Stacks Explained: Will Stacks L2 Unlock Bitcoin’s Multi-billion Dollar DeFi Economy?

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Stacks (STX), a leading Layer 2 network on Bitcoin (BTC), is garnering investor interest ahead of a key network upgrade dubbed “Nakamoto” that could become a catalyst event in unlocking the multi-billion dollar DeFi potential of Bitcoin.

April 2024 will be a defining month for Stacks, with the network slated to implement the Nakamoto upgrade in the same month as the highly-anticipated Bitcoin halving event.

Why is the upcoming Stacks upgrade important? Will the STX crypto add to its 70% year-to-date gain? 

Stacks: STX One Year Price Chart
Stacks: STX One Year Price Chart (CoinMarketCap)

In this article, we take an in-depth look at the project to answer these questions.

Key Takeaways

  • A key Stacks network upgrade called Nakamoto is scheduled for April 2024.
  • The Nakamoto upgrade will coincide with Bitcoin’s 4th halving event.
  • Nakamoto will increase network security, reduce Maximal Extractable Value (MEV), and enable faster transactions.
  • The upgrade could spur DeFi activity on Bitcoin.

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What is Stacks (STX)?

To fully grasp the importance of the upcoming Nakamoto upgrade, we first need to learn how it functions. 

Stacks is a blockchain layer that brings smart contract functionalities and decentralized applications (dApps) to Bitcoin. It uses the Bitcoin blockchain as a settlement layer and enables the use of BTC beyond peer-to-peer payments and store-of-value.

All Stacks blocks are recorded on Bitcoin, enabling transactions to be publicly visible on the Bitcoin blockchain. Concurrently, smart contracts on Stacks can read the Bitcoin state and can be triggered by Bitcoin transactions. 

Stacks uses a consensus mechanism called proof-of-transfer where miners submit bids in BTC on the Bitcoin blockchain to win the chance to create the next block. The block creator earns block rewards in STX. 

The BTC committed by miners for block building is distributed to a network of STX stakers (called Stackers) for participating in consensus. Stackers are responsible for keeping a check on miners.

They are responsible for approving and validating newly proposed blocks. The responsibility and BTC rewards of Stackers are expected to increase following the introduction of a token called sBTC (More on that later).

Stacks features customizable execution layers called subsets that support smart contracts and virtual machines. Decentralized applications can customize their subnets to their needs and can make tradeoffs between decentralization and performance.

Why is the Stacks Nakamoto Upgrade Significant?

The Nakamoto upgrade is seen as a key upgrade not only for the L2 network but also for the growth of DeFi activity on Bitcoin. Here is why the upcoming Nakamoto upgrade is a key moment for Stacks and the Bitcoin ecosystem:

1. Growth of Bitcoin DeFi

Bitcoin’s lack of programmability has restricted BTC from being used as a store-of-value cryptocurrency. To unlock the value of the world’s most valuable blockchain, L2 networks can bring smart contract programmability to the rigid Bitcoin network, enabling decentralized exchanges, crypto lending, and other DeFi activity.

Although Stacks is the leading L2 on Bitcoin, the network is still nascent and faces issues such as slow transactions, security vulnerabilities, and maximal extractable value (MEV) issues. The Nakamoto upgrade will address these problems creating better end-user and developer experience, which will ultimately accelerate the growth of DeFi on Bitcoin.

American Hedgefund Pantera Capital said in a research note:

“Bitcoin is the most valuable, widely adopted, secure and decentralized cryptocurrency, and thus arguably the best candidate to act as a global settlement layer, and yet there is only a relatively small crypto economy built on it today.  There is enormous value creation potential if even just a fraction of the $850bn+ capital base is deployed as liquidity in decentralized finance applications.” 

2. Precursor to sBTC

Nakamoto upgrade will prepare Stacks for a highly-anticipated feature called sBTC, which the project said will solve a “holy grail” problem for a decentralized BTC pegged token that does not exist in the market today.

sBTC is a decentralized pegged BTC token on the chain that is operated by a fully permissionless, decentralized, dynamic set of crypto-incentivized Stackers. 

An equivalent amount of sBTC tokens will be minted when users send BTC to a peg wallet on the Bitcoin chain. The sBTC token is similar to wrapped Bitcoin (wBTC) on Ethereum, but without centralized actors enabling and managing the peg between the base and mirror tokens.

Applications and end-users will be able to use sBTC for decentralized Bitcoin lending, Bitcoin-backed stablecoins, and other DeFi activity without compromising the security and decentralization promises of Bitcoin.

Hal Press, founder of crypto hedge fund North Rock Digital, said in a research note:

“The sBTC peg can be extended to lock ordinals on L1 and use them on Stacks L2 instead, which would provide a faster, cheaper, and more programmable way to trade ordinals. Additionally, there is room to explore more traditional DeFi applications with sBTC such as lending.”

3. Faster Transactions on Stacks

At the time of writing, the block times of Stacks are as slow as the block times on Bitcoin. A single block is created every ten minutes due to the protocol only allowing one block proposer per Bitcoin block. 

Following the Nakamoto upgrade, a miner will be able to produce many Stacks blocks per Bitcoin block instead of one. According to the Nakamoto upgrade draft, the time taken for a Stacks transaction to be mined within a block will reduce from ten minutes to seconds. 

4. Increased Security by Anchoring to Bitcoin

Nakamoto upgrade will bring the Stacks L2 and Bitcoin L1 ever closer. The upgrade will require miners to add the indexed block hash of the latest block to their bidding transactions submitted on the Bitcoin blockchain (as explained earlier, Stacks miners bid in BTC to win a chance to create the next block).

This process will anchor Stacks’s chain history to Bitcoin, ensuring that Stacks blocks and transactions are protected by 100% of Bitcoin’s mining power. According to the Nakamoto upgrade draft, altering a transaction will be as hard as reversing a Bitcoin transaction following the upgrade.

5. Bitcoin Miner MEV Resistance

Bitcoin miners mine Stacks to increase their mining profits. The Stacks mining process is rather seamless for Bitcoin miners as bids to win the chance to mine blocks are submitted on the Bitcoin blockchain in BTC. 

It was discovered that whenever F2Pool – one of the biggest Bitcoin mining pools in the world – created Bitcoin blocks, F2Pool would censor rival Stacks block-building bids and only include their bid in their Bitcoin block. 

Stacks research scientist jude.btc said on the Stacks forums:

“F2Pool simply ignores other Stacks miners’ block-commit transactions when creating a Bitcoin block, thereby ensuring that their Stacks miners’ block-commit is the only block-commit in that Bitcoin block. Moreover, F2Pool’s Stacks miner only mines in F2Pool-produced blocks.”

F2Pool would extract maximum value from their Bitcoin block by creating Stacks blocks and earning the STX block rewards off it. Nakamoto upgrade will add conditions to the Stacks protocol that will prevent such censorship.

STX Tokenomics

STX is the native token of Stacks. It is used to pay gas fees, for paying block rewards, and for providing added crypto-economic security to the network via stacking. In this section, we talk about the STX tokenomics and relevant market information:

  • STX was the 29th largest cryptocurrency with a market cap of $3.78 billion, as of 23 February 2024
  • The token’s total circulating supply stood at 1.443 trillion, which was about 80% of its max supply of 1.818 trillion
  • STX’s all-time high stood at $3.61, hit on 16 November 2021.
  • STX has gained 73% year-to-date, as of 23 February 2024
  • Total value locked (TVL) in Stacks hit an all-time high of $71.2 million in mid-February 2024.
  • The reason for STX price rise and Stacks TVL record-high was the launch of STX20 protocol, the growth of decentralized exchanges, and the introduction of liquid stacking protocols.

The Bottom Line

Stacks and other Bitcoin L2s are key to the evolution of Bitcoin into a vibrant and secure DeFi ecosystem. But first, the network has to successfully implement the upcoming Nakamoto upgrade which will enable higher network throughput, lower fees, and improved security. 

FAQs

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Mensholong Lepcha
Crypto & Blockchain Writer
Mensholong Lepcha
Crypto & Blockchain Writer

Mensholong is an experienced crypto and blockchain journalist, now a full-time writer at Techopedia. He has previously contributed news coverage and in-depth market analysis to Capital.com, StockTwits, XBO, and other publications. He started his writing career at Reuters in 2017, covering global equity markets. In his free time, Mensholong loves watching football, finding new music, and buying BTC and ETH for his crypto portfolio.