Bitcoin Upgrade: Taproot Could Lower Transaction Costs and Increase the Use of Smart Contracts (UPDATE)

Last Updated on June 18, 2021

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Bitcoin upgrades are rare. And for good reason. The one now underway, Taproot, is the first in four years. The last one, Segwit, led to a hard fork, thus earning it the title “the last civil war” and creating the separate Bitcoin Cash blockchain. 

Taproot Has Broad Support

But Taproot has broad support. It should lower transactions costs, increase the use of smart contracts beloved of crypto entrepreneurs, and improve privacy. To understand how it will do all that, let’s start with how crypto-coin blockchains work.

A public address has to prove that it has all the permissions necessary for a transaction. In the process, it uses a private key to provide a unique signature. The cryptographic proof is stored on the blockchain. Transaction fees are a function of the amount of space this takes up. Because of this feature of the system bitcoin is really on one level quite transparent. Someone who can decipher the cryptographic proofs in each block can follow transactions between addresses and can identify the user and the receiver.

It is possible to organize multi-party transactions. Self-executing (“smart”) contracts do routinely involve multiple parties.

Unfortunately, before Taproot, smart contracts require a lot of space on the blockchain. Transaction fees are a function of the space that a transaction uses. That means that smart contracts are very expensive.

Taproot, then, is an upgrade because it will combine the public keys of all the users participating in a smart contract to create a new key that will then have its own unique signature, one possible for that specific collection of addresses only.

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There are three great advantages offered by Taproot. First, an individual user’s public key signature is hidden within the single key of the smart contract, making the task of tracking a particular user’s activity more complicated. Photo credit: Shutterstock.com

Understanding the Advantages

These digital signatures were invented by a German mathematician, Claus Schnorr, in the 1970s, and they are named in his honor, Schnorr signatures.

Now we can understand the three great advantages offered by Taproot. First, an individual user’s public key signature is hidden within the single key of the smart contract, making the task of tracking a particular user’s activity more complicated. Second, the Schnorr signatures take up less space than the current method, known as the “Elliptic Curve Digital Signature Algorithm,” (ECDSA) which in essence has meant the retention of every user’s signature in the smart contract. Abandoning ECDSA means lowering fees.  Third, of course, there is the facilitation of smart contracts.

Bitcoin’s miners have approved of the introduction of Taproot. What remains is the Speedy Trial, a five-month period during which developers will be adding support for the Taproot “soft fork” leading to official activation in November.

A “soft fork” is a change to software protocol where previously valid transaction blocks are made invalid, but no previously invalid blocks are validated. Because old nodes will recognize the new blocks as valid, a soft fork is backwards-compatible. This contrasts with a more drastic event, the “hard fork,” in which previously valid blocks can become invalid and previously invalid blocks can be rendered valid, as happened in 2017 with Segwit.

Smart Contracts

Fred Thiel, the CEO of a a patent holding company that owns a good deal of IP relating to encryption, told CNBC,  “The most important thing for Taproot is…smart contracts.” He added that smart contracts are already “the primary driver of innovation on the Ethereum network. Smart contracts essentially give you the opportunity to really build applications and businesses on the blockchain.”

Jameson Lopp, writing at Casa Blog, predicts that as “wallet developers begin to take advantage of more complex scripting with Taproot  … we’ll see the development of novel redeem script conditions accelerate.”