Bitcoin Layer 2s and Custody Tradeoffs

Multisig federations are the dominant model because they are the only practical way to achieve high throughput today. Protocols like Stacks and Liquid use a known set of signers to secure assets, creating a trusted execution environment that enables fast, cheap transactions.

The security-scalability frontier is rigid. To inherit Bitcoin's full security, a system like Drivechain requires a soft fork and a slow, on-chain challenge period, which throttles throughput. Conversely, a rollup like Merlin Chain scales by trusting a centralized sequencer and a proof system, creating a new security surface.

Client-side validation is the endgame. Proposals like BitVM and RGB push verification logic to the user, aiming for trust-minimized scaling. This shifts the custody burden to the user, requiring them to store and validate data, which is the ultimate decentralization tradeoff for scalability.

Custody defines security. The location of Bitcoin custody determines the L2's security model. Solutions like Lightning Network and RGB use client-side validation and cryptographic proofs, keeping assets under user control. Conversely, federated or multi-sig bridges used by Stacks or Liquid Network introduce a new custodial committee, creating a trusted third-party layer.

Trust minimization is expensive. Truly non-custodial L2s like Lightning require complex state channels and limit programmability to payment logic. To enable generalized smart contracts, protocols like Botanix or BOB adopt an EVM-compatible sidechain model, which necessitates a trusted bridge for Bitcoin deposits, trading absolute security for developer adoption.

The bridge is the bottleneck. The security of any custodial L2 collapses to its weakest bridge validator. This creates a single point of failure distinct from Bitcoin's Nakamoto Consensus. Projects mitigate this with economic staking (Babylon), fraud proofs, or leveraging existing federations (Liquid), but the trust vector remains.

Evidence: The Liquid Federation comprises 60 institutional members, a stark contrast to Bitcoin's permissionless validator set. Meanwhile, Lightning Network holds over 5,400 BTC in public channels, secured entirely by its underlying script and time-lock contracts without intermediary custody.

The security-scalability tradeoff is absolute. A Bitcoin L2 cannot be maximally secure, maximally scalable, and fully decentralized simultaneously. The core constraint is custody of user assets, which dictates the entire system's trust model and performance ceiling.

Multi-sig federations dominate for a reason. Solutions like Stacks and Liquid use a known, auditable set of signers because it's the only way to achieve high throughput today. This model outsources security from Bitcoin's proof-of-work to a social consensus, creating a trusted but efficient execution layer.

Drivechains represent the purist's gamble. Proposals like BIP-300 keep coins under Bitcoin's consensus but require a contentious soft fork. This offers maximal security inheritance but sacrifices immediate scalability and developer adoption, betting on long-term ideological alignment over short-term utility.

Hybrid models are the inevitable compromise. Protocols like Botanix and Merlin Chain blend elements: they use a multi-sig for fast asset movement but incorporate Bitcoin light clients for fraud proofs or periodic checkpointing. This creates a sliding scale of trust users can opt into.

The market votes for pragmatism. TVL and activity metrics show users prefer the functional compromise of federated models today. The winning architecture will be the one that makes the custody tradeoff explicit and lets users choose their own risk profile, not the one that pretends the tradeoff doesn't exist.