Taproot Assets: The Next Growth Point for Stablecoins Market Beyond a Trillion-Dollar

15 min readAug 21, 2024

Written by: Evan & Haozhe, Waterdrip Capital; Peter & Boris, BitTap

Introduction

The essence of blockchain is an extension of payment use case. In terms of that, stablecoins not only hold a crucial role in the cryptocurrency market but are also playing an increasingly important role in global payments, cross-border settlements, and other areas. Currently, the centralized stablecoin market still holds over 90% of the market share. Among them, USDT, issued by Tether, dominates the stablecoin sector. Although more than $150 billion worth of stablecoins have been issued, this only represents 0.75% of the M1 money supply, which the Federal Reserve estimated to be $20 trillion in 2024 (including all circulating cash, traveler’s checks, funds in checking accounts, etc.). The application of stablecoins in payments still faces significant challenges ahead. The introduction of the Taproot Assets protocol suggests that stablecoins have a vast potential for use in high-frequency, small-scale payment use cases, and it also indicates that large-scale adoption of stablecoins as a regular means of payment could become a reality.

1. Stablecoins: The Next Trillion-Dollar Market of the Future

The flourishing growth of the stablecoin market signals its potential to become a trillion-dollar market in the future financial landscape. Currently, the market capitalization of stablecoins has exceeded $160 billion, with daily trading volumes surpassing $100 billion. Mainstream countries are rolling out policies and regulations related to stablecoins, and various institutions predict that stablecoins will herald in a new trillion-dollar market, with the main growth coming from their widespread use in global payments.

Stablecoins can be categorized into two major types: centralized stablecoins and decentralized stablecoins. Decentralized stablecoins can be further subdivided into algorithmic stablecoins, crypto-collateralized stablecoins, and hybrids of both. At present, centralized stablecoins hold a dominant position in the market. The two giants, USDT and USDC — issued by Tether and Circle — have respectively issued $114.46 billion and $34.15 billion worth of dollar-pegged stablecoins. Tether, with a company size of just 125 employees, generates an annual gross profit of $4.5 billion. Such a lucrative opportunity has naturally attracted many large institutions to enter the market:

· BlackRock has issued a tokenized fund, BUILD, on Ethereum, which aims to provide stable value and generate returns, becoming a large, tokenized fund with a market value of $384 million.

· On July 24, according to reports by the Financial Associated Press, JD Chain Technology (Hong Kong) will issue a stablecoin in Hong Kong pegged 1:1 to the Hong Kong dollar.

Centralized stablecoins have already achieved widespread adoption within the crypto ecosystem, with daily trading and settlement on DEXs (Decentralized Exchanges) or CEXs (Centralized Exchanges) typically conducted through centralized stablecoins. On the other hand, the collateral assets behind decentralized stablecoins are mostly crypto assets, often used for lending.

Although stablecoins have played a crucial role in cryptocurrency trading and DeFi (Decentralized Finance), their integration with real-world commerce is still in its infancy. In the long run, the most promising application scenario for stablecoins lies in the payments sector, especially in cross-border payments. Currently, cross-border payments involve multiple intermediaries, including issuing banks, payment gateways, and payment processors, which complicates the process, making it costly and time-consuming. Stablecoins present not just a better alternative but also an important channel for economic participation. As stablecoin regulations gradually move towards compliance, their importance in global payment use cases will only increase. Moreover, with the large-scale adoption of stablecoins in payment use cases, the integration with DeFi could give rise to Pay Fi, achieving interoperability, programmability, and composability in payment use cases, thereby creating a new financial paradigm and product experience that traditional finance cannot achieve.

2. Taproot Assets Protocol + Lightning Network: The Promising Infrastructure for a Global Payment Network

Currently, stablecoins mainly circulate on the ETH and TRON blockchain networks, but their transaction fees often exceed $1, and on-chain transfer times are longer than one minute. In contrast, the Lightning Network offers advantages of faster, lower-cost, and more scalable transactions.

2.1 What is the Lightning Network?

The Lightning Network is the first relatively mature Layer 2 scaling solution for the Bitcoin network. After the release of the Lightning Network whitepaper, multiple teams independently began developing the Lightning Network, including Lightning Labs, Blockstream, and ACINQ. Taproot Assets is an asset issuance protocol developed by Lightning Labs.

How does it work? First, the two parties establish a bidirectional payment “state channel”. The two parties, A and B, create a 2 of 2 multi-signature address on the blockchain, allowing both A and B to transfer or receive Bitcoin within the limits from this new address. Before transferring, the parties exchange some locked data and record the transactions, enabling multiple payments back and forth. Once the transaction records are finalized, the parties settle, and the Bitcoins in the new address are distributed according to the settlement amounts. Therefore, only the latest version is valid, which is enforced by Hash Time-Locked Contracts (HTLCs). Either party can close the channel by broadcasting the latest version to the blockchain at any time, without the need for trust or custody.

This allows the parties to conduct unlimited off-chain transactions, using the Bitcoin blockchain as an arbitrator. The smart contract only intervenes and executes on the blockchain when the final transaction is completed or if there is an error (such as one party having insufficient funds in their wallet). This is akin to A and B signing multiple legal contracts but only going to court when the final contract is confirmed or when there is a dispute.

2.2 The Lightning Network as the Best Infrastructure for Global Stablecoin Payments

This means that users can send unlimited transactions off-chain to each other without congesting the Bitcoin network, while still relying on the security of the Bitcoin network. Theoretically, the scalability of the Lightning Network has no upper limit.

As of the present, the Lightning Network has been in operation for 9 years and is built on the most secure network in the crypto ecosystem — the Bitcoin network, which has over 57,000 nodes and uses the Proof of Work (PoW) mechanism, ensuring maximum security for the Lightning Network.

Source: https://mempool.space/zh/lightning

As of now, the Lightning Network has a capacity exceeding 5,000 Bitcoins, with over 18,000 nodes and 50,000 channels worldwide. By establishing bidirectional payment channels, it enables instant and low-cost transactions. The Lightning Network is being integrated and used by numerous payment providers and merchants globally, gradually becoming the most widely accepted decentralized solution for global payments.

2.3 The Taproot Assets Protocol bridges the last mile for the Lightning Network

The limitation before the introduction of the Taproot Assets protocol was that the Lightning Network only supported Bitcoin as the currency for payments, which significantly restricted its application scenarios. As Bitcoin has become digital gold, most people are reluctant to spend their Bitcoin.

Although there were already some assets issuance protocols on the Bitcoin Layer 1, such as Atomical and BRC20 based on Ordinals, none of them supported direct integration with the Lightning Network. The introduction of the Taproot Assets protocol perfectly addresses this issue. Developed primarily by Lightning Labs, Taproot Assets is an asset issuance protocol based on the Bitcoin network. Similar to the Ordinals protocol, anyone or any institution can use the Taproot Assets protocol to issue their own tokens, and it also supports the issuance of stablecoins pegged to fiat currencies like USD, AUD, CAD, and HKD.

The key advantage of the Taproot Assets protocol over other asset protocols is that its assets are fully compatible with the Lightning Network, making it possible to use stablecoins for payments on the Lightning Network. This means that in the future, a large number of new assets issued on the Bitcoin network (especially stablecoins) will circulate on the Lightning Network, thereby enhancing the network’s global payment infrastructure and influence.

Relying on Bitcoin’s security and decentralization, Lightning Labs’ vision of “Bitcoinizing the US dollar and global financial assets” is becoming a reality. The launch of the Taproot Assets mainnet protocol signifies the official beginning of the trillion-dollar payment use case for stablecoins.

3. Detailed Explanation of the Taproot Assets Protocol (TA Protocol)

The operational principles of the TA protocol are deeply rooted in Bitcoin’s UTXO model and are implemented based on the Bitcoin network’s Taproot upgrade. These two elements serve as the core drivers of the TA protocol’s effective functioning.

3.1 Similarities and Differences Between the UTXO Model and the Account Model, Along with Their Pros and Cons

UTXO (Unspent Transaction Output) is a crucial concept that underpins the implementation of all Bitcoin Layer 2 solutions and protocols like Ordi and Runes. In fact, most public blockchains, such as Ethereum and Solana, adopt the Account model. Below is an explanation and comparison of these two concepts:

Comparison between Account Model with UTXO Model

The Account model is easy to understand; it works just like our Alipay account. Each income and expenditure corresponds to a change in the numbers on the account interface, which is directly intuitive to the user.

The UTXO model can be understood as a wallet belonging to an individual, “A.” Inside this wallet, there are checks authorized by B, C, and D that A can redeem, as well as checks that A has authorized for E, F, and G to redeem. At any given time, the balance of A’s wallet equals the sum of the face values of the checks given to A by B, C, and D minus the face values of the checks A gave to E, F, and G. The Bitcoin network functions like a bank that can redeem these checks, calculating the latest balance of each user’s address by tracking the most recent transactions of these checks.

Due to the unique nature of the UTXO model, it inherently eliminates the double-spending problem, offering higher security compared to the account-based model. Additionally, the TA protocol fully inherits the security features of the Bitcoin network layer, avoiding the risks of erroneous or missed transfers.

Furthermore, the TA protocol adopts the concept of “Single-use Seals”, meaning that once a UTXO is confirmed as spent, it cannot be reused. This ensures that assets move with the UTXO. Under this mechanism, the miner who mines the longest chain has the final say over the interpretation of the UTXO and can control its use. Unlike BRC20, which relies on off-chain indexing to identify assets, the TA protocol enhances transaction security by preventing double-spending attacks and eliminates the risk of errors or malicious actions that could arise from centralized institutions. These features make the TA protocol combined with the Lightning Network a reliable infrastructure for payment use cases.

3.2 Taproot Upgrade: Enabling More Complex Functions

The Taproot protocol upgrade in 2021 introduced basic smart contract functionality to the Bitcoin network. For example, wallet addresses in the P2TR format can use Bitscript to implement more complex logic, making new and complex transaction types possible on the blockchain. A schematic of the Taproot upgrade is shown in the figure below:

Taproot Mechanism, River: https://river.com/learn/what-is-taproot/

The most significant improvement is the implementation of multi-signature (Multisig). This feature makes transactions more secure for institutional users. On public key addresses, Multisig addresses, and private wallet addresses have the same length, making it impossible for outsiders to distinguish between them, thereby enhancing security and privacy protection. This technological advancement also provides a solid foundation for institutional and B2B transactions, promoting broader commercial applications.

The most visible change for users is the format of wallet addresses. Wallet addresses that start with “bc1p…” indicate that the wallet supports the Taproot upgrade.

3.3 TA Technical Principles

Initially, the Ordinals protocol and the derived BRC20 protocol, which ignited the Bitcoin ecosystem, were both based on the Account model, where balances are tied to addresses. Asset issuance was achieved by “tagging” the smallest unit of Bitcoin, the “satoshi,” with specific identifiers or data, mapping the “satoshi” to a particular asset. The data corresponding to the asset’s status was stored in JSON format in the SegWit section of the block (the area that holds transaction signatures or witness data). Once an asset transaction occurred between two parties, the script recording the asset’s change would be “inscribed” into the block and interpreted via an off-chain indexer.

However, this approach requires that every Ordinals and BRC20 asset transaction be recorded on the blockchain, which increases the block size, leads to the accumulation of redundant data, and permanently stores this data on the Bitcoin blockchain, ultimately putting increasing pressure on full-node data storage. In contrast, the TA protocol adopts a more efficient method: assets are tagged on each UTXO, with only the root hash of the script tree stored on-chain, while the scripts themselves are kept off-chain.

Additionally, TA assets can be deposited into Lightning Network payment channels and transferred through the existing Lightning Network, meaning that TA assets represent a new type of asset that can circulate on both the Bitcoin mainnet and the Lightning Network.

As the name suggests, Taproot Assets is a protocol developed using Bitcoin’s Taproot upgrade (BIP 341). The Taproot upgrade allows a UTXO to be spent using either the original private key or a script from the Merkle tree.

In simple terms, the Taproot Assets protocol builds on the Taproot upgrade by recording asset state transitions in the Taproot Merkle tree. At the same time, it leverages Bitcoin’s UTXO “ Single-use Seals” characteristic to achieve consensus on asset state transitions on the Bitcoin blockchain, eliminating the need for off-chain indexers required by other protocols.

The Taproot Assets protocol uses the asset management structure shown in the diagram below, employing a Merkle-Sum Sparse Merkle Tree (MS-SMT) to manage asset states. The Taproot Assets protocol defines the standards that must be followed for asset state transitions.

Taproot Assets Trees, Lightning Labs:

https://docs.lightning.engineering/the-lightning-network/taproot-assets/taproot-assets-protocol

It is important to note that not all data from the Merkle tree is written onto the Bitcoin blockchain — only the root hash of the Merkle tree is recorded on-chain. This means that no matter how large the asset data is, the transaction size on the Bitcoin blockchain remains unchanged. In this sense, Taproot Assets is a protocol that does not pollute the Bitcoin blockchain.

3.4 The Relationship Between the TA Protocol and the Lightning Network

In Lightning Labs’ latest product release, Taproot Assets protocol assets can now seamlessly enter Bitcoin’s Layer 2 Lightning Network through the TA Channel (Taproot Assets Channel). Previously, the Lightning Network was exclusively a peer-to-peer Bitcoin payment network, with no other crypto assets circulating within it. The introduction of the Taproot Assets protocol has changed this, allowing assets, especially stablecoins, to be issued on the Bitcoin mainchain via the Taproot Assets protocol and then circulate within the Lightning Network.

As shown in the diagram below, a stablecoin asset, L-USD, is issued through the Taproot Assets protocol. Alice then transfers $10 worth of L-USD to Zane via the Lightning Network.

An example of a Taproot Assets payment made to the wider Lightning Network, Lightning Labs:

https://docs.lightning.engineering/the-lightning-network/taproot-assets/taproot-assets-on-lightning

The implementation principle of the TA Channel is the same as that of a State Channel, as it is also based on Hash Time-Locked Contracts (HTLCs). Since Taproot Assets are contained within a UTXO, the implementation mechanism of the TA Channel has not changed. The only difference is that while Channels previously could only facilitate the transfer of Bitcoin, they can now also support the transfer of TA assets.

The TA protocol makes it possible for assets other than Bitcoin, such as stablecoins, to be transferred seamlessly over the Lightning Network.

3.5 High User Costs and the Need to Address Centralized Custody Issues

Although the TA protocol only records the root hash of each transaction on-chain to maintain the simplicity of the Bitcoin blockchain, the trade-off is that asset data must be stored off-chain on every client. Similar to the RGB protocol, clients need to verify (CSV) the validity of assets. If users want to use Taproot Assets as easily as they use Bitcoin, they need two things: the private key of the UTXO (Virtual UTXO) corresponding to the asset, and the relevant data for that asset in the Merkle tree.

Moreover, the official implementation of the Taproot Assets protocol (Tapd) is deeply reliant on the wallet services of Lightning Network nodes (LND) and lacks an account management system. The unique decentralized architecture of the Lightning Network requires users to set up their own nodes, which is a significant barrier for ordinary users and one of the main reasons the Lightning Network has not yet achieved widespread adoption.

As a result, most wallet services on the Lightning Network currently offer custodial solutions, meaning that newly issued TA assets are also stored in custodial wallets. In the future, when a large number of stablecoins circulate on the TA protocol, large assets will likely be stored on the TA (Bitcoin mainnet) due to its higher security and stronger consensus. Only small assets and spare change will be transferred to the Lightning Network to meet payment needs. Therefore, it is crucial to develop more decentralized methods for storing and managing large assets securely, allowing users to fully own their stablecoins.

4. Self-Custody Solutions: Completing the Last Piece of the Lightning Payment Network Puzzle

Currently, several teams have developed decentralized solutions for the circulation of TA assets on the Lightning Network. For example, LnFi has proposed a cloud custodial solution that allows users to easily deploy their own Lightning Network nodes, effectively lowering the barrier to entry.

Additionally, the BitTap team, which focuses on building decentralized infrastructure for the TA protocol ecosystem, has developed a wallet of browser extension version, giving users on the TA protocol the right to self-custody their assets.

BitTap Wallet Interface, Source: BitTap Team

BitTap has introduced an innovative wallet protocol (Bittapd), where users have complete control over their private keys. When a transaction signature is required, Bittapd interacts with Tapd on behalf of the user, providing a fully decentralized experience and security assurance similar to that of the Metamask wallet. Once stablecoins are issued and circulated on the TA protocol, users can use the BitTap wallet to store and transfer stablecoin assets on the Bitcoin mainnet, as well as freely move small amounts to the Lightning Network. The technical principles of BitTap are shown below:

BitTap wallet architecture, BitTap Docs:

https://doc.bittap.org/developer-guides/overview

The Bittapd protocol functions as a decentralized proxy for the TA protocol, transforming the native centralized custodial account system of Tapd into a decentralized solution. It also acts as a network communication and forwarding agent for plugin wallet users when they make transaction requests.

5. Conclusion

Stablecoins have garnered widespread attention and application globally, gradually expanding from the narrow scope of cryptocurrency trading to becoming a significant choice for global payments. The Lightning Network, with its low fees and fast transactions, has emerged as an ideal infrastructure for global payments. At the same time, the introduction of the Taproot Assets protocol further enhances the capabilities of the Lightning Network, making it possible to issue and circulate stablecoins on the Bitcoin network. This protocol addresses the issue of Bitcoin’s volatility, significantly improving its suitability for payments.

In addition, to address the centralization issues of the Lightning Network and its wallet services, decentralized wallet solutions such as the one developed by the BitTap team have emerged, offering users a more secure and decentralized method of asset management. This completes the last piece of the puzzle, making the Taproot Assets + Lightning Network combination a global payment infrastructure.

Although traditional payment infrastructures like Alipay, PayPal, and Stripe leverage their transaction volumes, large user bases, government partnerships, regulation, and brand recognition, they remain hampered by their custodial nature and reliance on complex internet and banking systems. These factors lead to inefficiencies and the potential for malicious actions or government sanctions. Additionally, in the realm of cross-border payments, strict regulatory policies and institutional limitations often restrict payment accounts based on location and transfer limits. These factors collectively impact the security and flexibility of traditional payment methods.

The payment infrastructure composed of the TA protocol and the Lightning Network not only matches traditional payment institutions in terms of immediacy but also achieves trustlessness through sophisticated code design. At the same time, self-custody solutions within the ecosystem ensure that users have full control over their assets, enabling TA protocol tokens to be transferred freely, without restrictions, anytime and anywhere. This elevates the freedom of payments to an unprecedented level.

References:

Web3 Payment Report: From Electronic Cash and Tokenized Currency to the Future of PayFi: https://www.theblockbeats.info/news/54626

OKX Ventures Report: Understanding the Development and Future Direction of Stablecoins in One Article: https://www.theblockbeats.info/news/48341

What Is Taproot and How Does It Benefit Bitcoin?

https://river.com/learn/what-is-taproot/

About BitTap: https://doc.bittap.org/

Taproot Assets Protocol: