The overlooked risk: Security challenges and threats of BTC Layer 2 technology

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Number: Chain Source Security Knowledge No.018

BTC (Bitcoin), abbreviated as BTC, is a decentralized Consensus based on the Block chain, and runs an Open Source Cryptocurrency system through peer-to-peer network communication, maintained by computer networks and Nodes from around the world. However, with the continuous development and growth of the encryption community and ecosystem, the early BTC technology can no longer meet the scalability needs of the Cryptocurrency system. Directly modifying the underlying protocol of BTC is not only complex, but also faces significant community resistance, increasing system risks, and may lead to a hard fork and community split. Therefore, the BTC Layer 2 solution has become a more suitable choice - by building new layers, it is compatible with BTC without modifying BTC, and meets the scalability needs of users. The Chain Source Security team has comprehensively analyzed the security of BTC Layer 2 from multiple aspects such as L2 solutions, protective measures, and future development, hoping to provide valuable references for everyone.

The solution and potential security issues of BTC Layer 2

BTC Layer 2 refers to the second layer extension technology of BTC (BTC), which aims to improve the transaction speed of BTC, reduce fees, and increase scalability, addressing a series of issues faced by BTC. Currently, there are many BTC Layer 2 solutions, including well-known ones such as Lightning Network, Rootstock, and Stacks. In addition, some projects and protocols like Liquid, Rollkit, RGB also have certain use cases.

1.Lighting Network（Lightning Network）

The Lighting Network may be the most well-known BTC Layer 2 solution. It operates as an off-chain network, allowing participants to conduct fast, low-cost transactions without recording every transaction on the BTC Block on-chain. By creating a payment channel network, the Lighting Network supports microtransactions and significantly reduces congestion on the main on-chain.

Usage Scenarios:

Content creators’ micro payments/peer-to-peer payments/e-commerce and retail transactions.

Key Features:

• Instant payment: Transactions settle immediately.
• Low fees: Very low fees, suitable for micro-trading.
• Scalability: Able to handle millions of transactions per second.

Security issue:

• Channel Attacks: Lighting Network relies on payment channels, which may be vulnerable to attackers exploiting stale transactions or fraudulent channel closure.
• Liquidity Issue: If funds are concentrated on a small number of Nodes, these Nodes may become targets of attack, leading to a drop in the degree of Decentralization of the network.
• Network Splitting Attacks may attempt to split the network, causing different parts of the network to have asynchronous ledgers.

2. Rootstock (RSK)

Rootstock, abbreviated as RSK, is a Smart Contract platform built on BTC. It leverages the security of BTC while supporting Smart Contracts compatible with the Ethereum network. RSK operates as a Sidechain of BTC, using a two-way pegging mechanism to enable the flow of BTC between the BTC network and the RSK blockchain.

Usage Scenarios:

Decentralized Finance (DeFi) applications/issuanceToken/Cross-Chain Interaction applications on the BTC network.

Key Features:

• Smart Contract: Compatible with Ethereum, supports Decentralized Finance applications.
• Merged Mining: BTCMiner can mine RSK at the same time to enhance network security.
• Interoperability: Bridge BTC with similar features as ETH.

Security issue:

• Double Spend Attack (Double-Spending): RSK, as a sidechain, may be vulnerable to Double Spend Attacks in certain cases, especially when transferring BTC between BTC and RSK.
• Smart Contract Vulnerabilities: RSK allows the deployment of Smart Contracts, which exposes it to similar Smart Contract vulnerability risks as Ethereum, such as reentrancy attacks, integer overflow, etc.

3. Stacks

Stacks is a unique Layer 2 solution that brings Smart Contracts and Decentralized Applications (dApps) to BTC. Unlike other Layer 2 solutions, Stacks introduces a new Consensus Mechanism called Proof of Transfer (PoX), which anchors Stacks transactions to the BTC blockchain on-chain.

Use Cases:

NFT platform/Decentralized Finance (DeFi) services/governance and identity solutions.

Key Features:

• Smart Contract: Clarity, a secure language designed for predictable Smart Contracts.
• BTC Anchor: Trading is secured by BTC.
• Decentralization applications (dApps): Allow developers to build Decentralization applications on BTC.

Security issue:

• Consensus Attacks: Because Stacks’s Consensus Mechanism PoX relies on the BTC network, attackers may attempt to manipulate the BTC network to influence Stacks’s Consensus.
• Smart Contract Vulnerabilities: Similar to other Smart Contract platforms, Stacks also faces potential vulnerabilities in Smart Contract code.

4. Liquid

Liquid is a Sidechain-based Layer 2 solution that aims to improve the transaction speed and privacy of BTC. Developed by Blockstream, Liquid is particularly well-suited to traders and exchanges, supporting faster settlements and confidential transactions.

Usage Scenarios:

High-frequency trading/cross-border payment/tokenization asset issuance.

Key Features:

• Confidential Transactions: Transaction amounts are hidden to enhance privacy.
• Fast Settlement: Transactions are settled within approximately 2 minutes.
• Asset issuance: Allows the creation of digital assets on the BTC network.

Security issue:

• Mainnet Dependency Risks: As a sidechain, Liquid relies on the security of the BTC Mainnet. Any attack or vulnerability on the Mainnet may affect Liquid.
• Privacy Risk: Although Liquid supports confidential transactions, if Secret Key management is not done properly, privacy may still be compromised.

5. Rollkit

Rollkit is an emerging project aimed at introducing the popular scaling solution Rollups from the Ethereum ecosystem to BTC. Rollups aggregate multiple transactions into a batch, which is then submitted to the BTC blockchain, reducing network load and dropping fees.

Usage Scenarios:

Scalable Decentralized Finance applications/aggregation of micropayment/high-throughput Decentralization applications.

Key Features:

• Scalability: significantly increase transaction throughput.
• Cost efficiency: Processing transactions in bulk to reduce drop fees.
• Security: Inherit the security model of BTC.

Security issue:

• Data Availability Attacks: In rollups, if data is unavailable, it may lead to validators being unable to verify the validity of transactions.
• Economic Incentive Issues: Rollups need to design strong economic incentive mechanisms to prevent participants from attempting to gain benefits through improper means.

6. RGB

RGB is a Smart Contract system that utilizes the UTXO model of BTC. It aims to support complex Smart Contracts while maintaining the privacy and scalability of BTC. RGB focuses on creating an off-chain environment where Smart Contracts can be executed, minimizing their impact on the mainchain.

Usage Scenarios:

Asset tokenization/privacy applications/flexible Smart Contract development.

Key Features:

• Based on UTXO: Maintaining the security and privacy features of BTC.
• off-chain execution: Minimize on-chain occupancy.
• Customization: Supports a wide range of Smart Contract application scenarios.

Security issue:

• The complexity risk of Smart Contracts: Smart Contracts in the RGB system may be very complex, leading to potential security vulnerabilities.
• Trustworthiness issue of off-chain execution: RGB relies on off-chain environment for the execution of Smart Contracts. If the execution environment is attacked or manipulated, it may affect the security of the contract.

Existing Security Measures

BTC Layer 2 solutions have shown great potential in improving the scalability and functionality of the BTC network, but they also introduce a series of new security challenges, and security will be one of the key factors for its success and widespread adoption. To address potential security risks, BTC Layer 2 can take the following main security measures:

• Channel Security and Fund Safeguard

Multi-signature and Timelocks: In the Lighting Network, funds are typically stored in a Multi-signature Address, and can only be transferred once all parties reach consensus. The timelock mechanism ensures that funds will not be permanently locked in case of disputes, and can ultimately be returned to the owner.

Reliability of off-chain transactions: By using off-chain transactions, users can quickly conduct transactions, but these transactions still need to be regularly synchronized with the mainchain to prevent Double Spending or fund loss.

• fraud proof and challenge mechanism

fraud proof (Fraud Proofs): In some Layer 2 solutions (such as Rollup), fraud proof is used to detect and counter malicious operations. For example, if one party attempts to submit an invalid state update, other participants can challenge it with fraud proof to prevent invalid transactions from being included on-chain.

Challenge Period: A period of time given to users to review and challenge suspicious transactions, thereby enhancing the security of the network.

• Robustness of the network and protocol

Protocol upgrades and audits: Regular review and upgrading of the protocol to fix known vulnerabilities and enhance security. For example, in Rootstock or Stacks, code audits and community reviews are crucial to ensuring the security of Smart Contracts.

Decentralized operational Node: By increasing the distributed nature of Nodes, the possibility of network single point failures is reduced, thereby improving the network’s resistance to attacks.

• Privacy and Data Protection

encryption communication: ensure that all communication between participants is encryption, to prevent middleman attacks or data leakage.

Zero-Knowledge Proof (Zero-Knowledge Proofs): In some Layer 2 solutions, Zero-Knowledge Proofs are introduced to enhance privacy and security, avoiding the disclosure of sensitive information about the transaction parties.

• User Education and Risk Warning

Raise user security awareness: educate users about the risks of layer 2 networks and encourage them to use reliable wallets and secure operating methods.

Risk Warning: When using Layer 2 solutions, remind users of potential risks, such as the complexity of off-chain transactions or disputes when channels are closed.

• Security of off-chain transactions

State Channel Security: Ensures the integrity of off-chain state and regularly submits state updates to the mainchain to reduce the risk of fund theft or fraud.

These measures work together to ensure the security of the BTC layer 2 network and provide users with a reliable and scalable trading environment.

Future Trends in Security Development

The industry is changing rapidly, with new BTC L2 solutions emerging every second, but the inevitable trend is the development of the BTC ecosystem to the second layer. BTC is a train that everyone wants to board, and despite facing challenges, the future of the BTC ecosystem is full of infinite possibilities. From Consensus based on fair distribution to scaling solutions based on inscription, and then to fully mature expansion solutions that pursue strong security shared with BTC, the BTC ecosystem is undergoing a historic transformation.

• Unlock the Decentralized Finance market: By enabling features such as EVM-compatible Layer 2 solutions, BTC can enter the multi-billion dollar Decentralized Finance market. This not only expands the utility of BTC, but also unlocks new financial markets that were previously only accessible through Ethereum and similar programmable blockchains.
• Expand Use Cases: These Layer 2 platforms not only support financial transactions but also various applications in the fields of finance, gaming, NFT, or identity systems, greatly expanding the original scope of BTC as a simple currency.

Layer 2 networks use Zero-Knowledge Proof to enhance security, Rollup technology improves scalability, fraud proof ensures the security of transactions, etc. These technologies not only have the potential to significantly improve the scalability and efficiency of the BTC network, but also introduce new types of assets and transaction methods, opening up new opportunities for users and developers. However, achieving these goals successfully requires the joint efforts of community consensus, technological maturity, and practical verification. In the process of exploring the most effective L2 solutions, security, decentralization, and optimizing user experience will still be of utmost importance. Looking ahead, with technological progress and community collaboration, BTC L2 technology is expected to unleash the new potential of the BTC ecosystem, bringing more innovation and value to the cryptocurrency world.

Conclusion

With the market’s huge demand and the free competition in the market, technological innovations will definitely emerge. The future of L2 solutions is closely related to the overall development of Blockchain technology. By analyzing the solutions and potential security challenges of BTC Layer 2, we reveal the risks it faces in smart contracts, identity verification, data protection, and other aspects. Although there are already various security measures in place, BTC Layer 2 still needs continuous innovation in areas such as ZK technology, Cross-Chain Interaction security, and even quantum encryption to meet future security challenges. As Blockchain technology matures, we can expect to see more innovation and changes. Firstly, with the continuous maturity and standardization of technology, L2 solutions will become more stable and reliable. Secondly, as the ecosystem expands, BTC will be applied in more scenarios and industries, further driving the development of the entire cryptocurrency industry. Overall, the Mainnet launch of the BTC Layer 2 project signifies a new milestone for the BTC network.

ChainGuardian is a company specializing in blockchain security. Our core work includes blockchain security research, on-chain data analysis, as well as asset and contract vulnerability rescue. We have successfully recovered multiple stolen digital assets for individuals and institutions. At the same time, we are committed to providing industry institutions with project security analysis reports, on-chain traceability and technical consulting/support services.

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