Bitcoin just got its first makeover in four years – CNBC

The first bitcoin upgrade in four years has just been approved by miners around the world. It is a rare moment of consensus among stakeholders, and crypto experts tell CNBC it's a pretty big deal for the world's most popular cryptocurrency.

The upgrade is called Taproot, and it's due to take effect in November. When it does, it will mean greater transaction privacy and efficiency and crucially, it will unlock the potential for smart contracts, a key feature of its blockchain technology which eliminates middlemen from even the most complex transactions.

"Taproot matters, because it opens a breadth of opportunity for entrepreneurs interested in expanding bitcoin's utility," said Alyse Killeen, founder and managing partner of bitcoin-focused venture firm Stillmark.

Unlike bitcoin's 2017 upgrade referred to as the "last civil war" because of the contentious ideological divide separating adherents Taproot has near universal support, in part because these changes are fairly incremental improvements to the code.

Bitcoin's makeover has to do with digital signatures, which you can think of as the fingerprint an individual leaves on every transaction they make.

Right now, the cryptocurrency uses something called the "Elliptic Curve Digital Signature Algorithm," which is created from the private key which controls a bitcoin wallet and ensures that bitcoin can only be spent by the rightful owner. Taproot will switch over to something known as Schnorr signatures, which essentially makes multi-signature transactions unreadable, according to Alejandro De La Torre, vice president at Hong Kong-headquartered major mining pool Poolin.

In practice, that means greater privacy, because your keys won't have as much exposure on the chain. "You can kind of hide who you are a little bit better, which is good," said Brandon Arvanaghi, previously a security engineer at crypto exchange Gemini.

It won't translate to greater anonymity for your individual bitcoin address on the public blockchain, but it will make simple transactions indistinguishable from those that are more complex and comprised of multiple signatures.

These souped-up signatures are also a game changer for smart contracts, which are self-executing agreements that live on the blockchain. Smart contracts can theoretically be used for practically any kind of transaction, from paying your rent each month, to registering your vehicle.

Taproot makes smart contracts cheaper and smaller, in terms of the space they take up on the blockchain. Killeen says that this enhanced functionality and efficiency presents "mind blowing potential."

Currently, smart contracts can be created both on bitcoin's core protocol layer and on the Lightning Network, a payments platform built on bitcoin, which enables instant transactions. Smart contracts executed on the Lightning Network typically lead to faster and less costly transactions.

"Lightning transactions can be fractions of a penny...while a bitcoin transaction at the core protocol layer can be much more expensive than that," explained Killeen.

Developers have already begun to build on Lightning, in anticipation of the upgrade, which will allow for highly specific contracts.

"The most important thing for Taproot is...smart contracts," saidFred Thiel, CEO of cryptocurrency mining specialist Marathon Digital Holdings. "It's 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."

As more programmers build smart contracts on top of bitcoin's blockchain, there is also the potential for bitcoin to become more of a player in the world of DeFi, or decentralized finance, a term used to describe financial applications designed to cut out the middleman.

Today, ethereum dominates as the blockchain of choice for these apps, also referred to as "dapps."

Though the bitcoin community has agreed to the upgrade, the rollout itself won't happen until probably November. A lot of testing ahead of time will reduce the likelihood of something going wrong during an upgrade.

"Upgrades allow the extremely remote possibility of a bug entering the system, which would destroy confidence in the whole cryptocurrency system, effectively wiping it out a 'self-inflicted wound' if you like," said Jason Deane, an analyst at Quantum Economics.

Deane says this is why upgrade processes are so carefully tested, retested, and vetted, again and again, over very long periods of time, prior to being deployed.

Many also remember the disastrous migration of 2013, when an upgrade gone wrong resulted in bitcoin temporarily splitting in half.

"You don't want different clients or miners in the protocol out of sync. That's how catastrophic stuff happens," Nic Carter,founding partner at Castle Island Ventures, told CNBC. "Because we don't want a repeat of 2013, we have these extremely long lead times."

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Bitcoin just got its first makeover in four years - CNBC