This article was published in Bitcoin Magazine “The question of inscription.” Click here For your annual subscription to Bitcoin Magazine.
This article is based on data as of November 15, 2023. The data in this article was prepared by SQRR Research, https://sqrr.xyz
Bitcoin, not blockchain
Bitcoin, not blockchain. This has been a prominent meme throughout the past couple of eras, steering newbies towards a Bitcoin-only lifestyle, away from fraudulent “cryptocurrencies” promising more “blockchain technology.” However, here we are more focused than ever on blockchain technology. But this time it's different: the whole world is clearly focused on the Bitcoin blockchain. The driving force of this interest is a new meta-protocol – a protocol that rides on top of the Bitcoin protocol – called Ordinals. Ordinals are a new way to “name” individual satoshis from the Bitcoin UTXO pool, but perhaps more interestingly, they include a way to “record” data files to the Bitcoin blockchain. This article provides an analysis of how Ordinals will impact the demand for block space on the Bitcoin blockchain in 2023, and explores the challenges and opportunities presented by this development.
Technical overview of ordinal
Ordinals is a protocol installed on top of the Bitcoin protocol. It is made of two distinct parts: ordinal theory and inscriptions. Ordinal theory is a protocol for assigning serial numbers to satoshis, the smallest subdivision of Bitcoin, and tracking those satoshis as they are spent through transactions. This has led to some controversial conversations about fungibility as the market might give more value to one satoshi over another, but the market is gaining interest in this part of the Ordinals protocol. The second and primary focus of this article is on the inscriptions. Patterns allow random content to be attached to individual satoshis, turning them into native Bitcoin digital artefacts. Perhaps the easiest example to explain an inscription is to record (save) an image to the Bitcoin blockchain (a hard drive or mass storage database) and assign that image to a single Bitcoin Satoshi. This individual satoshi shows when the inscription was recorded in the blockchain, and this inscription, or that individual satoshi representing the image, can then be transferred from one person to another. Many people do not see the value in collecting or trading these coins and some go so far as to call the coins “spam” or a “denial of service attack” on Bitcoin, but a new market has emerged from the Ordinals protocol and this year has shown a significant impact on the shape of block space and demand. It and its cost. What's even more interesting are the possibilities that tokens bring to Bitcoin, some of which we'll discuss in more detail while many of which are yet to be conceived.
As Ordinals transitioned from a white paper at the end of 2022 to production in 2023, we have seen a significant increase in the growth rate of the Bitcoin blockchain. In February of this year, you can see that the daily growth trajectory of blockchain makes a noticeable change. It is important to note that the block size has not increased, rather more block space is being used every day. Blockspace limits the code in the Bitcoin protocol to about 4MB per block. This graph shows us that in February 2023, there was a significant spike in block space usage.
By zooming in on the chart, you can see in February 2023 the average block size increased in a meaningful way, which was attributed to the widespread use of the ordinal protocol. We'll dive deeper into block space in the next section, but the main takeaway is that the growth trajectory of block space has increased and this new demand doesn't look like it's going away anytime soon.
Blockspace Demand Analysis
The advent of ordinal arrangements has affected market demand through the limited supply of block space across inscriptions. These inscriptions take up bytes in each block, and the people registering the inscriptions pay the dynamic market price for that space. Since Ordinals did not yet exist in 2022, we only saw demand for block space from “economic” transactions. Now with the advent of rankings, we see “economic” transactions competing with inscriptions for block space. Because block space is scarce, only a very small number of bytes – and thus transactions – can be included in each block. Since patterns now require more of this space, the free market for block space does its thing and markets open every 10 minutes or so.
As we dive deeper into the impact of blockchains on Bitcoin's block space economics, we'll first look at the demand for block space in 2023. As we mentioned before, blockchains only started in 2023, so it's easy to see how these transactions are starting to take up space. In blocks.
In February, you can see where the rankings started to have a significant impact on block space. In January, we saw an average of 0.5MB of daily inscriptions added to the blockchain, but February during the rest of the year saw an average of 85MB of inscriptions added per day.
Economic impact
The economic implications of Ordinals are significant, especially in the context of transaction fees and miner revenues. Analysis of transaction fees in 2023 shows an upward trend affecting users and miners alike. Miners, in particular, have seen a notable benefit from this increase, as higher fees translate into greater revenues. In fact, over the past few years we have heard calls for the imminent failure of Bitcoin if fees are not increased in a meaningful way, and with Ordinals innovation we have seen fees increase significantly. During January 2023, we saw an average of 12.97 BTC paid in fees per day with 0.005 BTC generated from inscriptions. But from February to November 15, we saw an average of 44.22 BTC of fees per day, an increase of 240%, with 8.67 BTC of that coming from scribbles.
Considering that the total new Bitcoin mined daily is currently around 900 BTC, total transaction fees make up only 4.5% of miners' revenue. While this is not enough revenue to move the needle for small and medium-sized miners, this is important for industrial-scale miners who have the added benefit of lower energy costs due to large-scale purchasing. You can see a direct correlation with the hash price and transaction fees, specifically in May 2023. The rest of the chart does not show an exact correlation, mainly because the hash price is a function of the Bitcoin price in USD and the total network difficulty. We know that when mining becomes more profitable, additional miners are brought on board to take advantage of the increased revenue, and this year has seen massive growth in mining difficulty from 252 exahashes/s in January 2023 to 457 exahashes/s in November 2023 — an 81% increase in A little less than a year.
Future expectations and repercussions of the halving
As we approach the halving in April 2024, it will be interesting to see what happens to block space dynamics as daily mining supply is halved. How could a hypothetical rise in the price of Bitcoin make Bitcoins more valuable? Will we see continued demand for engravings or will they become too expensive in US dollars? Another thing to consider is the emergence of new data markets within the Bitcoin ecosystem that have the potential to bring new applications and future uses of the Bitcoin block space, beyond traditional transactions and engravings. Ordinals' ability to store different types of data and develop markets for this data opens up exciting possibilities for the future, ranging from digital art storage to complex data applications, signaling a new era in the Bitcoin Blockspace.
What's interesting to think about is what happens to fees and subsidies leading up to the halving in 2024 and beyond. We saw earlier that if you calculate the average daily revenue from transaction fees plus registration fees, this equals about 4.5% of miners' daily revenue. But what happens after the halving? What happens if we live in a vacuum and keep fees constant until the halving in 2028?
If we continue with the current clip, you see that transaction fees become more important to mining revenues after the fourth halving and hold significant value in the post-halving environment in 2028. It is difficult to imagine block space demand remaining constant over the halvings, and using current demand is quite conservative. This also reduces the importance of inventing new ways to use block space that we have not yet imagined.
The markets are clear
In conclusion, the emergence of ordinals has fundamentally reshaped the Bitcoin blockchain, representing a major shift in both the artistic landscape and economic dynamics. As we delve deeper into this new world of Bitcoin development, we must consider the broader implications of ordinal numbers and new uses of block space and their potential impacts. As the next halving approaches new supply complexities, the role of rankings in shaping Bitcoin's future becomes more interesting. In my view, this is an exciting chapter in the blockchain saga, full of uncharted territories and enormous potential. This is not about JPEG files; It's about a censorship-resistant free market. As the Bitcoin protocol continues to evolve, it remains to be seen how the market will adapt to these changes and what other new uses for block space will emerge. One thing is clear: the journey ahead will be strange and unexpected. But ultimately, the markets are clear.
This article was published in Bitcoin Magazine “The question of inscription.” Click here For your annual subscription to Bitcoin Magazine.