Smart contracts could be coming to bitcoin by November.

With bitcoin (CRYPTO:BTC), people can complete financial transactions digitally, or they can simply hold coins as they would any other investment. By contrast, other cryptocurrencies like Ether (the tokens that are part of the Ethereum blockchain) have more decentralized finance (DeFi) features, including something known as smart contracts -- but more on that in a moment.

Some investors recognize Ethereums broader utility, and because of this, they believe it has more long-term upside than bitcoin. However, cryptocurrency investors need to know that a big change is coming to the bitcoin blockchain network. And when it happens, bitcoin will be a lot more like Ethereum than it is now.

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Image source: Getty Images.

Theres two kinds of forks

The likely pseudonymous Satoshi Nakamoto posted the bitcoin whitepaper in 2008 (whitepapers are documents used by blockchain networks outlining the mechanics of the system). No one party controls bitcoin -- its decentralized -- something many cryptocurrency investors love. But in the whitepapers final section, Nakamoto acknowledged bitcoin might need to be updated someday.

How do you change something when no ones in charge? For bitcoin, developers make a Bitcoin Improvement Proposal (BIP), and these are voted on during the mining process. Indeed, theres been changes in the past -- these are called forks.

Now, lets say people in the bitcoin community disagree on a proposal. Occasionally this happens and creates whats called a hard fork -- select miners take their ledgers in a completely different direction from the rest of the group. Thats where cryptocurrencies like Bitcoin Cash and Bitcoin Gold came from. Its kind of like how French, Italian, and Spanish are different languages, but they all started as Latin long ago. These bitcoin communities wanted a change and were willing to go their own way to do it.

However, theres also whats known as a soft fork where the vast majority of bitcoin miners agree to go in the same direction. If miners are all good with the proposed changes, they upgrade their software and keep moving forward together.

At least thats what a soft fork is in theory. In reality, the last so-called soft fork was BIP-141 (the 141st bitcoin proposal) which came in 2017. Called Segregated Witness (SegWit), this fork intended to make bitcoin faster and more secure. But Bitcoin Cash hard forked just prior to SegWit activation while Bitcoin Gold left shortly thereafter -- hardly widespread consensus.

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Image source: Getty Images.

Meet Taproot

Some people refer to the SegWit fork as bitcoins civil war. And the process was so contentious that there hasnt been a major soft fork -- a major upgrade -- since. But thats all about to change. On June 12, bitcoin developers noted that over 90% of bitcoin miners had signaled support for a major upgrade that was proposed years ago, dubbed Taproot.

Taproot intends to make bitcoin more private and more scalable, in addition to unlocking new features. The proposals in Taproot arent necessarily revolutionary for a cryptocurrency. For example, Taproot will implement a new signature protocol for bitcoin called Schnorr. I dont bring up Schnorr to debate the merits -- I only wish to note that this is a change that Bitcoin Cash already implemented in 2019. So bitcoin isnt blazing any new trails here.

However, Taproot updates dont have to be revolutionary to be important. Crucially, bitcoin has had a scalability problem for years. Consider that over the past five years, the total hash rate of the bitcoin blockchain network has skyrocketed -- this is the computing power needed to process transactions. It comes with high consumption of electricity, and its why some people believe bitcoin is unsustainable. Moreover, over these past five years, average daily transactions havent budged -- the network processes only hundreds of thousands of daily transactions whereas credit cards can handle hundreds of millions.

Bitcoin

Data by YCharts.

With Taproot, bitcoin is expected to take a step toward scalability by essentially shrinking transaction data down to make it quicker and less energy intensive. 

However, for me, the bigger leap forward for bitcoin is how Taproot will allow smart contracts. A smart contract is executed by the blockchain network automatically when the stipulations of the contract are met. Until now, Ethereum has dominated this real-world application angle, and its why I personally own it as well as bitcoin. Developers previously couldnt build on the bitcoin blockchain like they could on the Ethereum blockchain, but soon, theyll be able to. 

With over 90% of miners officially approving, the Taproot update process has been set in motion. By November, miners need to be operating with the upgrades. What remains to be seen is whether developers will start building bitcoin applications that will be adopted as those on Ethereums blockchain are. However, if this new use case for bitcoin does enjoy wide appeal, it could help sustain demand for the coins long term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Jon Quast owns shares of Bitcoin and Ethereum. The Motley Fool owns shares of and recommends Bitcoin. The Motley Fool has a disclosure policy.

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