Epoch V: The Dawn of Bitcoin's Transformation into a Layer-2 Ecosystem

Welcome to "Epoch V" of Bitcoin, marked by the recent halving event that reduces the issuance of new BTC. The surge in on-chain activity, including meme coin creation on Runes, has driven up transaction fees, prompting speculation about the increased adoption of layer 2 solutions like the Lightning Network. The halving has also spurred a rise in tokens associated with Bitcoin L2s, raising concerns about the accessibility of these platforms for users with lower BTC balances.

Epoch V: The Dawn of Bitcoin's Transformation

On April 20th, the Bitcoin network underwent its highly anticipated fourth halving, a predetermined reduction in the issuance rate of new bitcoins. This event, while significant in its own right, has also sparked speculation and excitement about the potential ramifications for the Bitcoin ecosystem in the years to come.

The halving has coincided with the emergence of Runes, a novel protocol that has facilitated the creation of numerous meme coins on the Bitcoin blockchain. This surge in token issuance has generated over $80 million in fees for bitcoin miners and contributed to an increase in transaction costs. The average transaction fee on the Bitcoin network has now surpassed $70, a notable rise of over 1,395.8% compared to the 30-day trailing average.

While the sustainability of this elevated activity remains uncertain, some experts anticipate that the period leading up to the next halving in 2028, known as "Epoch V," will witness the widespread adoption of Bitcoin layer 2 solutions. These solutions, such as the Lightning Network, aim to alleviate congestion and reduce transaction costs on the main Bitcoin blockchain.

"Any factor that leads to a spike in fees will likely prompt individuals to seek out alternative options," explained Ava Chow, a Bitcoin Core developer, in an interview with CoinDesk. "Lightning is one such option, along with side chains like Fedimint and Ark and a range of layer 2s. Elevated fee environments will drive people to consider these alternatives."

This sentiment is echoed in a recent Messari report, which emphasizes the necessity of layer-2 solutions for Bitcoin in light of the increasing on-chain activity. According to analyst Nikhil Chaturvedi, "layer-2 solutions for Bitcoin are not just a luxury but a necessity." Bitcoin is evolving from its former perception as "digital gold" into a platform upon which various applications and services can be built.

This shift in perspective was initiated by the introduction of the Ordinals protocol last year, which enabled novel methods of storing data on the smallest units of BTC, known as satoshis. To date, over $3 billion worth of Ordinal "inscriptions" have been traded, with an upward trend in trading activity and an average transaction volume approaching 2 million.

Ordinals, however, is not the sole contributor to rising Bitcoin fees. BitVM, a solution that facilitates off-chain computation, enables the development of Ethereum-like smart contracts on Bitcoin. Babylon is developing a mechanism for staking and earning yield on BTC holdings. Additionally, layer 2 solutions such as Stacks and Merlin are hosting a growing number of decentralized applications (dApps) and meme coins.

Intriguingly, tokens associated with Bitcoin layer 2s have outperformed BTC in the aftermath of the halving. Elastos' (ELA) token has experienced an 11% increase, while SatoshiVM's (SAVM) has ascended by 5%. Stacks' (STX) token has witnessed a remarkable surge of nearly 20%, reaching $2.87, although this may also be attributed to the network's forthcoming Nakamoto upgrade.

While market forces are expected to drive adoption of Bitcoin's secondary layers, this may not always be entirely beneficial. For instance, users with modest bitcoin holdings may be priced out of non-custodial usage of platforms like Lightning, which requires an initial on-chain setup transaction and a subsequent on-chain closing transaction, explained Chow.

"In a high fee environment, it becomes somewhat challenging to initiate using such solutions," Chow added.

However, there are potential workarounds, such as custodial Lightning services that subsidize these costly transactions.

"I am concerned that higher BTC fees will push users toward custodial Lightning services, thereby compromising their sovereignty and anonymity over their BTC holdings," pseudonymous bitcoiner and Lightning critic Sovereign Matt told CoinDesk. "Custodial Lightning services could become the new intermediaries that people are compelled to trust with their savings, as self-custody and conducting transactions on the main Bitcoin blockchain become prohibitively expensive."

To a certain extent, the current landscape is a consequence of the "Blocksize Wars" that transpired years ago, when the Bitcoin community debated how to scale the network. Ultimately, it was decided that instead of increasing the block size, scaling would be achieved through layer 2 solutions. This decision has shaped the current trajectory of Bitcoin development.

"There are essentially two schools of thought regarding increasing the number of transactions per block," said Chow. "One approach is to enlarge the block size, while the other is to reduce the transaction size." Expanding the block size, according to Chow, would be akin to "brute forcing" a solution.

While methods exist for reducing the size and compactness of bitcoin transactions, until such optimizations are implemented, layer 2 solutions are likely to continue to proliferate.