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Sector Brief - Extra Ordinary Bitcoin

May 16, 2023 ⋅  12 min read

Bitcoin – The Latest Casino

Ordinals and Inscriptions have brought about a resurgence of interest and enthusiasm for the Bitcoin ecosystem. Before we get into the newfound implications, let’s understand what these terms mean.

  • Ordinal Theory, as proposed by Casey Rodarmor, is an off-chain method of serializing or numbering individual sats (the smallest unit of bitcoin) using a First-In-First-Out algorithm. These numbered sats or Ordinals can then be tracked by any Bitcoin full node running Rodarmor’s open-source software, ORD. The numbers assigned to Ordinals can make them seem more valuable, for example, Ordinals with round number serials. They hold a similar appeal as fiat currency notes with special serial numbers (like 000001 or 999999), which can command a premium from collectors.
  • Inscriptions are a way to attach arbitrary data to the Bitcoin blockchain using the witness data section, which was introduced in the SegWit upgrade in 2017 and whose scope was expanded by the Taproot upgrade in 2021. This data can then be assigned to an individual sat using Ordinal Theory, making it a digital artifact that can be tracked and transferred. This would be similar to a currency note that has a drawing on it by a famous artist.

All Your Favorite Memes, Now on Bitcoin

Since any arbitrary data can be inscribed, multiple data types have been used in Inscriptions, including pictures, audio, video, and text. In its first wave, pictures or JPEGs were primarily being inscribed on Ordinals. Prominent collections include Bitcoin Rocks, Ordinal Punks, TwelveFold by Yuga Labs, BTC DeGods, and Taproot Wizards by Udi Wertheimer. These Inscriptions have been highly sought after, with individual pieces trading at tens of thousands of dollars.

A more recent invention, the BRC-20, is a fungible token standard that uses Inscriptions. BRC-20s have been the primary catalyst for the latest wave of activity on Bitcoin. Created on March 10, 2023, by domodata, BRC-20s now dominate Ordinal activity.

Although named similarly to the well-known ERC-20 tokens, BRC-20s are more limited in their scope. ERC-20s can be programmed; for example, holders of Lido's stETH programmatically receive daily yield earned by Lido’s validators. This is not possible with BRC-20s. BRC-20s are more akin to the meme coin implementation of ERC-20s, with their key stats being ticker, total supply, and creator.

While they are usually ignored by serious investors, meme coins are still an important part of crypto and represent considerable market caps. Dogecoin (DOGE) is the third largest payment chain by market cap, trailing only Bitcoin and Ripple. And Shiba Inu (SHIB) is the largest non-pegged ERC-20 token, ahead of Uniswap (UNI) and Chainlink (LINK).

The market cap of BRC-20 tokens is relatively small compared to other meme coins. ORDI, the first and largest BRC-20, has a market cap of just ~$250 million compared to SHIB’s $5 billion or PEPE’s $800 million. The comparison becomes even more stark when adjusted against the market caps of their respective parent chains. ORDI is just 0.05% of Bitcoin's market cap, whereas SHIB and PEPE are 2.3% and 0.4%, respectively.

BRC-20s may have comparatively smaller market caps because they are much earlier in their maturity and adoption cycle. The creator of BRC-20s considers it an experiment, and the tooling to create, buy, and sell BRC-20s is much more limited compared to other platforms. That being said, legendary collections like CryptoPunks and Autoglyphs also started off as experiments with limited tooling.

As expected, tooling and adoption for BRC-20s have started to grow. Multiple decentralized marketplaces and wallets have emerged, and centralized exchanges have begun listing some of the most prominent BRC-20 tokens.

Impact on Bitcoin

Whether BRC-20s have a future or not, they have already had a tangible effect on key blockchain parameters for Bitcoin.

Firstly, Bitcoin blocks are full again. This has historically predicted speculatory bubbles, with Bitcoin’s price crashing soon after. Bitcoin’s blocks were full or near-full during the peaks in the 2017 bull run, the 2019 revival, and the first bull run of 2021. However, this time may be different as blocks are filled with Inscriptions rather than BTC transactions.

Full blocks naturally mean high transaction fees. Thanks to Inscriptions, transaction fees on Bitcoin have increased significantly, and daily fees are at levels not seen since the 2017 and 2021 bull runs. On May 8, 2023, miners earned $17.4 million in transaction fees, making it the third-highest fee-generating day in all of Bitcoin history.

High fees are the salve to Bitcoin's long-term security budget problem. As Bitcoin's daily rewards halve every four years, there is a concern that Bitcoin's security budget will fall, leading to lower hash rate securing the network. Therefore, the network must move from a block rewards subsidy model to a transaction fee model to have a sustainable and secure future. With the rise in fees from Inscriptions, miners have begun earning a greater amount from transaction fees. On May 8, 2023, 42% of all miner rewards came from transaction fees, the second-highest contribution from daily fees in Bitcoin’s history.

Daily transactions recently hit all-time highs. On May 1, 2023, the Bitcoin blockchain recorded 685,000 transactions, the highest ever for any single day in its history. In fact, the top 11 transactions by day have all occurred within the last 15 days.

A similar pattern cannot be seen in active addresses. In fact, as fees spiked, active addresses fell over the last 15 days. A high transaction count with low active addresses would imply that Bitcoin is currently being used by power users who are creating and trading these Inscriptions.

The Future of Bitcoin

The Bitcoin community is split over what Ordinals and Inscriptions mean for Bitcoin. Traditionalists believe Bitcoin should only be used as decentralized money, and these new use cases are improperly using inadvertent bugs in the code. More progressive thinkers believe that expanding the use cases of the blockchain could solve its security budget problem and make it future-proof.

We are optimistic about these new implementations and use cases. While it is hard to argue that meme coins can sustain their hype over a long-term time frame, the first step to innovation is often speculation and mania. Large tech companies like Amazon and Microsoft participated in the tech bubble in 2000. Ethereum’s blue-chip DeFi products like Chainlink, Aave, and Synthetix also had roots in the ICO bubble of 2017. Moreover, the increased demand in L1 blockspace could lead to the adoption of L2s. For example, Binance only integrated Lightning after Bitcoin fees surged so high that Binance had to temporarily halt BTC withdrawals.

Bitcoin will likely always be decentralized money. But it can perhaps use a part of its blockspace to accommodate new and developing use cases. The current meme coin hype may bring more developers that create innovative new applications. Trustless Computer is working on creating Solidity-based smart contracts on Bitcoin and recently deployed a Uniswap fork on Bitcoin. There are also attempts at creating rollup infrastructure on Bitcoin which could give it even more programmability. These may, in turn, attract more users and developers to use Bitcoin, growing its adoption and securing its future.

Forks

Like any good open-source crypto project, multiple forks have already emerged for Ordinals and BRC-20s. ORC-20 is a new fungible token standard that addresses some of the shortcomings of BRC-20. Instead of BRC-20’s account-like model, ORC-20s use a UTXO-like model for tracking spends, lowering the risk of double spends. It also allows for greater flexibility in naming the coin.

Forks have also extended beyond Bitcoin. A fork of BRC-20 has come up on Litecoin called LTC-20. The same playbook is being repeated, and similar positive effects can be seen on-chain. On May 10, 2023, Litecoin set its all-time high for transactions and active addresses with 580,000 transactions and 830,000 active addresses, respectively.

Ethereum’s Finality Issues

Ethereum failed to finalize twice over the past week. This was a problem at the Consensus Layer which meant that liveness (i.e., the ability to post transactions on the Execution Layer) remained intact. However, without finality, there is a risk of reorg, which means off-chain settlements like exchange deposits and withdrawals cannot be processed. Since then, Prysm and Teku, two Consensus Layer clients, have pushed upgrades to make the clients more resilient to these issues in the future.

Chart Book

Market caps for all major protocols decreased across the board with the exception of Solana which was flat for the month. The largest fall was in the market cap of Optimism as it continued to lose market share to Arbitrum across all key metrics.

Ethereum had a huge surge in gas prices as meme coin speculation drove DEX activity. PEPE was at the center of the hype cycle, leading Uniswap to be the largest consumer of Ethereum gas. Ethereum’s gas prices naturally had a downstream effect on the gas fees of Arbitrum and Optimism.

The impact of meme coin mania was also felt in DEX volumes. Ethereum had the high absolute growth in DEX volumes to $1.6 billion. BNB Smart Chain had the highest relative growth in DEX volumes, growing by 163% to $747 million. The launch of PancakeSwap’s V3 implementation in conjunction with the token launches for Space ID (ID) and Open Campus (EDU) contributed to BSC’s DEX volume growth.

As prices have tumbled across the board, TVL fell in tandem. Arbitrum was the only one to buck the trend with a 7% growth in TVL to $2.4 billion dollars. It saw growth in TVL across all its major protocols — GMX, Radiant, Uniswap, and Aave.

BNB Smart Chain and Avalanche saw growth in their transaction activity even as all other chains saw a decrease. PancakeSwap’s V3 upgrade and token launches were the cause for BSC’s growth. Avalanche was the beneficiary of the increased interest in its native DEX, JOE, after it underwent an upgrade recently.

With nearly 1 million daily active transactions, Arbitrum overtook Ethereum in the number of transactions and now laps Optimism five times over.

Solana saw huge growth in active users, jumping to second place after BNB Smart Chain. The launch of Mad Lads NFTs likely contributed to this spike in user activity. Arbitrum continued its dominance over Optimism with six times as many daily active users, slowly inching up on Ethereum.

Stablecoins have continued to suffer as regulatory pressure increases. BUSD and USDC supply continues to shrink falling by 16% and 6%, respectively. BNB Smart Chain saw a huge increase in TUSD supply of 55%. TUSD has become Binance’s preferred stablecoin after the Securities and Exchange Commission served BUSD’s issuer Paxos with a Wells notice. Solana’s stablecoin supply growth was led by growth in USDT supply by 7%.

Despite regulatory pressure, stablecoins continue to be the most important application of crypto, with the highest number of active addresses of any app category. After stablecoins, the most popular application was DeFi, which saw significant speculative growth in active users after the recent meme coin craze. Social has become a more important use case and overtook NFTs as the third-largest app category.

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Kunal previously worked in equity research and now considers himself a financial analyst in crypto. He specializes in valuation and bottom-up analysis for Layer-1 and DeFi protocols because he has yet to learn of a way to value NFTs.

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About the author

Kunal previously worked in equity research and now considers himself a financial analyst in crypto. He specializes in valuation and bottom-up analysis for Layer-1 and DeFi protocols because he has yet to learn of a way to value NFTs.