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Taproot Update to Improve Bitcoin's Functionality



Bitcoin is scheduled to introduce an update to the bitcoin protocol in November. This update is a large security and efficiency overhaul that is designed to address some of the concerns that many crypto investors have voiced.


Types of Bitcoin Users

Before we get into details, it may be beneficial to review how bitcoin is updated, as bitcoin has three different types of participants:

  • Miners: Miners purchase expensive computer systems and use their computing power to “mine” bitcoin. They also help secure transactions by providing Proof of Work.

  • Investors: Investors are individuals, businesses, mutual funds and hedge funds that purchase Bitcoin through exchanges. This includes businesses such as Microsoft, PayPal, Whole Foods, and numerous other businesses that accept bitcoin as a payment vehicle.

  • Developers: Developers are those who create updates to Bitcoin, to implement changes that may be necessary.


A Democratic Process

When a developer creates an update to Bitcoin, the changes are not immediately made. Instead, the proposed change to the protocol is put to a vote. These votes are made by the miners as they are the ones most invested in Bitcoin and they help keep the system running. Votes are determined by how much processing power a miner has. The more processing power a miner holds, the more influence they have on the outcome. This method of determining voting power rewards the ones who make the greatest contribution to the maintenance of the system.


Bitcoin’s Newest Update

Taproot is the first update that the bitcoin protocol has seen in 4 years. The vote for Taproot was approved with 99% of voters in favor. Below are some of the major changes that this update brings.


What’s New in Taproot?

The Taproot update should lead to cheaper and more efficient transactions. Even though the update has yet to be implemented, experts estimate that this will reduce transaction costs by 10% or more.


Smart Contracts

In addition to the capacity for more-efficient transactions, the Taproot update should provide the bitcoin network with more smart contract capabilities. A smart contract is a digital agreement that is automatically executed once predefined criteria are met. Smart contracts can be extremely complex and include multiple conditional criteria, or they can be as simple as requiring a digital signature to get executed.


One of the downsides to bitcoin in the past has been a lack of smart contract capability as compared to Ethereum, the second-largest crypto asset as measured by market share. One of the key elements of smart contracts is that they allow individuals to enter into a secure transaction and make a secured purchase or sale without the need for a central authority.


One way to think of smart contracts is as a traditional “if/when…then…” statement, so that when certain parameters are met, a transaction is completed with the security features needed. Smart contracts are also a great way for individuals to secure royalties for their work, as smart contracts can be attached to work in a way that any future purchase would result in payments going back to the royalty rights holder.




Summary

The Taproot update opens the door for smart contracts on the Bitcoin blockchain and it should improve the efficiency of transactions. This update improves the sustainability of the network and increases its competitive position relative to other crypto assets.


This article is a general communication being provided for informational and educational purposes only and is not meant to be taken as tax advice, investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions, inflation or US tax policy. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.


LEGAL, INVESTMENT AND TAX NOTICE. This information is not intended to be and should not be treated as legal, investment, accounting or tax advice.


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Copyright 2021. Monotelo Advisors Inc. All Rights Reserved

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