The first Bitcoin upgrade in four years, the long-awaited Taproot has been activated and it promises to improve transaction privacy and efficiency and unlock the potential for smart contracts, which can be used to eliminate middlemen from transactions.

As more programmers build smart contracts on theblockchain, Bitcoin hopes to become a bigger player in decentralized finance (DeFi) — blockchain-based financial applications that do not rely on traditional intermediaries such as brokerages, exchanges, and banks for personal finance. Instead, DeFi apps use smart contracts on blockchains. The most common one is Ethereum, the No. 2 cryptocurrency on the market after Bitcoin.

A big part of the Taproot upgrade involves digital signatures, which are like a fingerprint that a Bitcoin user leaves on every transaction. Right now, Bitcoin uses something called the “Elliptic Curve Digital Signature Algorithm,” which creates a signature from the private key that controls a Bitcoin wallet. It ensures that Bitcoin can only be spent by the rightful owner. Taproot will add something known as Schnorr signatures, which essentially makes multi-signature transactions unreadable, according to CNBC.

It won’t mean more anonymity for your individual Bitcoin address on the public blockchain, but it will make simple transactions indistinguishable from more complex ones — often called smart contracts — that comprise multiple signatures.

“You can kind of hide who you are a little bit better, which is good,” said Bitcoin mining engineer Brandon Arvanaghi, who runs Meow, a company that enables corporate treasury participation in crypto markets. 

“Bitcoin works with an unprecedented level of transparency that most people are not used to dealing with. All Bitcoin transactions are public, traceable, and permanently stored in the Bitcoin network,” according to Bitcoin.org.

This is potentially a game-changer on the Bitcoin blockchain for smart contracts — self-executing agreements that could theoretically be used for any kind of transaction, from paying your monthly rent to registering your car.

The Taproot upgrade was locked in five months ago when more than 90 percent of Bitcoin miners signaled their support for it. A programmed waiting period between lock-in and activation has since given node operators and miners time to fully upgrade to the latest version of Bitcoin Core, 21.1, which includes the merged code for Taproot, Coindesk reported. So far, just more than half of known Bitcoin nodes are signaling support for the upgrade. The rest are running old software. Only once they upgrade will they be able to enforce the new rules making it possible to use the new type of transaction.

Users won’t be able to send or receive the new type of transaction until their Bitcoin wallet supports it – and most wallets don’t support it yet. Wallet developers must write new code for their wallets to make such transactions possible.

Upgrade processes are carefully tested, retested, and vetted over long periods to prevent 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.

During a disastrous 2013 migration, an upgrade went wrong that resulted in Bitcoin temporarily splitting in half.

Coindesk described Taproot as “a melting pot of various technical innovations throughout Bitcoin’s history into one upgrade” — part of a larger effort by developers around the world to improve Bitcoin’s privacy because its transaction history is public. A user can look up any transaction ever sent on Bitcoin on a public block explorer such as Mempool.space.

This will still be the case with Taproot, but details of smart contracts will be able to be hidden. 

Listen to GHOGH with Jamarlin Martin | Episode 74: Jamarlin Martin Jamarlin returns for a new season of the GHOGH podcast to discuss Bitcoin, bubbles, and Biden. He talks about the risk factors for Bitcoin as an investment asset including origin risk, speculative market structure, regulatory, and environment. Are broader financial markets in a massive speculative bubble?