trustless, or at least minimal L2 <> base layer bridging

8. On-chain BTC-on-BTC yield products for institutions: Given STX's BTC yield and regulatory compliance, it may be a winner.

9. Liquidity staking on Bitcoin: ETH is skeuomorphic, but LST-on-BTC projects such as Lorenzo Protocol have their merits and can optimize the liquidity of BTC Defi