What are the opportunities and risks in Bitcoin’s modularity story?

Author: Alex Bergeron, Bitcoin Magazine; Translator: Tao Zhu, Golden Finance

What exactly is modularity?

Modularity is the result of an interesting experiment conducted on Ethereum, a response to the poor scalability of blockchain. To address this bottleneck, developers took a radical approach and auctioned off the core functions of the main chain to... other blockchains.

With Rollup technology at its center, this modular transformation completely redefines the way products and services are built on top of Ethereum. Separating each element of the stack allows for different architectures to be designed based on their use cases. Understandably, this has led to a surge in... blockchains.

I kid you not. Everyone is making a fortune by peddling blockchain.

While each new consensus protocol offers novel and interesting scaling opportunities, they also pose a strange coordination problem. How can economic efficiency be improved if users are scattered across different networks? How can we get everyone in the distribution to sync? Maybe another... blockchain?

This fragmentation of the ecosystem has some obvious consequences. First, users are isolated and trapped between intermediaries.While Rollups have compelling trust-minimizing properties, the inefficiencies created by transfers in and out of these systems impose unreasonable costs on users. It also exposes them to riskier options like bridges and centralized services.

For developers, the lack of cross-platform interoperability creates friction and fosters an environment of competition rather than collaboration. A new protocol is created every other day for new and old teams to compete with another copy of the same application. In many cases, teams choose to “bet on themselves” and spin off into their own ecosystem (i.e. blockchain). It is critical to emphasize the appeal of this model, which allows for various components to be customized and optimized for each application. This flexible architecture enables anyone to contribute their own unique framework and inspire new designs. The possibilities are endless!

Unfortunately, these incentives lead to a fragmentation of network effects. If nothing built can be combined together, users will concentrate into only a few competing networks. As a result, economic activity is concentrated into fewer permissioned systems.

This modular model takes people away from the goal, and it shouldn’t. Using different interfaces to interact with the consensus protocol is a perfectly valid idea. However, Ethereum’s strategy has proven to be problematic; it treats interoperability as an optional feature rather than a foundational design principle. As long as Ethereum continues to pursue scalability by adding more to the blockchain, the debate will continue, providing ample opportunities for competitors to exploit these divisions and encourage discord. Divide and conquer.

Bitcoin’s Opportunity

On Bitcoin, a different architecture is emerging that favors a fundamentally different design. Using Lightning as an interoperability backbone, developers are slowly moving toward a technology stack that is closer to Bitcoin’s peer-to-peer model.

Rather than trying to replicate a global shared state, protocols like Cashu or Fedimint are optimizing for local and permissionless interactions. Financial services can now be deployed in different economic hubs and stay connected via the Lightning Network.

Liquidity providers, atomic bridges, and e-cash mints. A novel financial network, all sharing the same settlement layer.

Nostr has emerged to provide the social abstraction that ties all of this together. It is a social network based on similar principles to Bitcoin, which provides a simple set of rules designed to maximize interoperability. By avoiding being prescriptive about the features it implements, Nostr is sparking a Cambrian explosion of open innovation.

Today, different projects are beginning to explore how to facilitate transactions on the Bitcoin network by making Nostr a native component of the Bitcoin user experience. The public key infrastructure underlying the protocol is a natural match for wallets and other payment applications, allowing them to communicate with each other and exchange messages securely. This communication layer can connect users with each other and with a variety of services offered over the network. Standards such as Nostr Wallet Connect create new opportunities for Bitcoin applications to interact with Nostr's growing ecosystem.

Case Studies

Projects such as Mutiny perfectly embody a different take on Bitcoin's modular vision. Users can simultaneously connect to services such as Nostr relays, Fedimint Alliance, and Lightning Service Providers (LSPs). Each of these services allows access to an increasing number of features and applications. Using Nostr as a discovery service, we are able to leverage our social network to identify and natively access peer-approved applications and services. This network of trust introduces an interesting alternative to so-called trustless systems. Participants can begin to rely on market incentives to engage in more efficient transactions that are not hindered by the trade-offs required by more decentralized systems.

Eventually, a marketplace of liquidity providers, e-cash mints, lenders, and coinjoin coordinators will emerge to advertise their services through Nostr. The decentralized order book project Civkit can be seamlessly integrated into Mutiny and allow users to participate in peer-to-peer transactions. Each integration is designed around permissionless participation so that users have full control over their interactions.

Platforms & Protocols

Bitcoin’s modularity story is not without risk. Basic elements such as LSPs involve significant capital requirements, which will create economies of scale among competing providers. Regulatory issues and operator fraud may hinder the growth of electronic cash mints. Nostr relays have already shown a tendency towards centralization, and it is not yet clear how the network topology will play out.

The success of this approach depends on market optionality, and the barriers to entry into these businesses must remain low. To this end, people are taking a variety of different approaches. For example, multiple Lightning companies are currently collaborating on a specification that would allow any market participant to implement their own LSP.

It is probably too early to predict how these architectures and protocols will develop. As the two worlds continue to collide, Rollups may well find their place in the Bitcoin ecosystem. Application-specific designs such as exchange Rollups or zkCoins do not require global state and may be interoperable with Lightning.

The tension between the two approaches is somewhat reminiscent of the early days of the internet. Commercial interests may favor platforms that allow them to capture part of the network effects in order to monetize them. More open and permissionless protocols may take longer to really take off. The internet provides a cautionary tale in terms of services and applications being consolidated into gated walled gardens. Hopefully, the current path of Bitcoin development will address the issues of the future — prioritizing interoperability and permissionless access over financial silos.