The first Bitcoin upgrade in four years has just been approved by miners around the world. It’s a rare moment of consensus among stakeholders, and crypto experts tell CNBC that it’s a pretty big deal for the world’s most popular cryptocurrency.
The upgrade is called Taproot and is scheduled to take effect in November. If so, it will mean more privacy and efficiency in transactions – and most importantly, it will unlock the potential for smart contracts, a key feature of its blockchain technology that eliminates middlemen in even the most complex transactions.
“Taproot is important because it opens up a variety of opportunities for entrepreneurs interested in expanding the uses of Bitcoin,” said Alyse Killeen, founder and managing partner of Bitcoin-focused venture company Stillmark.
Unlike the 2017 Bitcoin upgrade – dubbed the “last civil war” due to the controversial ideological divide that separates followers – Taproot has near universal support, in part because those changes are fairly incremental improvements to the code.
Bitcoin’s overhaul has to do with digital signatures, which you can think of as the fingerprint a person leaves on every transaction.
At the moment, the cryptocurrency uses the so-called “Elliptic Curve Digital Signature Algorithm”, which is created from the private key that controls a Bitcoin wallet and ensures that Bitcoin can only be issued by the rightful owner. According to Alejandro De La Torre, vice president of the large mining pool Poolin, headquartered in Hong Kong, Taproot will switch to so-called Schnorr signatures, which make transactions with multiple signatures essentially illegible.
In practice, this means more privacy as your keys are not exposed as much on the chain. “You can hide a little better who you are, what is good,” said Brandon Arvanaghi, previously a security engineer at the Gemini crypto exchange.
It does not lead to greater anonymity of your individual Bitcoin address in the public blockchain, but it makes simple transactions indistinguishable from those that are more complex and consist of several signatures.
These pimped up signatures are also a tipping point for smart contracts, which are self-executing agreements that live on the blockchain. Smart contracts can, in theory, be used for virtually any type of transaction, from paying your rental monthly to registering your vehicle.
Taproot makes smart contracts cheaper and smaller in terms of space requirements on the blockchain. Killeen says this improved functionality and efficiency offers “overwhelming potential”.
Currently, smart contracts can be created on both Bitcoin’s core protocol layer and the Lightning Network, a Bitcoin-based payment platform that enables instant transactions. Smart contracts executed in the Lightning Network usually lead to faster and cheaper transactions.
“Lightning transactions can be fractions of a cent … while a Bitcoin transaction can be much more expensive at the core protocol level,” explained Killeen.
Developers have already started building on Lightning in anticipation of the upgrade that will enable very specific contracts.
“The most important thing for Taproot is … smart contracts,” said Fred Thiel, CEO of cryptocurrency mining specialist Marathon Digital Holdings. “It’s already the main driver of innovation in the Ethereum network. Smart contracts essentially give you the ability to really build applications and businesses on top of the blockchain.”
As more and more programmers build smart contracts on top of Bitcoin’s blockchain, there is also the potential for Bitcoin to become more of an actor in the world of DeFi, or decentralized finance, a term used to describe financial applications that exclude the middleman should.
Today, Ethereum dominates as the blockchain of choice for these apps, also known as “Dapps”.
Why the wait
Although the Bitcoin community has agreed to the upgrade, the rollout itself is not expected to take place until November. Doing a lot of testing in advance reduces the chance that something will go wrong during an upgrade.
“Upgrades allow the – extremely remote – possibility of a bug entering the system that destroys trust in the entire cryptocurrency system and effectively obliterates it – a ‘self-inflicted wound’ if you will,” said Jason Deane, analyst at Quantum economy.
Deane says this is why upgrade processes are so carefully tested, retested, and verified over very long periods of time before they are deployed.
Many also remember the disastrous migration of 2013 when a failed upgrade resulted in Bitcoin being temporarily split in half.
“You don’t want different clients or miners to be out of sync in the protocol. That’s how catastrophic things happen, ”Nic Carter, founding partner at Castle Island Ventures, told CNBC. “Because we don’t want a repetition in 2013, we have these extremely long lead times.”