Bitcoin’s strongest narrative is “digital gold”. Investors do not buy it out of the expectation that it will behave as gold does in the market today, but that one day it will take on the historical significance that gold has had across cultures and ages.
My colleague George Kaloudis recently reminded me that there is one important aspect where Bitcoin will never be like gold: in a vault or in the ground, gold will always be gold; However, Bitcoin is a technology and a technology is being updated. This quality is now becoming apparent as the Bitcoin network progresses towards an update called Taproot. (Look out for George’s upcoming in-depth report on Taproot at coindesk.com/research.)
Taproot is a bundle of several suggestions for improvement. Notable among them would be that it would increase data efficiency, which could ease supply-side pressures in Bitcoin’s transaction fee market. It also includes updates to multi-signature transactions, a bitcoin feature that is important to custodians and other organizations that hold bitcoin directly. In this column, I will focus on the latter.
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Multi-signature addresses are a governance tool for organizations that hold Bitcoin directly. Taproot contains updates that simplify the use of Multi-Signs and improve their data protection: A Taproot transaction with multiple signatures cannot be distinguished from other Taproot transactions. This can be important for organizations that need multi-signature transactions but do not want to let the network know that they are using them.
Bitcoin’s pseudonymity has made it the target of criticism that the network can be misused for criminal purposes. Pseudonymity also provides security for legitimate operators. Nobody on the internet knows you are a dog; with bitcoin, nobody knows you are a financial institution. For companies using the Bitcoin network, data protection reduces the likelihood of cyberattacks.
The story goes on
This diagram, customized for txstats.com for readability, shows how visible current multi-sig users are to the network. It also begs a question: in multi-sig growth at the anemic level, is there really a need to add these traits? (We discussed this question last week on CoinDesk TV’s All About Bitcoin show.)
Multi-sig’s shortcomings can be a barrier to adoption that Taproot could address and open the door to increased use. This could improve custodian banking services and make direct custody forms more attractive. Or, this could be a much touted new feature that no one will be using. (Do you remember Microsoft sets?)
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Most technology investors understand the technology risk inherent in an update. (See Samsung Galaxy Note 7.) There is also the risk of developing a feature that nobody uses. In contrast to Ethereum, Bitcoin developers prefer backward compatible updates. After implementing Taproot, users can still use transactions before Taproot. This would be self-destructive to Taproot’s multi-sig privacy features: pseudonymity only works in a crowd.
Improving multi-sigs could also make it easier to develop applications in addition to Bitcoin, a particularly relevant topic in 2021 as decentralized finance, non-fungible tokens, and stablecoins have fueled the cryptocurrency bull market. As of this writing, Ether’s year-to-date returns are roughly 10x higher than Bitcoin’s.
At this point, it seems likely that Taproot will be waived by the Bitcoin network as more and more miners signal approval. Whether or not users are utilizing its features will be an insightful test of Bitcoin’s adaptability and, by extension, its viability as an upgradeable technology investment.
On the flip side, a perceived inability to update or customize can heighten Bitcoin’s similarity to gold – which it ultimately doesn’t.
Among the events in Bitcoin’s history, the Taproot update gets far less attention than, for example, the Bitcoin halving that happened around this time last year. In the long run, it can prove to be more meaningful.