Schnorr Signatures and Taproot Coming to Bitcoin Soon!

  • Taproot and Schnorr signatures are incremental changes to the Bitcoin protocol.
  • These changes will institute a new bitcoin address standard that may take over a year to be adopted by all users.
  • By reducing the amount of data contained in each transaction, Schnorr signatures can increase privacy for multi-signature transactions and reduce network fees.
  • Taproot enhances Bitcoin’s smart contract capabilities.

In November 2021, there will be an incremental upgrade to bitcoin’s network protocol. These upgrades will decrease data per transaction and subsequently network fees (holding all other variables, like demand, constant), while increasing privacy and enhancing smart contract functionality. This change will help bitcoin maintain its lead over other blockchains in the decentralised finance race.

Taproot Will Help Keep BTC The King

Bitcoin (BTC) has been and remains the king of the crypto-verse. It is considered a Generation One (Gen1) blockchain. While it has the first-mover advantage, as the blockchain that started the entire distributed ledger revolution, it lacks many features that Gen2 and Gen3 blockchains pose. It is essential to understand what each Generation represents to fully understand the implications and long-term implications on Bitcoin's value over time.

First, Second, and Third Blockchain Generations

Bitcoin is a Gen1 cryptocurrency. After all, it is the genesis of this entire revolution. The traits of a Gen1 are that they are written in general source code like C++ and employ proof-of-work mining. Gen2 has significant differences that set them apart from Gen1. The most remarkable being that they have the ability to carry out smart contracts.

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A smart contract is a trustless (governed by code, not an independent party), autonomous, transparent, and decentralised "if this happens, then this happens" agreement built on a blockchain. While it is not a smart contract in the same sense as what is being described here, this can be analogous to setting up an automatic payment of a bill through a bank account. When the date of the bill comes up each month, it triggers an automatic payment from the bank account to the recipient.

Ethereum (ETH) is the most notable and second-largest cryptocurrency by market cap. It is a Gen2, propelled to its position by its capabilities, which are more significant than bitcoin's. This allows ETH and other Gen2 to be used in decentralised finance (DeFi), allowing lending/borrowing and other yield-producing activities. Gen3 is all about interoperability, or the ability to work cooperatively with other blockchains and provide faster and more robust scaling solutions than the previous generations. Gen3 examples include Polkadot (DOT), Avalanche (AVAX) and Solana (SOL).

Calm and Calculated Progress on Bitcoin

With all of these different evolutions of blockchains, how does bitcoin keep its number one spot? If all these "new and improved" versions of a cryptocurrency exist, why doesn't everyone just switch to those? Bitcoin's principal reason for continued market dominance is that it is the most decentralised network with the highest adoption rate out of all cryptocurrencies. Since it is the oldest and most decentralised, it is the most secure, dependable, and trusted. Though, if bitcoin does not change and adapt over time, it may very well eventually lose its market dominance to chains that can provide more utility than just being a store of value. BIPs or Bitcoin Improvement Proposals can be introduced to upgrade the monetary network for updates – at least incrementally. What has been proposed and voted on by miners and the community is BIP340, BIP341 and BIP342. This is where the Taproot and Schnorr upgrades come into the picture.

What are Schnorr and Taproot?

The last bitcoin upgrade was in 2017 with SegWit (Segregated Witness), which helped reduce the amount of data needed for blocks to record per transaction. Schnorr is a signature scheme that allows multi-signature functionality for allowing a BTC transaction with less data needed than the old elliptic curve signature scheme (ECDSA). This removes unnecessary data from being recorded in the ledger as well. Less metadata in blocks means an increase in privacy and scalability (the ability to process many transactions per second).

Schnorr is also what allows Taproot to be implemented. Taproot allows several different transaction participants to add their public keys together to create a "threshold public key," which makes a "threshold signature," which enables the initiation of a bitcoin transaction. This gives this upgrade the secondary boost to move bitcoin along to the next step by enhancing its smart contract capability.

Figure 1 High-level Impact of Taproot and Schnorr on Bitcoin Network

Source: Image by portald from Pixabay

NFTs on Bitcoin?

Non-Fungible Tokens (NFT) are a recent hot trend in the blockchain space, predominantly focusing on art. NFT sales of various artists reached $10.7bn in the third quarter of 2021. The updates to BTC in this review are likely not to give bitcoin the same ability for graphics, art, or other NFT formats. However, the use of bitcoin for more substantial applications may be possible. Property deeds and titles for land are two examples where the most decentralised and trusted blockchain may be the best suited to log property transfers. This would remove the need for title searches, title insurance and other expenses associated with such processes. The same would go with any transfer of ownership in physically non-tangible assets like business ownership, legal contracts and a myriad of other applications. While BTC is likely not to be the king of NFT applications for everything, BTC is the most likely to have long-term durability and continued adoption, increasing its viability as a trusted NFT blockchain for generations. This would increase demand for Bitcoin, increase network adoption and set the price soaring.

Schnorr and Taproot’s Impact on Bitcoin Price

The proposed changes to the bitcoin protocol will impact the viability and return on investment (ROI) on BTC over time. There may be an increase in the US dollar price of bitcoin on the announcement of the implementation of Taproot. However, this is a "buy the rumor and sell the news" event. If the change to SegWit in 2017 is any indication, the Taproot upgrade will take approximately a year to be adopted and for the community to feel its effects. The update will create a soft fork and users will need to use a new type of bitcoin address for transactions. The new address will be backward compatible, meaning that old wallet addresses can interact with it and vice-versa. But to fully take advantage of the new functionality, the new address will depend on the network’s overall adoption.

In the short term, upon the release of Taproot in mid-November 2021, there may be a change in price on the news of the release. However, it is unlikely that this sudden price increase will have a long-lasting impact only because, as described above, the address adoption will take time to roll out.

In the long-term, the Taproot upgrade means that Bitcoin can maintain its status as the king in the crypto universe. It is a step closer to being a viable payment system with smaller fees per transaction and increased privacy as Satoshi had envisioned in the Bitcoin whitepaper.

Conclusion
The Taproot and Schnorr upgrades to Bitcoin further help to cement BTC’s market dominance over the long term. However, any short-term price action is most likely speculative since the adoption of the new wallet addresses standard and benefits (and risks) will take a year to be felt. Overall, this software update is a positive change that can keep bitcoin relevant while at the same time not changing so fast as to bring instability to the network.

*Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.