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  • Writer's pictureThomas Hall

Bitcoin Ordinals and BRC-20 Tokens

Updated: Feb 15

The creation of Ordinals protocol and the BRC-20 token standard has added a new use case for the Bitcoins blockchain: no longer just a secure store of value, now also a secure registry of Bitcoin-based NFTs or digital collectables. The Trovio investment team believes the fact that market forces drive this application of the Bitcoin blockchain are reasonable (a free market efficiently allocates resources) but temporary as market forces will also drive the use case back to the higher value propositions. These innovations, nonetheless, may have potential positive externalities for the Bitcoin community.

An increased scope of the blockchain’s use cases could spur further Layer-2 protocol innovation - potentially increasing transaction speed and lowering costs. Bitcoin-based NFTs are in their infancy and have caused some near-term network disruptions; however, this development reinforces the thesis that the evolution of distributed ledger technology could be a catalyst for further adoption that may become exponential at any point in time.

In recent weeks, congestion in the Bitcoin network has sharply increased transaction fees and caused the suspension of withdrawals by the world’s largest exchange, Binance. The unexpected surge, pushing main chain transactional volume past prior all-time highs, has been largely driven by the recent implementation and proliferation of Ordinals and the BRC-20 token standard. A closer look at Ordinals, the BRC-20 token standard and block space will help explain the impact to the Bitcoin network.

The Bitcoin Ordinals protocol was launched in January 2023 allowing for the first Bitcoin-based NFTs. The launch is significant because the Bitcoin blockchain has traditionally been seen as unsuitable for NFTs due to its limited scripting language and block capacity. However, following the rollout of Taproot and the subsequent Ordinals protocol, developers have been able to inscribe small pieces of data to a bitcoin transaction providing additional information and functionality.

Recently, a Bitcoin based token standard complementing the Ordinal protocol was released, known as the BRC-20. It is a fungible token that was specifically created for the Bitcoin blockchain and uses Ordinal inscriptions to deploy token contracts allowing network participants to mint and transfer tokens. Tokens can be attributed to Satoshi’s (smallest unit of a Bitcoin) and then traded or swapped with others in a similar vein to Ethereum’s ERC-20 token standard. BRC-20 tokens have become popular as they have provided an approachable method for users to transfer assets via the Ordinals protocol.

Although the ability to inscribe arbitrary data to a Satoshi may seem trivial, this new use case has gained popularity over the past month resulting in BRC-20 and Ordinals accounting for over 50% of total Bitcoin transactions as of May 10th.

The increased demand for available block space has also resulted in transactional fees rising to over 40% of total block rewards, a welcome reprieve for miners following a tumultuous 2022. The Bitcoin network uses a market-based system to determine which transactions are included in the next block. Miners will always prioritize transactions with the highest fees, i.e., carrying the most immediate economic benefit. This means that users who want their transactions to be confirmed quickly must pay higher fees.

Accordingly, more transactions that have yet to be confirmed can become stuck in the mempool, a temporary transaction storage area, if they do not offer high enough fees to incentivize miners to include them in the next block. The chart below shows how heightened volumes driven by BRC-20’s compared with the mempool’s recent history.

In the traditional proof-of-work mining model, miners receive a block subsidy for successfully mining a block of transactions. As described in our recent piece on the Bitcoin Halving, the block subsidy is cut in half every 210,000 blocks. This ever-decreasing pool of total rewards is supplemented by transactional fees which become an increasingly important source of miner revenue. The decreasing block subsidy has been a point of contention in recent years, causing many to believe network adjustments will be necessary as miners lose the block subsidy incentive to participate, resulting in centralisation and decrease in total hash rate

The increased demand for block space following the implementation of Ordinals and BRC-20 has proven fees are an important source of income for miners.

Bitcoin block space is a scarce commodity and over the past decade, the value of block space and the luxury of its availability has arguably been underappreciated. The main Bitcoin use cases have been as a store of value and for larger financial transactions. As the adoption of Bitcoin as a global settlement layer grows and larger transactions increase, monetarily smaller inefficient uses of block space, such as Ordinals & BRC-20’s, will be priced out by the larger financial transactions where layer 1 security is imperative. Smaller transactions will need to be enabled by layer 2 scaling solutions such as the Lightning network. Greater activity is incentivizing innovation in layer-2 protocols that benefit not just Ordinals & BRC-20's but other peer-to-peer payments and small transactions. On the other hand, a central argument from Bitcoin sceptics is that Bitcoin's cost per transaction makes it unsuitable as a transactional exchange of value. The emergence and sudden popularity of the Ordinals Protocol & BRC-20's is spurring innovation that might solve this critique

Free market forces will continue to decide the best use of Bitcoin’s scarce block space. The increasing network utilisation and the resulting fees will support miners in the future and have the positive externality of preventing any unnecessary alterations to block size or Bitcoin’s sanctified hard cap.

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