Bitcoin is about to update. Four years ago, Bitcoin went through a kind of civil war over its technological limits. Deep-rooted beliefs about block size, which limits the amount of information that can fit in a block, splitting the Bitcoin (BTC) network into Bitcoin Cash (BCH) and later into Bitcoin SV (BSV). Since then, the original Bitcoin still reigns supreme, and the others have lagged behind in price appreciation to a large extent. Last month, the Bitcoin network reached an overwhelming consensus when 90% of the nodes signaled that they are in favor of a new update scheduled to go live in November, dubbed Taproot.
The Taproot update will do a lot to improve the technology base that bitcoin runs on. Focusing primarily on increasing privacy features, it will also enhance the network’s ability to execute smart contracts, a main feature that has propelled Ethereum to new all-time highs this year as institutional interest in the technology has exploded.
While the average Bitcoin user won’t notice many changes, the various layer 2 and sidechain solutions like the Lightning Network and Liquid will see massive improvements. Currently, these protocols built on top of Bitcoin are distinguished from normal on-chain transactions due to the need to reveal all the complex rule scripts that they execute when interacting with the blockchain. Taproot implements an improved signing method called Schnorr signatures that allows those programs to only reveal the exact rules used for each transaction instead of all. Ultimately, this allows these complex transactions to appear on the chain in the same way as a normal wallet-to-wallet transaction. Not only does this improve privacy by making it difficult to select these complex transactions during chain analysis, it also saves block space and increases the speed of transactions.
These improvements will incentivize developers to build more complex applications on top of Bitcoin, opening up a world of possibilities, notably increasing Bitcoin’s ability to participate in the world of decentralized finance (DeFi), which has become the most widely used use case. advertised from other blockchains such as Ethereum. DeFi enables the average person to cut out the institutional middleman in the world of finance, giving users the ability to lend, borrow, and engage in countless other transactions that typically require a bank or other financial institution to facilitate. In fact, last week Square CEO Jack Dorsey announced that his company is already building a DeFi platform on top of Bitcoin.
For investors, this is an important reminder that Bitcoin is an ever-evolving technology that is still in its early stages. Protocol updates carry a high potential for reward as well as risk. Any change in technology could introduce bugs that could threaten trust across the cryptocurrency sphere. This is why these updates are highly controversial and infrequent, and why developers test, retest, and audit them over and over again before deploying and adopting them.
How the market will respond remains to be seen, as bitcoin’s famous volatility tends to react unpredictably to both good and bad news. What is certain, however, is that Taproot will vastly increase institutional adoption capacity as it increases privacy, speed, and lowers fees for the more complex interactions these participants are likely to engage in.
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