The latest Bitcoin update was the Segregated Witness (SegWit) soft fork update in 2017. This eventually ended in a split in the Bitcoin community and to an undesirable hard fork that created Bitcoin Cash.
In November 2021 Bitcoin will undergo a significant soft fork upgrade. In contrast to the SegWit update, this update has the full support of the Bitcoin community and the risk of an unexpected hard fork like the one in 2017 is negligible.
This upgrade, Taproot, can finally give Bitcoin the power to launch itself into the world of smart contracts. In my opinion, there is even a chance that Bitcoin will be able to compete with other blockchains that offer smart contracts of which Ethereum is the biggest. Especially in relation to DeFi. The number one question that comes with this upgrade: “is this upgrade already accounted
for in the current price?”. This post will give some more insight into the Taproot soft fork upgrade and the improved functionalities it offers. Hopefully, this will explain why it might be attractive to develop DApps for smart contracts on Bitcoin after the upgrade and why it isn’t interesting right now without the Taproot upgrade.
The taproot can be split into three Bitcoin Improvement Proposals (BIPs) and I will explain all three of them in more detail.
BIP340 Schnorr
Currently, Bitcoin uses the Elliptic Curve Digital Signature Algorithm (ECDSA) as cryptographic code. ECDSA has been used since the beginning of Bitcoin but is not seen as completely fire-proof. Though there have not been any attacks that have successfully cracked ECDSA, formal security proof is still not discovered. Additionally, ECDSA can’t be compressed which means that it can’t aggregate multiple signatures into one signature.
With the Schnorr upgrade, Bitcoin will introduce the “Schnorr signatures” scheme. Schnorr uses a mathematical structure as the basis for its digital signature system. This feature effectively reduces the network’s data load, improving privacy and allowing for a faster transaction verification process. In contrast to ECDSA, Schnorr signatures are provably secure because they include easily verifiable security proof. Schnorr’s key aggregation feature also combines all the public keys involved in a multisig transaction. This requires participants to perform signature aggregation to produce a single signature for its aggregated key. This technique eliminates the requirement that more than two users are involved in the transaction and reduces the size of the transaction from a larger multisig transaction to a smaller single-sig transaction. This is important in order to be able to handle smart contracts in an efficient way. Schnorr also enables bip-taproot which means that bip-taproot is useless without Schnorr.
Shortly summarized, Schnorr signatures are less complicated, quicker, and are provably secure. All big advantages/improvements over the current ECDSA application.
Fun fact: Schnorr signatures is not a recent innovation in cryptography. Claus-Peter Schnorr invented Schnorr in the 1980s. Now the question is of course why Schnorr was not used during the launch of Bitcoin if it outclassed ECDSA. The reason for this is that the Schnorr patent expired in 2008, the same year that Satoshi Nakamoto invented Bitcoin. Because the cryptographic signature scheme was patented for 20 years, most innovation revolved around the open-source ECDSA scheme. Schnorr signatures were only shortly released when the patent stopped and this meant that there was a lack of utilization, standardization, and testing in software at that time in order to secure a global monetary system like Blockchain. This is the reason why Satoshi chose ECDSA over Schnorr: it was patent-free, it was standardized and it was an open-source encryption tool.
BIP341 Taproot
This adds “Taproot” to Bitcoin. Taproot is a privacy solution that utilizes Schnorr signatures to enable Merklized Alternate Script Trees (MAST). MAST uses Merkle trees (data structures used for data verification and synchronization) to make smart contracts much more efficient and private by only revealing the condition of the contract that was met without giving up any details inside the contract. In the old situation, all conditions were revealed during verification and synchronization. You can compare this for instance when you have to show your ID to verify your age when you want to buy alcohol at a supermarket. Imagine that by showing your ID you also show your complete personal file with your home address, blood group, license number, marital status, and shoe size, to the person at the counter that only wants to verify your age. All other information is completely irrelevant. Before Taproot it worked like that with contracts which is pretty ridiculous in my opinion. This was another reason why it was not interesting to develop DApps for smart contracts on Bitcoin. With the MAST implementation, the problem where all spending conditions are revealed during a transaction will be solved. You won’t be able to see it anymore.
Bip Taproot also introduces a new script type known as Pay-to-Taproot (P2TR). This allows outputs to be spent using a single Schnorr signature to satisfy the keypath spending condition or by revealing and satisfying one of the scripts from the Merkle tree. This means that DApp developers can write more complex scripts for fewer fees because they can be compressed into a single hash because of MAST.
BIP342 Tapscript
Tapscript is an upgraded scripting language that complements the Schnorr and Taproot upgrades by improving signature hashing to validate Taproot scripts. It introduces more flexibility by enhancing Bitcoin’s smart contract capability. It also changes some limits for resource requirements, including the removal of the 10K byte size limit that currently exists in legacy scripts. Additionally, Tapscript provides “tagged public keys”. This is a forward-compatibility mechanism and it makes it easy for future soft forks to extend the signature-checking opcodes (the portion of a machine language instruction that specifies the operation to be performed) with new sighash types or other changes. This reduces the risk that a developed DApp becomes unusable with a new soft fork upgrade in the future.
Compared to Schnorr and Taproot, it might seem that Tapscript is not really worth mentioning. However, it is a key piece of the puzzle. Verification of signatures is the most computationally intensive operation in a script. The reason for this is that signatures are all verified individually. Allowing signature batch verification, Bitcoin will realize a big efficiency boost, complemented by Schnorr and Taproot.
A brief summary
The Taproot soft fork upgrade will allow multi-signature (multisig) transactions and complex smart contracts to be indistinguishable from standard transactions. This is done with key aggregation: a smart contract is completed at address creation time and not at signing time or post-signing time. Because of this, even the most complex smart contracts will be virtually identical to the regular transactions on the blockchain. This means that Taproot’s signature aggregation technique can improve the privacy of the Lightning Network (LN), an application that is built upon Bitcoin to improve scalability by making LN-related transactions look like single-signature transactions instead of multiple signature transactions. Because of Taproot, opening and closing channels will look like standard single-signature bitcoin transactions. This is done by packaging signatures. Because of this, the details of multi-signature transactions can remain private and users will pay lower transaction fees. This means that after Taproot, Bitcoin Lightning Networks should become more intuitive and cost-effective for users, using less energy as well. This means that with taproot, transaction costs will be reduced and this will lead to far more transactions.
For DApp developers this update might be very interesting. Taproot permits more complicated multisig contracts and opens up the possibility of Bitcoin-based Decentralized Autonomous Organization (DAOs) and other Decentralized Finance (DeFi) applications.
Users who want to verify Taproot transactions have until November 16th, 2021 to update their node software to Bitcoin Core v0.21.1. This is the newest version of Bitcoin Core and it contains activation logic for the Taproot soft fork.
Final thoughts
So now, it’s up to you to try to answer the question many crypto investors ask themselves. How big will the impact of the Taproot upgrade be? Personally, I think the Taproot upgrade won’t have a significant value impact when it launches. Of course, this depends on the value of bitcoin at the launching date. If crypto is in a bear market and bitcoin has an attractive price at the time of launch, it might bring a spark to bitcoin. I don’t want to sound negative but the spark can be short-lived as well. In the case of a bull market in combination with a higher price, I don’t expect an increase.
Once DApps for smart contracts (and in particular DeFi) are becoming available for Bitcoin, the state of uncertainty might change. I suggest keeping a very close eye on the smart contract developers instead of looking at the bitcoin value graph on the stock exchange. Personally, I will look to the long term and not to the short term.
If DApps are coming to Bitcoin in the future it might be the beginning of something beautiful. A price increase is almost certain when there is a successful adaption/acceptance of Bitcoin by DApp developers. This would also mean extra competition for smart contract blockchains like Ethereum because of the big support that Bitcoin has. Imagine a world where the correlation between Bitcoin and Ethereum is being reduced because of internal competition. This would make it possible to have a more defensive portfolio because of less correlation between cryptocurrencies.
On the other hand, it can also be a bust if there is no interest from DApp developers. My opinion is that there will be interest because Bitcoin is the biggest blockchain there is. If I was a DApp developer I would at least research the opportunity to separate myself from my competitors to offer smart contract applications on the Bitcoin blockchain.
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