Why Taproot Is A Big Deal For Bitcoin

While each new block includes an important update to the transactions on Bitcoin’s timechain, there is typically no major significance of one block versus another. Block 709,632 (estimated for mid-November 2021), however, will signal the activation of the first new upgrade to Bitcoin since 2017: Taproot.  Taproot is a soft fork upgrade, meaning that these new rules are backwards-compatible. In other words, anyone who chooses not to upgrade to Taproot will continue to be able to use the Bitcoin protocol (just without the benefits of Taproot discussed below).

In short, the Taproot upgrade increases the efficiency, privacy, and functionality of Bitcoin transactions for users who choose to upgrade. While the underpinnings of Taproot can be quite technical for normal users, all users will benefit in the long-run for three primary reasons. 

First, by introducing a new signature type called Schnorr signatures, transactions will use less data. Less data per transaction will lead to a reduction in the amount of block space required per transaction, which will ultimately reduce transaction fees. This is especially true of more complex transactions such as multisignature payments, Lightning channel opens, and smart contracts. Even users who only make basic transactions will benefit since more complex transactors will not need to bid nearly as high for block space.

Second, Taproot allows for faster transaction verification, meaning that running a node will be less resource intensive. Reducing the cost of running a node is clearly positive for each individual user. Further, it ensures that the Bitcoin protocol remains decentralized since people across the globe can more easily run their own copy of the Bitcoin time chain. Other cryptocurrencies consistently add more data to their ledgers, making it increasingly difficult for less wealthy and less technical users to run a node. An inability for users to run a node ultimately leads these protocols on a path towards centralization. Meanwhile, Bitcoin continues to be contrarian by optimizing for data efficiency without sacrificing the globally decentralized nature of its ledger.

Third, perhaps the most important benefit of Taproot is increased privacy via a new address type. For example, let’s consider opening a Lightning channel. Before Taproot, opening a Lightning channel was easily identifiable as a 2-of-2 multi signature transaction by anyone looking on-chain. While these transactions were still pseudonymous, if a chain surveillance company was able to associate a user’s name with their Bitcoin address, it would be relatively easy to determine that a transaction was likely used to open a Lightning channel. With Taproot, this same chain surveillance company trying to identify a Lightning channel open will be out of luck. They will still be able to see the amount of Bitcoin sent, but it could just as well be a basic peer-to-peer transaction as a Lightning channel open.

Just as with the reduced fees, privacy benefits will accrue to all users, even those who make the simplest transactions. Enhanced privacy increases the anonymity set, effectively making different types of Bitcoin transactions indistinguishable on-chain. Before Taproot, a simple transaction was easily identifiable on-chain due to a process of elimination: more complex transactions were so obvious that any non-complex transactions could be assumed to be basic peer-to-peer transactions. Post-Taproot, these simple transactions will blend in with complex transactions, massively increasing the fungibility of Bitcoin. 

While Taproot provides major benefits for all users, it is undoubtedly a huge upgrade for builders, developers, and tinkerers who have been chomping at the bit for more transactional flexibility. This includes those building on the base layer of Bitcoin, as well as those working on second layer protocols such as Lightning and Liquid. While we cannot predict specifically what new layers and applications will be built, we can say with certainty that Taproot unlocks far more flexibility with transactions and smart contracts on Bitcoin and its layers. These developments are exciting for anyone building on Bitcoin, as well as users across the globe who will eventually benefit from this huge inflow of innovation. With the activation of Taproot, we may be at the precipice of a flood of new layers and applications built on Bitcoin, unlike anything we have seen before. 

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