What Are Overlay Networks?
Bitcoin overlay networks are special network layers built on top of the Bitcoin blockchain. These networks interpret transaction data in their own unique ways to provide additional services or functionalities beyond sending and receiving Bitcoin.
One type of overlay network solution proposed by Ty Everett (Project Babbage) is a UTXO-based overlay network known as Confederacy. UTXO stands for Unspent Transaction Output, the leftover bitcoin after a transaction has taken place. Using these UTXOs, the overlay network can track and manage states derived from the Bitcoin network in a decentralised manner.
What makes the Confederacy system unique is its concept of 'topics,' which are defined sets of data rules. When previous outputs are spent in new transactions, these data rules help determine which UTXOs become valid members of the overlay network. Thus, each 'topic' within the Confederacy forms its own unique overlay network.
These networks are highly secure as they rely on Bitcoin's built-in double-spend prevention mechanism. Essentially, users do not need to trust any centralised party, reducing the risk of fraud. Moreover, these networks are scalable, as users only need to keep track of transactions that are directly relevant to them.
Another innovative feature of these overlay networks is their Lookup Services. These services make it easy for users to find specific UTXOs within a topic by handling queries based on specific search criteria. This makes overlay networks not only a tool for transactions, but also a platform where various kinds of data can be stored, searched and retrieved efficiently.
Finally, the Confederacy system provides a monetization model for network node operators. By utilising a solution called PacketPay, operators can charge for the use of their overlay network and lookup services. This incentivizes more people to become node operators, promoting further decentralisation and network resiliency.
In summary, Bitcoin overlay networks, such as Confederacy, enhance the utility, security, and scalability of Bitcoin networks. They provide a means of storing, searching and retrieving data in a decentralised way, opening even more potential use cases and benefits for Bitcoin.