Sidechain Observer - Bitcoin L2 Projects & current state of development

[franky1]

I think Sztorc's opinion there is of course directed to those that say that Bitcoin is "outdated" and there will be a "flippening", and in this case I somewhat agree.

value/price/market cap flippening:
alot of people think blockchain currency units are created at no cost and so the market can speculate down to zero or up 'to the moon'.. much is true for PoS coins and other silly meme tokens that are based on nothing but drama. however bitcoin does have major cost of block/coin creation cost. the hashrate/difficulty vs mining cost gives bitcoin units real underlying creation cost value which the markets then speculate above, preventing it from going to complete zero(unless the hashrate/difficulty dropped)

for there to be a flippening where another network takes the top spot, it requires some real underlying cost security, meaning that a currency needs to push itself above the underlying cost of bitcoin or bitcoin loses a substantial amount of hashrate/difficulty to drop its underlying cost

currently ethereums cost of creation dropped by 95% when it changed to PoS and is only being held up speculatively by its conversion to bitcoin where traders on the bitcoin side are manipulating the ethereum price to keep ethereum speculative high compared to its cost value.
in short ethereum has alot more chances of crashing to near zero compared to bitcoin because its only due to bitcoin that ethereum is being held up so high

utility/usage/popularity flippening:
currently no subnetwork has more then ~6000 coin pegged so i dont see any subnetwork taking on the majority of usage/utility away from bitcoin.
as for other mainnets, which pretend to offer more/better/faster features, if you look at their market price movements, most just shadow follow bitcoins movements so there is little independent market sentiment separating other mainnets from bitcoin. they just shadow each other due to the arbitrage opportunities of bitcoin.
if we start to see things like ethereum become more price independent and less shadowing bitcoins whim, then it shows they are developing more independence, but for the moment i cant see a flippening happening where a different mainnet gets popular in utility/usage to go full independent and starts to be the dominant mainnet for crypto.. but with thats said, the future can change things

[d5000]

alot of people think blockchain currency units are created at no cost and so the market can speculate down to zero or up 'to the moon'.

I disagree here. I'll keep it short because it's OT in this thread: for me Bitcoin and all cryptocurrencies work like platforms (i.e. social networks). The mining cost is not very relevant for the value creation, it's usage and above all demand for the blockchain. If you want a "cost" to speculate on, I think the most convincing metric would be the volume of fiat/other assets being converted to Bitcoin without being immediately converted back ("new buy orders created", for example). So I actually don't see a big difference to PoS coins here.

currently no subnetwork has more then ~6000 coin pegged so i dont see any subnetwork taking on the majority of usage/utility away from bitcoin.

Correct.

A short remark here: I guess there will be always an equilibrium between the coins "pegged into subnetworks" and those that "stay at the mainchain". And it will be always better to have several subnetworks, above all if we talk about sidechains.

If a subnetwork becomes too important without its underlying blockchain providing a convincing amount of security, this could lead into this subnetwork becoming an attractive target for attackers wanting to short Bitcoin (attacking the sidechain's consensus). So I guess that if millions of BTC are eventually locked into sidechains, we could see community action caring about no one of them becoming too strong, similar to what's currently occuring with mining pools (no one should come close to 50%).

We could speculate that this could even lead to the situation where already strong mainnets which have still some space for transactions could become attractive for "layer-2" mechanisms. This is for example the reason why I created a thread about the idea "Bitcoin on Litecoin" (until now, I conclude that it's possible but would require a lot of development work for the protocol). tBTC on Ethereum (pegged to wBTC) is another example, but Ethereum doesn't really have the capacity to accomodate all transactions of a full-fledged Bitcoin "subnetwork", i.e. working as Bitcoin sidechain. LTC would be a more convincing choice.

as for other mainnets, which pretend to offer more/better/faster features, if you look at their market price movements, most just shadow follow bitcoins movements so there is little independent market sentiment separating other mainnets from bitcoin.

Yes, that's an interesting point. So actually I think Sztorc is too fearful of altcoins being able to "dethrone" Bitcoin.

If we talk only about "features" of the scripting language, Ethereum should have "dethroned" it already but that didn't happen. The market thus thinks that either 1) Ethereum's features are not that relevant and/or 2) Ethereum has some disadvantages with respect to Bitcoin. I think both things could actually be true. The disadvantages being, apart from Bitcoin's first mover advantage, the large premine, the not-complete censorship resistance (TheDAO rollback) and PoS as an inferior consensus system.

[d5000]

I took a deeper look at the Nomic protocol to describe the incentives governing it here. Nomic is currently functional, but the sidechain functionality is limited to 21 BTC before an audit has been concluded. There is also a fork called OraiDex or OraiChain - they seem to be more active with development, but be cautious like with every new project

The whitepaper is here.


Nomic is to my knowledge the most advanced project which has implemented a dynamic federation. This means: The sidechain is run by a set of validators which also operate a Bitcoin client and vote for every valid peg-in and peg-out. In the case of Nomic, the sidechain is controlled by a proof-of-stake algorithm, i.e. the validators are also probably those with most stake in the utility token. This makes the incentive structure easier than in merged-mined sidechains if we assume that the stakers are interested in their token's value (what Vitalik Buterin called once "altruism-prime"), but of course if this is not the case then the typical potential vulnerabilities of PoS consensus are also present in Nomic.

The Nomic stakers are also signatories of a multisig address called Reserve Wallet on the Bitcoin main chain. They have to pay a collateral which will be slashed if they misbehave. Via Schnorr signatures and MAST trees up to 1000 signatories can be supported in a so called reserve script controlling the coins. This set of signatories is regularly updated, see below.

Nomic signatories have to vote with a 2/3 supermajority for each transaction they carry out. The voting (through the reserve script) occurs in two ways: via a key path using the Musig2 Taproot multisig algorithm containing a "standard" set of signatories, or with a fallback script using a standard multisignature scheme, if one of the signatories in the key path becomes unresponsive.

How does this work in practice?

1. When a Bitcoin user wants to peg-in the coins (i.e. deposit coins on the mainchain to receive sidechainBTC), he transfers the BTC to the Reserve Wallet via a P2TR transaction with an additional OP_RETURN output containing the sidechain address the user wants the sidechain coins to be deposited to, and a timelocked "reclaim" scriptpath for the case the sidechain signatories are unresponsive, then the user can reclaim the funds after a number of blocks (144 are recommended according to the whitepaper).

The sidechain nodes build a deposit proof from the deposit transaction and publish it in the sidechain network. This will later enable the user who deposited Bitcoins create sidechainBTC on the Nomic sidechain.

2. When a sidechain user wants to peg-out, he builds a transaction on the Nomic sidechain burning the sidechainBTC and requesting withdrawal to a Bitcoin address.

3. Periodically, the signatories publish checkpoints on the Bitcoin main chain. This allows to process deposits, pre-process withdrawals and update the signatory set if the set of validators/signatories has changed on Nomic. Checkpoints are made of up to three connected transactions:

- Deposit Collection Transaction: The signatories spend all deposit utxos to a script containing the current sidechain reserve script. This transaction is only carried out if since the last checkpoint deposits have been made.
- Checkpoint Transaction: This transaction is always carried out, even without deposits. It collects the UTXO from the last checkpoint transactions and, if deposits were made, the UTXO from the Deposit Collection Transaction. The coins are spent to the Reserve script, and if withdrawals have been made, then a second UTXO is spent to which will pay out the withdrawals. The main purpose of this transaction is to update the set of signatories (stakers).
- Disbursal Transaction: This transaction pays out pending peg-outs or withdrawals from the second UTXO of the Checkpoint Transaction. It is only carried out if there were withdrawals since the last checkpoint.

In addition an Emergency Disbursal Transaction is signed, which would send the whole reserve to the current sidechainBTC holders. This transaction has a long Locktime. It protects sidechain holders from a "liveness failure", i.e. when the signatories become unresponsive for a long time. At the same time it slashes all collaterals on the sidechain, so the signatories are incentived to always create checkpoints regularly.

As far as I interpret the whitepaper, the Deposit Collection Transaction is still signed by the "old" set of signatories (where the depositors spent to), while from the Checkpoint transaction on, the reserve script contains the "new" set of signatories and these also sign the transaction.

I also interpret that after a deposit, the sidechainBTC will be created only after another checkpoint (more precisely: the Deposit Collection transaction) has occurred, to prevent the depositors to cheat, create sidechainBTC and then spending the coins of the "reclaim" script path (see above).

The peg-out process depends on the behavior of the signatories before the Disbursal Transaction is built. This means that, before voting positively for a withdrawal, the nodes have to check that the withdrawal request corresponds to a legitimate "burn" on the sidechain and that its ancestry is correct (this should of course be validated continuously by the PoS validators).

At a first glance the scheme looks reasonable. It does not protect 100% from a liveness failure but as long as the PoS incentive process works correctly the sidechain should also work as expected. In the case of a liveness failure the coins will be returned and the signatories/stakers will be punished for that failure. This means that the system depends heavily on the Nomic tokens having at least some value to make punishing effective, but again, that is common to PoS systems. Another reason the utility token should be valuable is that otherwise the signatories could be contempted to "pause" their participation in periods with high Bitcoin fees (e.g. around Bitcoin's last halving).

The big con is, of course like in most L2 projects, the premine of the utility token NOM. However, at this moment the NOM token is not traded at any exchange, so it's not the typical pump and dump where the utility token is launched and dumped before the main functionality is added. And of course it's possible to think about a no-premine fork

Nomic also doesn't provide a tail emission for Bitcoin miners via merge-mining, a topic we discussed in several threads which could be a long term solution for Bitcoin's "Year 2140 problem". Possibly the protocol could however be changed in a way to make that possible, for example if the sidechain block "production" is changed to a PoW/PoS model.