Bitcoin Layer 2 Wars: Lightning, Liquid, and Stacks

Introduction

Bitcoin was designed as a secure, decentralized ledger for peer-to-peer value transfer. Its conservative approach to scalability and limited scripting language make it exceptionally secure, but also restrict throughput and programmability. To overcome these limits without changing Bitcoin’s base protocol, developers have built a growing ecosystem of Layer 2 (L2) solutions - protocols that extend Bitcoin’s functionality while inheriting its security.

This first part of the Bitcoin L2 series provides a technical and economic overview of Lightning, Liquid, and Stacks - three of the most established Bitcoin extensions. We will cover their underlying technologies, use cases, security models, protocol dependencies, tokenomics, and associated risks.

1. The Lightning Network

Technology and architecture
The Lightning Network is an off-chain payment network built on Bitcoin’s existing scripting capabilities. It uses hashed timelock contracts (HTLCs) to establish payment channels between participants. Two parties lock BTC into a 2-of-2 multi-signature address on Bitcoin (the funding transaction). Once the channel is open, they exchange signed but unbroadcasted commitment transactions reflecting updated balances. Only when the channel is closed are transactions settled on-chain.

This design enables instant, high-frequency payments and routes multi-hop transactions through a network of channels without requiring global consensus.

Security model
Lightning’s security is enforced directly by Bitcoin’s Layer 1 through the HTLC mechanism. Each participant can unilaterally close a channel and broadcast the latest valid state to the Bitcoin blockchain. Timelocks and revocation keys ensure that dishonest participants attempting to broadcast outdated states are penalized. The security assumption is that users remain online or employ watchtowers to monitor the Bitcoin chain for fraud attempts. When a channel counterparty tries to cheat by publishing an outdated commitment transaction, the honest user (or their watchtower) must detect this within the timelock window and broadcast the revocation transaction to claim the cheater’s funds as penalty. If the user is offline beyond the timelock period, the dishonest counterparty could succeed in stealing funds. To mitigate this, users can outsource monitoring to third-party watchtowers, which store encrypted channel states and act automatically, ensuring the Lightning Network remains secure even when users are not continuously online.

Lightning relies on several Bitcoin protocol upgrades - some introduced specifically to enable it. Segregated Witness (SegWit, 2017) removed transaction malleability, making payment channels reliable. CheckSequenceVerify (BIP-68) added timelock functionality for secure channel operations, and Taproot (2021) improved privacy and efficiency for multi-signature scripts used in Lightning channels.

Tokenomics and economics
There is no native Lightning token. Users transact directly in BTC, and node operators can earn small routing fees for relaying payments. The network’s economic incentives are minimal, as profit margins depend on channel liquidity and usage volume rather than inflationary rewards.

Downsides and risks

  • Requires users to be online or rely on watchtowers.

  • Liquidity and routing constraints limit scalability for large or complex payments.

  • Lightning supports payments only, not general-purpose smart contracts or DeFi.

2. The Liquid Network

Technology and architecture
Liquid is a federated sidechain developed by Blockstream to enable faster, confidential Bitcoin transactions and token issuance. BTC is moved into the network via a federated peg-in: users send BTC to a multi-signature address controlled by a federation of functionaries (currently 15-of-65). An equivalent amount of L-BTC is issued on the Liquid blockchain, which runs a modified version of Bitcoin’s consensus called Strong Federations.

Liquid blocks are produced every minute. In addition to L-BTC, users and institutions can issue Liquid Assets such as stablecoins or tokenized securities.

Security model
Security rests on the federation. Functionaries use Hardware Security Modules (HSMs) to store signing keys and collectively validate transactions. The network uses Confidential Transactions (CT) and Confidential Assets (CA) to hide transaction amounts and asset types, enhancing privacy. However, there is no mining or PoW; trust is distributed among the federation members, which are primarily large exchanges and financial entities.

Liquid leverages the pegging model enabled by Bitcoin’s multisig capabilities and SegWit for efficiency.

Tokenomics and economics
Liquid has no native token or inflationary rewards. Functionaries may collect small service fees for peg-outs or asset issuance but otherwise operate without block rewards. Economic value comes from faster settlement and privacy benefits for high-volume traders and exchanges.

Downsides and risks

  • Federation trust requirement; if a quorum colludes or is compromised, custody risk exists.

  • Limited programmability and ecosystem; primarily a settlement layer for exchanges.

  • No native yield opportunities; value accrues through operational efficiency rather than protocol incentives.

3. The Stacks Network

Technology and architecture
Stacks introduces smart contracts and decentralized applications to Bitcoin through a unique consensus mechanism called Proof-of-Transfer (PoX). Instead of mining with hash power, Stacks miners transfer actual BTC on Bitcoin’s base layer to compete for the right to produce Stacks blocks. The chain runs its own programming language, Clarity, which is interpreted rather than compiled, making contract execution predictable.

Stacks anchors its block hashes and state commitments directly to Bitcoin through PoX. After the Nakamoto upgrade (activated April 2024), each Stacks block is permanently linked to a Bitcoin block, giving it Bitcoin-level finality once confirmed.

Security model
Security is inherited from Bitcoin anchoring. Reversing a Stacks block would require reorganizing Bitcoin itself. The PoX system distributes BTC from miners to Stackers (STX holders who lock tokens and validate consensus). This creates economic alignment between BTC spenders and STX stakers.

Tokenomics and economics

  • STX is the native token, used for gas, governance, and staking.

  • Miners spend BTC to earn newly minted STX and transaction fees.

  • Stackers lock STX to secure the network and earn the BTC spent by miners as yield.
    This two-asset flow links Bitcoin liquidity with Stacks incentives.

Downsides and risks

  • Miner economics are fragile; spending BTC to compete for STX rewards is only sustainable if STX/BTC prices remain favorable.

  • The number of active miners remains small, raising centralization concerns.

  • Clarity contracts are not EVM-compatible, limiting developer adoption and ecosystem migration.

Conclusion

Bitcoin’s conservative base layer has inspired diverse approaches to scaling and programmability. Lightning leverages Bitcoin’s existing scripts for real-time payments, Liquid extends custody and settlement efficiency through federation, and Stacks builds a parallel smart-contract environment tied to Bitcoin’s finality. Each solution reflects a trade-off between decentralization, functionality, and trust assumptions.

Lightning preserves full trustlessness but remains limited to payments. Liquid offers privacy and speed but requires federation trust. Stacks achieves programmability but introduces new economic complexity and limited compatibility with existing smart-contract ecosystems.

Future Bitcoin L2s such as Hemi and Babylon seek to combine the best of these worlds - Bitcoin anchoring with broader programmability - but they build on the technical foundations and lessons established by Lightning, Liquid, and Stacks.

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