Bitcoin side projects make pitches to investors. Buyer beware.
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overview
Bitcoin has always struggled with its inability to send more than a dozen transactions per second across the network. During peak periods, transaction fees can rise to over $60. Bitcoin's code is inflexible, making it difficult to directly improve its ability to process transactions. Added to this are Layer 2 solutions like the Lightning Network, which have helped make this possible by transferring the burden of transaction scaling and more versatile transaction options to a multi-layered technology that is dependent on, but still somewhat separate from, Bitcoin. As interest in the ecosystem increases with the success of spot exchange-traded funds (ETFs), investors are starting to think about investment opportunities in the broader Bitcoin economy. However, you should have a keen eye before getting involved.
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Important background
The hype surrounding Bitcoin investments, along with a few other options, mainly has to do with so-called Layer 2 solutions. Layer 2 platforms are complementary networks to a main blockchain like Bitcoin that help relieve congestion. Most popular are collateralized payment solutions like the Lightning Network, which transform Bitcoin from “digital gold” into a better, more private and decentralized version of Venmo. Secondly, there are “builder” solutions that aim to integrate “smart contract”-like functionality into Bitcoin such as Stacks (STX). Finally, there are entire platforms like Liquid that process transactions back and forth between Bitcoin.
The Lightning Network has been around since 2018. It transforms Bitcoin from “digital gold” into a usable currency for microtransactions. Public and private companies are integrating the Lightning Network to benefit from lower routing fees (less than $1). The number of nodes has increased from around 50 to around 16,000 since 2018, with network capacity exceeding 4,500 BTC and $280 million. There are also several merchants, with many hotspots having more than 200 merchants accepting Bitcoin as payment, mostly through Lightning. BitPay connects thousands of merchants with Lightning Network payers – and the number is growing every year.
Liquid Network has pledged around 4,000 BTC as L-BTC. L-BTC itself behaves similarly to a stablecoin pegged to the underlying Liquid Foundation BTC assets. L-BTC itself complements Bitcoin by providing more private and faster transactions – they are more private in that certain amounts are not sent to a public chain. There are decentralized peer-to-peer applications for lending and other Liquid-based utilities, but their volume can be quite small. Examples include Hodl Hodl, a peer-to-peer lending and borrowing solution with loans issued in USDT on Liquid to protect user privacy, and SideSwap, which currently offers a few hundred thousand offers for loans against Bitcoin and Direct Peer offers -to-peer trading and Aqua Wallet, which can seamlessly store Layer-1 Bitcoin as well as Lightning and L-BTC. In terms of direct investment, the value of L-BTC and Bitcoin is always said to correlate approximately 1:1, so Liquid is not intended as a way to invest directly, but rather as a way to build on the capabilities of Bitcoin and enable more private transactions between individuals and exchanges Trade Bitcoin.
There are also a number of companies that have launched Layer 2 and their own associated governance tokens. There are those listed under BRC-20, a standard for creating fungible tokens similar to Ethereum's ERC-20 standard and has around 60 entries. These include projects that bring Turing-complete computation to Bitcoin's security, similar to Ethereum's EVM, and ordinals, similar to NFTs. The vast majority have small market caps of less than $50 million and appear to exclusively trade the stablecoin Tether (USDT) in low volumes. The only possible standout is the original ORDI token that sparked the BRC-20 boom, but even that token fluctuated wildly based on individual tweets – and is ultimately a memecoin.
Outside of BRC-20, there are protocols like Stacks – since December 31, 2019, its token STX has risen from $0.10 to around $3 in March 2024, an all-time return on investment of around 30x. Bitcoin itself has risen about tenfold over the same period. Stacks also offers a return in Bitcoin for staking its token. Major decentralized apps on Stacks include Gamma, which provides a simple platform for trading Bitcoin NFTs, and AlexGo, which offers BRC-20 tokens – a similar standard to ERC-20 that marked the rise (and fall) of promoted ICOs. The plan is to release the Nakamato update and sBTC to peg stacks directly to Bitcoin while offering native yield, DeFI and NFT – in short, bringing Ethereum's capabilities to Bitcoin.
In summary, Stacks has been around since 2017 and there was an SEC-qualified presale involving 4,500 people, including several venture capital firms. Unlike Bitcoin, which had no premium, Stacks had initial distribution. The Nakamato update is about Stacks trying to bind more closely to Bitcoin's Layer 1, but currently there is no guaranteed binding or routing mechanism, but rather a “proof” that all transaction hashes are filed a block on Bitcoin. Despite years of trying, Stacks is still barely integrated into Bitcoin – for now.
Outlook and implications
Bitcoin's Layer 2 networks are still in development, so investors should exercise extreme caution before investing in Stacks, ORDI, or other tokens that are said to benefit from Bitcoin's increasing adoption. At the same time as these price increases, current holdings continue to ossify: users do not want to sell or part with these tokens, which is necessary for the growth of a Bitcoin-centric economy. A recent Forbes investigation even classified Stacks as one of the $20 billion zombie blockchains with insufficient activity to justify their high valuations. Additionally, atomic numbers and BRC-20 tokens on Bitcoin have also experienced implementation issues at times, leading to double spending of user funds and the risk of fraud.
Investors looking to purchase BRC-20 governance tokens should take note of the cautionary tale of the 2017-2018 ICO boom, which raised billions of dollars from gullible investors without any transparency or investor rights.
The risk-reward ratio may not always remain in this position, in fact the new flow of Bitcoin Layer 2s will provide miners with a necessary source of income as the issuance of new Bitcoins declines over the years. A total of over 3,559 BTC was paid out in transaction fees for registrations. This has resulted in significant transaction fees that reward miners for securing the Bitcoin network. There will come a time when there will be no reward for mining a block – in order for Bitcoin mining to continue, there must be transaction fees to support them.
Decision points
There are currently better ways to get additional exposure to Bitcoin than getting involved with these side projects.
1. Investing in public stocks of Bitcoin mining and treasury companies (especially MicroStrategy). Companies like Tesla and Block Inc. hold Bitcoin in their coffers, although Block Inc. also has a division called TBD dedicated to building Bitcoin services. There is at least one publicly traded company providing lightning liquidity (LQWD, albeit a small cap on the Canadian Venture Index).
2. Generating income/loans from self-custody Bitcoins. Loans can be extended from self-custody Bitcoins through solutions such as Unchained and Atomic Finance, which offload Bitcoins on a “hot wallet” and use covered calls to generate non-custodial yields that do not require switching to an L2.
3. Investing in private companies building Bitcoin infrastructure. There are several Bitcoin-based funds such as: B. Ego Death Capital, which is currently raising a $100 million Fund II. Lightning providers such as Breez wallet and ACINQ (which operates the largest Lightning node and wallet, Phoenix) have launched private funding rounds. This may not be an accessible option unless you are an accredited investor with ties to the Bitcoin space and/or part of an institutional fund, but it may be another way to be a big part of Bitcoin's future.
further reading
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