Bitcoin (BTC 0.56%) was not originally designed to handle complex smart contracts (the backbone of decentralized applications), and this limitation was the impetus for the creation of blockchains like Ethereum. But now this could be changing, as a blockchain known as Stacks (STX -2.32%) has developed a way to provide smart contract functionality on Bitcoin's network.
With Stacks, Bitcoin becomes programmable, and its use cases in decentralized finance (DeFi) increase exponentially. It's a little difficult to put into words, but to be blunt, Stacks is a game changer for Bitcoin, and could be for investors as well.
Image source: Getty Images.
How it all works
Similar to the Layer-2 solutions out there for Ethereum today, Stacks not only provides DeFi capabilities, but also helps reduce the high fees and slow speeds that plague Bitcoin. To accomplish this, Stacks processes transactions on its own blockchain and then adds them back to Bitcoin at a later date by using a unique consensus mechanism called proof of transfer.
Like Bitcoin, this process begins with miners. But Stacks takes things a step further by adding in other participants known as stackers who reside at the end of the mining process.
Let's start with miners. To earn the right to mine on the Stacks blockchain, miners must lock up a predetermined amount of Bitcoin as collateral. When they successfully mine a block, they earn a reward in the form of the STX token.
Then there is the role of the stackers. Stackers pledge their holdings to the network to increase the security and decentralization of the Stacks blockchain. They are incentivized to do so by getting rewarded with the collateralized Bitcoin originating from the miners. After a block is mined, the miner not only receives the Stacks token, but the stackers receive a portion of the Bitcoin collateral.
For those who are familiar with the proof of work and proof of stake consensus mechanisms, you could think of proof of transfer as a hybrid of the two. It can get a little technical, but essentially the symbiotic relationship between miners and stackers creates a profitable and cost-effective blockchain, all while maintaining the highly desirable decentralization and security of Bitcoin.
Why DeFi capability is a game changer
While the proof of transfer method makes Stack attractive in itself, arguably the most compelling reason for investing in the blockchain has to do with the simple fact that it enables DeFi capabilities on Bitcoin. Because of Stacks, a whole new world of possibilities opens up for Bitcoin.
For example, Stacks developers can create decentralized exchanges, lending platforms, non-fungible tokens (NFTs), and stablecoins on top of Bitcoin. All of these have the potential to revolutionize the financial industry, but were previously limited to blockchains such as Ethereum. Today, the DeFi economy is valued at $45 billion -- and thanks to the advent of Stacks, Bitcoin can finally tap into this lucrative industry.
Rising demand creates long-term potential
The recent unveiling of Bitcoin-based NFTs earlier this year makes the use case for Stacks more evident by the day. Known as Ordinals, demand for these Bitcoin NFTs skyrocketed and subsequently caused transaction fees to climb to record highs. So much so that Binance, one of the world's largest crypto exchanges, had to pause Bitcoin withdrawals temporarily.
The reason fees rose is because Ordinals don't use Stacks, and instead utilize a loophole on the main Bitcoin blockchain which enables the creation of NFTs tied to individual satoshis, the smallest denomination of a Bitcoin. While interesting, the better option would have been to use Stacks to create these NFTs. In doing so, fees would have diminished exponentially but would still allow for the transactions to be added to the Bitcoin blockchain. As fees remain high, it's more than likely that alternative solutions such as Stacks will be used.
As more people and developers become aware of Bitcoin's new DeFi capabilities, Stacks could be in a unique position to capitalize on these trends. With Stacks, Bitcoin becomes more than just a store of value, but also a platform for innovation and new use cases, and Stacks could become a true benefactor.
It will likely be a slow process, but for those trying to find the "next big thing" in crypto, look no further than Stacks and how it revolutionizes Bitcoin.
