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Bitcoin’s strongest narrative is ‘digital gold’. Investors do not buy it in the hope that it will behave like gold behaves in the market today, but that it will one day assume the historical significance that gold has had across cultures and ages.
My colleague George Kaloudis recently reminded me that there is an important aspect in which bitcoin will never be like gold: in a safe or in the ground, gold will always be gold; Bitcoin, however, is a technology, and a technology will be updated. This quality is now visible with the progress of the Bitcoin network towards an update called Taproot. (Keep an eye out for George’s next in-depth Taproot report at coindesk.com/research.)
Taproot is a set of several improvement proposals. Notably among them, it would increase the efficiency of data that could ease the pressure on the supply side in the Bitcoin transaction fee market. It also includes updates to multi-signature transactions, a Bitcoin feature that is important for custodians and other organizations that directly support bitcoin. In this column, I will focus on the latter.
Multi-signature addresses are a governance tool for organizations that directly hold bitcoins. Taproot includes updates designed to facilitate the use of multi-signatures and to improve their confidentiality: a multi-signature Taproot transaction cannot be distinguished from other Taproot transactions. This can be important for organizations that require multi-signature transactions, but don’t want to advertise to the network that they’re using them.
Bitcoin’s pseudonym has made it a target of criticism that the network can be used for criminal purposes. The pseudonym also ensures the security of legitimate operators. On the Internet, no one knows you are a dog; on Bitcoin, no one knows you are a financial institution. For organizations using the Bitcoin network, privacy reduces the risk of a cyber attack.
Source: txstats.com
This graphic, adapted for the readability of txstats.com, shows how visible current multi-sig users are on the network. It also raises a question: with multi-signature growth at anemic levels, is there really a demand to justify adding these features? (We discussed this question on CoinDesk TV’s “All About Bitcoin” last week.)
Multi-Sig’s shortcomings can be a barrier to adoption, which Taproot could address, opening the door to increased use. This could improve child care services and make forms of direct care investment more attractive. Or, it could be a touted new feature that no one will use. (Remember the Microsoft bundles?)
Most technology investors understand the technology risk inherent in an update. (See Samsung Galaxy Note 7.) There is also the adoption risk of developing a feature that no one is using. Unlike Ethereum, Bitcoin developers prefer backward compatible updates. After implementing Taproot, users will still be able to use pre-Taproot transactions. That would be doomed for Taproot’s multi-signature privacy features: the nickname only works in a crowd.
Improving multi-signatures could also make it easier to develop applications besides Bitcoin, an issue of particular relevance in 2021 as decentralized finance, non-fungible tokens and stablecoins have driven the cryptocurrency bull market. . At the time of this writing, the cumulative returns of ether are about 10 times that of bitcoin.
At this point, it seems likely that Taproot will be adopted by the Bitcoin network, as more miners report their approval. Whether users take advantage of its features will be a telltale test of bitcoin’s adaptability and, by extension, its viability as a scalable technology investment.
On the flip side, a perceived inability to update or adapt can reinforce Bitcoin’s resemblance to gold which, after all, does neither.
Among the events in Bitcoin’s history, the Taproot update is receiving much less attention than, say, Bitcoin’s halving, which happened around the same time last year. In the long run, this may turn out to be more important.
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