Why did we build on Bitcoin + Lightning + Nostr Part 1: The Shortcomings of Bitcoin

At Lnfi Network, we embarked on our journey with a clear vision to leverage the strengths of the Bitcoin ecosystem and the Lightning Network, confronting Bitcoin’s inherent limitations head-on. This 3 part series of articles delves into the strategic thinking behind our decisions, using Bitcoin’s challenges not as stumbling blocks but as catalysts for innovation and development.

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The Shortcomings of Bitcoin

Bitcoin, often celebrated as the cornerstone of the digital currency revolution, has transformed how we perceive and interact with money. Its decentralized nature, coupled with robust security protocols, has laid a solid foundation for trustless financial transactions, empowering users worldwide.

However, even pioneers have their limitations. These obstacles, while highlighting areas for growth, also serve as a testament to Bitcoin’s groundbreaking impact, guiding us toward innovative solutions that bolster its foundational strengths.

#1 Bitcoin’s Halving Challenges: Beyond a Store of Value for Network Security

Every four years, Bitcoin undergoes a “halving” that slashes the rewards miners receive for validating transactions, now at 6.25 BTC per block, with an upcoming halving in April 2024.

Source: BitDegree

This event is fundamental to Bitcoin’s design as it controls the cryptocurrency’s supply, but it could potentially impact security in two significant ways:

Decreasing Miner Participation:

The halving significantly impacts mining profitability, prompting miners to consider shutting down operations when operational costs exceed potential rewards.

Lowering Costs of 51% Attack:

Each halving reduces the costs associated with orchestrating a 51% attack. As the hash rate declines and miner numbers dwindle, it becomes more cost-effective to incentivize miners for such an attack, especially with decreasing rewards. This creates an opportunity for individuals to exploit the situation by taking significant short positions on BTC.

Source: Cipher

To address potential security risks within the Bitcoin network, two key strategies are employed:

Scarcity of BTC

The fixed total supply theoretically escalates the token price due to scarcity. However, the widely acknowledged maximum supply of approximately 21 million BTC is already factored into market dynamics.

As a result, the real-time price of BTC is predominantly influenced by broader macroeconomic factors and sentiments within the cryptocurrency market.

Nevertheless, this mechanism may not be entirely reliable.

Increasing Network Activity and Transaction Fees

It is anticipated that fees generated from heightened network activity and on-chain transactions will gradually offset the reduction in block rewards over time.

With the exception of the hype surrounding the “Ordinal inscription” trend since 2023, this mechanism has not been extensively utilized. However, there is growing anticipation that this will change in the future.

As a result, there’s a big push to make more people want to use Bitcoin’s network, which would raise the fees paid to miners, maintaining the security and sustainability of the Bitcoin network.

#2 BTC exhibits very low capital efficiency today

Bitcoin (BTC) is currently experiencing low capital efficiency, while Wrapped Bitcoin (WBTC) shows only moderate alignment with market needs. WBTC functions as an ERC-20 token on Ethereum, representing BTC with each token backed by BTC reserves held by BitGo in a 1:1 ratio.

Source: DeSpread

Despite its potential, WBTC’s market capitalization stands at around $8 billion (at the point of writing), peaking at approximately $15 billion, representing less than 1% of BTC’s overall market capitalization of $1 trillion.

However, it’s important to note that WBTC’s limited activity may not accurately reflect the broader interest in enhancing BTC’s productivity. Instead, it could highlight the constraints of a centralized approach and a focus on Ethereum Virtual Machine (EVM).

This suggests that the current framework for WBTC, relying on centralization and Ethereum’s ecosystem, may not fully meet market demands for improving BTC’s utility and efficiency.

#3 The Bitcoin blockchain is not inherently designed for programmability

Bitcoin does support scripting with Bitcoin Script, which is a specialized scripting language chosen to bolster network security by minimizing potential attack vectors, including vulnerabilities like Reentrance Attacks. It allows for programmable conditions to be attached to transactions, enhancing the flexibility of the Bitcoin network without compromising its security. While not as feature-rich as Ethereum’s Solidity, Bitcoin Script still offers limited smart contract-like functionality.

This scripting language enables users to define conditions for spending bitcoins in a transaction, such as multi-signature, time locks, or specific cryptographic proofs. It operates within a stack-based model and provides a specific set of operations to validate transactions.

Notable scripts available on Bitcoin include:

  • Pay-to-Public-Key-Hash (P2PKH): A fundamental Bitcoin Script allowing BTC to be sent to an address that only the corresponding private key owner can access.
  • Multi-Signature Scripts: These scripts enable multiple parties to jointly control funds, requiring a specified number of signatures for transaction authorization.
  • Time-Locked BTC Transactions: Transactions that enforce spending BTC only after a predetermined time, utilizing multiple signatures before a specific time and potentially fewer signatures thereafter.
  • Pay-to-Script-Hash (P2SH): This feature enables the creation of addresses requiring a series of instructions for unlocking balances during transactions.
  • Pay-to-Taproot (P2TR): Leveraging the privacy benefits of Taproot, this mechanism offers more adaptable authorization methods for transactions.
  • Partially Signed BTC Transaction (PSBT): A Bitcoin standard streamlining the portability of unsigned transactions, facilitating offline signing and multi-party transactions.
  • Discreet Log Contracts (DLC): A type of Bitcoin transaction leveraging oracles to execute smart contracts off-chain, with the Bitcoin blockchain serving as the final settlement layer.

These smart contract types illustrate Bitcoin’s evolving capabilities and potential for enhancing transaction functionalities while maintaining robust security measures.

However, it is important to note that Bitcoin is not inherently designed for the same level of flexibility and sophistication as other blockchains that prioritize smart contract execution as a core feature.

The Future of Bitcoin Ecosystem

As Bitcoin continues to solidify its position as the leading cryptocurrency, its future holds promise for significant growth and innovation within its ecosystem. Looking ahead, key areas of focus include enhancing programmability and scalability and improving capital efficiency and yields.

These developments are poised to shape the evolution of Bitcoin, paving the way for broader adoption and increased utility in the years to come.

Advancing Programmability and Scalability

The future trajectory of Bitcoin involves evolving towards an ecosystem akin to Ethereum. This transformation aims to overcome Bitcoin’s inherent limitations in smart contract functionality and scalability, particularly in transaction speed and cost efficiency.

Key development areas include:

  • Interoperability with other blockchain networks is facilitated through mechanisms like bridging and integration with the Ethereum Virtual Machine (EVM).
  • Implementation of advanced DeFi (Decentralized Finance) and trading features, including decentralized exchange (DEX) platforms, synthetic assets, and liquidity pool provisioning.
  • Support for emerging token standards such as Ordinals, BRC-20, and future tokenization protocols.
  • Facilitating the issuance of new digital assets on the Bitcoin blockchain using specific tokenization standards.
  • Integration of layer 2 solutions aimed at enhancing scalability, leveraging Bitcoin as a data availability layer. These solutions encompass Virtual Machines (VM), rollups, and other scaling methodologies.

Expanding upon the advancements outlined, Lnfi introduces a novel approach to address the programmability and scalability challenges of Bitcoin by leveraging the Lightning Network and Nostr protocol.

While Lightning Network enhances scalability by enabling off-chain transactions, it does not inherently extend programmability. However, by integrating the Nostr protocol, Lnfi combines Lightning Network’s scalability benefits with the capability to transmit users’ intent to the Nostr protocol.

The Nostr protocol introduces innovative decentralized messaging capabilities, allowing users’ intent to be transmitted and executed by any decentralized applications within the network.

This integration not only extends Bitcoin’s scalability but also unlocks new possibilities for decentralized applications, enhanced user interactions, and improved efficiency in transaction processing, further strengthening Bitcoin’s position in the rapidly evolving landscape of decentralized finance and blockchain technology.

Details will be covered later in this series.

Enhancing Capital Efficiency and Yields of BTC

Currently, BTC primarily serves as a store of value, with users predominantly buying and holding Bitcoin rather than circulating it. This lack of circulation limits its potential for generating economic activity and network effects. Therefore, fostering financialization becomes crucial to broaden Bitcoin’s utility beyond being a mere store of value.

As BTC becomes more integrated into financial systems through the development of financial products and services, its value accrual narrative expands to encompass utility. This strategy emphasizes financialization to facilitate sustainable yields and essential financial instruments while managing associated risks.

Key focus areas include:

  • Trustless BTC Staking and Yields: Introducing mechanisms for staking BTC without reliance on intermediaries, enabling users to earn yields while retaining control over their assets.
  • Native Stablecoin on Bitcoin or BTC-Backed Stablecoin: Establishing a stablecoin directly on the Bitcoin network or a stablecoin collateralized by BTC, enhancing stability and liquidity within the Bitcoin ecosystem.
  • Bitcoin Insurance: Exploring avenues to offer insurance coverage for BTC holdings, either through on-chain or off-chain solutions, to mitigate risks associated with theft, loss, or market volatility.
  • Layer 2 Solutions: Deploying scaling solutions to enhance transaction speed and reduce fees on the Bitcoin network. This may involve leveraging virtual machines, rollups, and utilizing Bitcoin as a data availability layer, among other techniques, to improve network scalability and efficiency.

Embedded within this evolving landscape are a growing number of startups dedicated to addressing these challenges and propelling Bitcoin’s ecosystem forward.

Lnfi aims to increase capital efficiency and yields of BTC by capturing routing fees on the Lightning Network and yields from DeFi applications on Nostr. This strategy is expected to yield higher returns while remaining more native to the Bitcoin mainnet compared to other Layer 2 solutions.

Detailed insights will be provided in subsequent parts of this series.

By leveraging the inherent strengths of Bitcoin and pioneering advancements in areas such as programmability and financialization, Lnfi is poised to play a pivotal role in shaping the trajectory of the Bitcoin ecosystem for years to come.

Stay tuned for the next article, as we share the unique proposition of Lnfi within the Bitcoin Ecosystem. Get ready to broaden your perspective and ignite your imagination!



Lnfi Network (formerly NostrAssets)

A Unified Layer 2.5 to supercharge web3 and tokenization on Lightning Network with Taproot Assets, leveraging: Bitcoin, Lightning Network and Nostr