What is Taproot?

Taproot: A Major Upgrade for Bitcoin

In November 2021, a decisive moment many Bitcoiners have eagerly anticipated had finally come: Block 709,632 was mined and the Bitcoin Taproot upgrade went live. While other blockchains update their code on a regular basis, Taproot is the first upgrade for the Bitcoin network since 2017, which made it a special event for Bitcoin developers and miners.

A consequence of the highly decentralized nature of the Bitcoin network is that finding a common consensus often takes longer than with other networks. Before any change can be implemented, the vast majority of network participants have to be convinced of the benefits of such a change. Consequently, changes happen slowly, but in return they are carefully and thoroughly tested by thousands of eyes.

Related Show: Raoul’s Big Picture – Bitcoin’s Taproot Facelift

What Does Taproot Do?

The Taproot upgrade is of rather a technical nature but its implications are easily comprehensible by the average Bitcoin user. Taproot is a soft-fork upgrade, meaning the full nodes running the Bitcoin network have the option but not the obligation to update their software with the Taproot code. This is crucial because otherwise the network would split into two different networks (nodes with old code vs. nodes with updated code), as it was the case with Bitcoin Cash. Such splits, called hard forks, weaken the network and can lead to uncertainty among network participants and users. This is why there is the unwritten rule in the Bitcoin community that hard forks should be avoided at all costs, while soft forks should only be done if absolutely necessary and if a high degree of conviction is present within the community.

But what does Taproot do? In short, the implementation of Taproot by Bitcoin full nodes enables improved scalability, increases privacy, and favors enhanced smart-contract functions of the Bitcoin blockchain. This is made possible by the introduction of so-called Schnorr signatures, Merklized Abstract Syntax Trees (MAST), and Tabscript.

The expected benefits of the upgrade include:

  • A singular Taproot output: The introduction of these new features allows for a new address type, which means that all Taproot Bitcoin transactions look similar whether a sender is making a simple payment, is using the Lightning network, or is performing a complex multi-sig transaction with multiple parties. Taproot consolidates all types of Bitcoin transactions into a singular Taproot output. This allows for more privacy in the network.
  • Block-space savings: The new address type uses a more efficient signature algorithm that requires less block space on the blockchain, thus saving transaction fees for users. This is especially important for more complex transactions. Thanks to these improvements, larger and more complex operations become possible on Bitcoin, which were not feasible prior to Taproot.
  • Improved Bitcoin programmability: Before Taproot, Bitcoin did have some native smart-contract capabilities. Transactions could be programmed to execute payments when certain conditions were met or missed. One of the most popular applications of Bitcoin smart contracts is the Lightning network. However, such contracts offer little privacy and are data-heavy. Taproot improves this by breaking up the execution of Bitcoin scripts, thus making Bitcoin contracts more viable.

It’s important to bear in mind though: The idea that Taproot will turn Bitcoin into a fully fledged smart-contracts blockchain is misplaced.

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Why Is Taproot Important?

Taproot is arguably the most important upgrade to the Bitcoin protocol to date. Among other things we have learned is that Taproot improves privacy on Bitcoin. But why is this important? The Bitcoin network is pseudonymous, meaning network participants don’t have to identify themselves to interact with the network. Nevertheless, each transaction made on the network is stored on Bitcoin’s public ledger and thereby easily traceable. As a result, the network is not anonymous. Once the person behind a Bitcoin wallet address has been identified, all the transactions ever made with this wallet can now be assigned to the respective person.

Further, prior to Taproot, different types of transactions, especially smart-contract transactions such as multi-sigs could be easily distinguished from ‘simple’ transactions. So not only could a blockchain-analysis organization like Chainalysis, which have enhanced tracking technology at their disposal, potentially identify the person behind a wallet but also distinguish the type of transactions the person made.

To keep a wallet address pseudonymous is mostly in the hand of the owner. But to make the different transaction types indistinguishable on the blockchain was only possible through the Taproot code upgrade. Taproot enables many different smart-contract transactions to appear on the blockchain as ‘simple’ transactions. By obfuscating a transaction’s true nature, Taproot makes it possible for smart-contract transactions to disguise themselves as regular transactions among the bulk of simple transactions. This increases privacy within the network.

Taproot and the Lightning Network

The Lightning network is a second-layer protocol for the Bitcoin blockchain. In recent months it has experienced exponential growth and has proven to be a reliable payment solution for everyday bitcoin payments. Real-world examples are Twitter’s new tipping function, which lets users send tips to their favorite Twitter accounts. El Salvador has also adopted the network as an integral part of their new Bitcoin law. Their Bitcoin wallet, Chivo, was specially designed for El Salvadoran citizens and enables a simple bitcoin-payment function over the Lightning network.

However, technically Lightning payments on the Bitcoin blockchain differ in appearance from other transactions and thus are easily identifiable. This poses a problem as it violates the monetary principle of fungibility. An important property of money is that all coins are interchangeable and it doesn’t matter if someone is in possession of coin A or coin B. But because Lightning transactions on the Bitcoin blockchain can be distinguished from other transactions, this principle is violated. Theoretically, Bitcoin nodes could choose to censor Lightning transactions, thus discriminating the layer-2 solution.

The Taproot upgrade solves this problem with a new address type, which eradicates the possibility to distinguish Lightning transactions from regular ones. This is an important step to guarantee Bitcoin’s fungibility for second-layer applications too.

Taproot and the Average Bitcoin User

Many readers might be wondering: Why is the Taproot upgrade of any importance to me? The majority of bitcoin investors only use bitcoin as an investment or a long-term store of value and rarely move their coins around on the mainchain. The reduction in transaction fees for more complex transactions won’t benefit the average user much and the privacy concerns around Lightning transactions prior to Taproot most likely haven’t caused sleepless nights either.

And it is true, in the short term, not much will change for the average user. But the Taproot upgrade lays the foundation for other important developments on Bitcoin. Just as the SegWit upgrade enabled the Lightning network and Bitcoin sidechains in 2017, Taproot will open the doors for new innovation.

Thanks to Taproot, layer-2 protocols and sidechains can use more sophisticated smart contracts to communicate with the Bitcoin blockchain. As a result, users will benefit from a broader offering with higher levels of security in the Bitcoin ecosystem. The Taproot upgrade will ultimately bring more functionality to Bitcoin, which will benefit all users.

Post Taproot: What Is Next?

Even though the Taproot update went live in November, the work is far from over. So far, a bit over 50 percent of nodes have upgraded their software to support Taproot. Bitcoin wallets, exchanges, and other services will need to upgrade their applications as well to support the new Taproot functionalities.

Further down the road, there are many more soft-fork proposals suggested by Bitcoin developers. The Covenants proposal wants to allow users to whitelist their coins, thus adding security by restricting to what addresses coins can be sent. SIGHASH_ANYPREOUT aims to improve the Lightning network and Drivechains wants to further develop the Bitcoin sidechains. 

Only time will tell if any of these proposals will make it into the Bitcoin code. Once more specific proposals are presented, the community will have to decide whether these are desirable improvements worth pursuing — or not.

For investors wanting to learn more about the taproot upgrade, check out this research paper.

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