Bitcoin (BTC), the oldest and largest cryptocurrency network, is dealing with a controversial new feature that has divided the community.
The launch of the Bitcoin Ordinals protocol in 2023 led to an increase in Bitcoin transaction volume. Described by some as Bitcoin NFTs, Ordinals brought a new type of application to the Bitcoin network that immediately resonated with users.
However, it has caused controversy because it both causes network congestion and is not designed as a payment solution.
Bitcoin is a decentralized, encrypted, decentralized digital currency transfer network that uses blockchain technology, which allows permissionless peer-to-peer transactions without the use of intermediaries.
It was created in 2008 by anonymous creator Satoshi Nakamoto and released as open source software in 2009.
The Bitcoin network has utility as a medium to facilitate private transactions, and it has been used for peer-to-peer payments, POS merchant sales, and online payments.
It is also used for investment, with the asset that powers the network, Bitcoin, or BTC, having a value proposition similar to digital gold.
It has a limited supply of 21 million coins, so it has scarcity, it is also very secure, and has a hard-coded release schedule.
What is Bitcoin Sat?
The Ordinals Theory, which powers the controversial new Ordinals protocol, defines sats as atomic units that can be individually identified and transacted on the Bitcoin network, with 100 million sats for 1 Bitcoin.
Bitcoin sats are sorted according to the order in which they were mined, and this sorted number that uniquely identifies a satoshi is the ordinal number.
These sats are uniquely identifiable and can therefore be inscribed with digital content, a feature that is central to the Ordinals model.
Once inscribed, Ordinal-powered sats become immutable digital collectibles that can be attached to images, text, and a variety of other assets.
Ordinals were enabled by the November 2022 Taproot upgrade, which enables the Ordinals protocol and opens the door to issuing fungible or non-fungible tokens on the Bitcoin network.
Ordinals can play a role in many different use cases. They are primarily used to create non-fungible tokens (NFTs), but are now becoming increasingly popular as a way to issue fungible tokens. Ordinals support the BRC-20 standard, which is similar to Ethereum’s popular ERC-20 standard.
Since the 3rd week of April, the total number of Ordinals has exploded, with approximately 250,000 new Ordinals being created every day, and over 7 million inscriptions now in the wild.
Bitcoin Ordinals Clog the Network
The emergence of Ordinals had a clear impact on the wider Bitcoin protocol; while it boosted transaction activity and increased demand for interacting with Bitcoin, it also bloated the network to the point of being unable to function.
Bitcoin’s scalability has once again come into question, with Ordinals now impacting Bitcoin’s ability to fulfill its primary function of peer-to-peer payment transactions.
One of the factors that causes Ordinals to bloat the network is the size of NFTs, Ordinals interactions are layered and can require close to Bitcoin’s 4mb maximum capacity, with standard Bitcoin transactions taking up only a few kilobytes.
The reason Ordinals NFTs scale so well is that they store data directly on-chain, rather than pointing to separate physical assets.
With the launch of BRC-20, Ordinals further advance Bitcoin
Glassnode recently reported that for the fifth time in history, the average fee per block exceeded the block subsidy.
The last time this happened was during the market peak in 2017, and in all five historical cases, high fees eased and the network normalized.
Glassnode said the surge in fees was driven by the popularity of the BRC20 standard supported by the Ordinals protocol.
Transaction fees amounted to 6.66 BTC, far higher than the block reward of 6.25 BTC, which brought the total miner reward to a staggering 12.9 BTC per block or about $348,000.
BRC-20s were created by anonymous developer Domo, and they are similar to Ethereum’s ERC-20 custom token model, but are not backed by smart contracts.
This means they cannot be plugged into decentralized applications or have multiple functions like Ethereum tokens, and users can currently only mint, deploy and transfer tokens.
Not all Ordinals are BRC20s, but all BRC20s are Ordinals, and while there are millions of Ordinals, there are approximately twenty-five thousand BRC20s, with the market cap of BRC20s quickly rising to approximately 462 million.
BRC20s use JSON to initiate simple token contracts, create new tokens, and move tokens. Their limited functionality means they have become a popular way to issue Meme tokens, which are designed to have no utility and act more as community badges. Some of the largest BRC20s include PEPE, MEME, and BRUH.
Ordi — the largest BRC20 — has a market cap of around $306 million and is listed on exchanges such as Crypto.com and Gate.io.
BRC20 and Ordinals have been controversial for the strain they put on the network, with opponents arguing that Ordinals are polluting the network because they are inconsistent with Satoshi’s version of a peer-to-peer decentralized remittance network, and they view Ordinals transactions as spam.
The most well-documented limitation of Bitcoin’s proof-of-work network consensus is its lack of scalability. Blockchains like Bitcoin face scaling challenges because every node in the network must verify and execute every transaction, which is computationally intensive and expensive.
Different Scaling Methods - The Main Bitcoin Layer 2
Ordinals are here to stay, at least in the short term, and there is another way to solve congestion and scaling problems besides blocking protocols — Layer 2 technologies.
Original base layer technologies like Bitcoin and Ethereum have faced historical challenges scaling and collapsing when put under stress, which has led to the construction of layer 1 and layer 2 infrastructure.
Layer 1 protocols such as Bitcoin and Ethereum can serve as a base layer for interacting with third-party Layer 2 protocols, which remove the computational load from the base chain and let it handle tasks such as verification and finality.
Lightning Network
The Lightning Network is Bitcoin’s layer 2 that buffers the network during times of congestion. The concept for the Lightning Network began in 2015 when Joseph Poon and Tadge Dryja began working on a solution to the Bitcoin network’s high fees, a key pain point for blockchain users.
In January 2016, the Lightning Network whitepaper was released and developers began working on a layer 2 solution driven by the Satoshi Vision and focused on payment channels.
Within a few years, a beta version of the Lightning Network was released, a protocol that, at its core, creates a peer-to-peer payment channel between two points on the Bitcoin network.
Once a channel is established, parties can conduct an unlimited number of transactions cheaply and quickly, making it useful for small payments that would otherwise be plagued by high fees and latency on base-layer Bitcoin.
Only interactions such as channel opening and closing are recorded on the Bitcoin main chain. Lightning Network nodes can verify transactions between peers within the channel, which frees up the capacity of the main Bitcoin network nodes. The Lightning Network has the additional benefit of reducing the output of the Bitcoin environment.
The Lightning Network is also able to route transactions by combining channels of related payments. It can also merge transactions, which is when two channels choose to complete a transaction. All transactions are recorded and then sent to the Bitcoin mainnet.
The number of channels and the amount of Bitcoin associated with the Lightning Network rose sharply in 2022 but have stagnated somewhat so far in 2023.
The Lightning Network ecosystem has a variety of tools for node management, wallets, payments, and games designed to increase functionality. They include:
Mining pools: They help manage the liquidity needs of Liquid users;
Taro: A tool for issuing or minting assets on the Lightning Network;
Faraday: Data analysis tool that helps node operators optimize channels and capital flows;
Lightning Network Daemon: Lightning Network node implementation tool;
Neutrino: A light client specification that allows non-custodial Lightning wallets to verify transactions privately, trustlessly, and fully synchronized with the Bitcoin blockchain.
Stacks Solution
Stacks is another layer 2 blockchain solution that connects to Bitcoin through a unique “Proof of Transfer” (PoX) model. Stacks aims to increase the utility of Bitcoin by allowing computationally intensive activities such as smart contracts and decentralized applications (Dapps). Stacks has a native token, STX, which is designed to align incentives within the network.
Founded in 2013 as Blockstacks before rebranding in 2020, Stacks was founded by Muneeb Ali and Ryan Shea, who met in the computer science department at Princeton University.
The first version of Blockstacks focuses on replacing the reliance on centralized cloud service providers in the smartphone and browser application market. It is a decentralized identity data storage solution that utilizes the Bitcoin blockchain.
In January 2021, the Stacks 2.0 mainnet was launched, allowing users to deploy smart contracts and decentralized applications (Dapps) on the Bitcoin blockchain.
A key selling point of Stacks is its unique “Proof of Transfer” (PoX) consensus mechanism, which is directly linked to the Bitcoin blockchain. PoX requires miners to spend Bitcoin to participate in miner elections and create new blocks on the Stacks blockchain. PoX has a one-to-one relationship with Bitcoin.
Miners send BTC to set up addresses for a chance to validate transactions and mine the next Stacks block, essentially bidding with BTC for a chance to mine the next Stacks block.
The PoX model is similar to the Proof of Burn (PoB) mechanism used by projects such as Slimcoin, except that unlike PoB, which sends Bitcoin to a destruction address, PoX sends BTC to STX stakers.
The model means that Stacks validators compete based on bid Bitcoins, rather than computational resources, like the proof-of-work model of the Bitcoin base chain.
Scaling PoW without incurring higher energy consumption, higher costs, and waiting is extremely challenging, PoX aims to be a scaling system for the Bitcoin network, which depends on the Bitcoin output of each block.
Stacks differs from the Lightning Network in that it is not designed as a peer-to-peer payment solution, but rather focuses on creating an extension of Bitcoin that allows Bitcoiners to interact with smart contracts and dapps.
In this sense, it is less consistent with the original Bitcoin vision than other scaling solutions.
However, solutions like Stacks seem inevitable, and as Bitcoin supporters observe the flow of money into smart contract-driven industries such as NFTs and GameFi, they may want to get a piece of the action.
Year-to-date, STX is up an impressive 204%, outperforming many other digital assets, with BTC up around 63% during the same period.
Ck-BTC
Brave New Coin recently interviewed Dominic Williams from the DFINITY Foundation (a major contributor to the Internet Computer) about Ck-BTC, a unique new implementation of layer 2 Bitcoin.
ckBTC is a version of Bitcoin built on the Internet Computer, a multi-chain Bitcoin "twin" that is 1:1 cryptographically secured with the real Bitcoin. It is created by a pair of open source, verifiable smart contracts that allow cross-chain transactions to remain completely decentralized.
The Internet Computer is a blockchain network and a set of protocols that allow independent data centers around the world to come together and provide a decentralized alternative to current centralized Internet cloud providers.
Williams said that thanks to chain key ECDSA and threshold cryptography, “Internet Computer smart contracts can create their own Bitcoin addresses and sign Bitcoin transactions on the Bitcoin network, which is a key difference. There are no chain bridges or centralized custodians involved. ICP is one of the first blockchains to have direct integration with other blockchains.”
In 2022, the DFINITY R&D team developed the ICP framework by designing a new threshold ECDSA (Elliptic Curve Digital Signature Algorithm) protocol, which can communicate directly with other blockchains such as Bitcoin and Ethereum.
The protocol, detailed in its research paper, is designed in a trustless manner using a cryptographic multi-party protocol to compute ECDSA signatures, with the container smart contract controlling the ECDSA signing keys on a public blockchain.
ckBTC allows Bitcoin transactions to be integrated into various smart contract-based decentralized applications, including the messaging app OpenChat.
“Every OpenChat account doubles as a crypto wallet, meaning OpenChat users can send ckBTC as an instant chat message. If you forgot a friend’s birthday or need to reimburse someone for dinner, you can just send them a message with ckBTC attached and they’ll receive it instantly. ckBTC can always be redeemed for BTC, there will never be liquidity issues or bridge holes,” Williams explained.
Williams also said that the prosperity of the Ordinals protocol has become an opportunity for products such as ckBTC. “Multi-chain solutions like ckBTC allow the Bitcoin network to operate normally, and Ordinal NFT is becoming more and more popular. I think this is positive. We hope that more people will use blockchain technology. The solutions we have now can satisfy more than just one use case.”
Williams also explained that his team is working on building a Bitcoin Ordinals marketplace that will use ckBTC as a payment method.
Liquid
Liquid is a scaling solution created by Blockstream in 2018. Blockstream and Liquid are famous because they were founded by Adam Back, a famous cryptographer and cypherpunk.
Liquid differs from solutions like Stacks in that it is built “on top of” Bitcoin, rather than alongside it.
Liquid has a consensus mechanism separate from Bitcoin and has nodes that are kept at an arm’s length from the network, and like other sidechains, it offers faster and cheaper transactions than those available on the base layer, Bitcoin.
The Liquid sidechain is a federated blockchain, and unlike PoW, where computational proofs regulate the network, a group of bad-behavior censors called the Liquid Worker govern the Liquid blockchain, a federation of members geographically and geopolitically dispersed around the world.
Federation members are vetted by three separate committees, all staffed by independent companies and required to use specific hardware and encryption tools.
There are currently 15 Federators, or Liquid workers, managing the network, and a recent update called Dynamic Federations allows the number of federations to expand further. Code updates to the blockchain network must be approved by Liquid workers.
Workers validate all transactions on Liquid, and they also have a secondary purpose, which is to protect the Bitcoin units held by the network.
When a user wants to interact with Liquid, they need to issue L-BTC or Liquid-Bitcoin and BTC needs to be transferred from the mainchain to the Liquid sidechain.
Real BTC units are frozen on the main chain until they are redeemed, where they remain in the sidechain. When this happens, L-BTC is removed and Bitcoin is released. In addition to L-BTC, Liquid is also able to issue other security and custom tokens backed by Bitcoin.
Liquid users, similar to layer 2 solutions like Polygon, don’t need to interact directly with the base chain very often, and similar to solutions like Stacks, it is designed more as an extension of Bitcoin, enabling it to complete more complex transactions like asset issuance.
in conclusion
The emergence of the Bitcoin Ordinals protocol in recent weeks has ushered in a new paradigm for the Bitcoin network, and this time, like the previous ones that led to events like the greater block debate and Segwit, is filled with promising opportunities but also daunting challenges.
One of the key opportunities presented by Bitcoin’s layer 2 ecosystem is solutions designed to help it address its scaling challenges, which Bitcoin needs now more than ever given the influx of new transactions that impact the network’s user experience.
However, as with any innovation, it is important to understand the potential trade-offs and challenges ahead, and Layer 2 solutions are often viewed as disruptors to a decentralized network.
Potentially, investment and development that would otherwise go into Bitcoin could go into Layer 2 solutions, which some argue would harm the main chain.
Many layer 2s create competition for value, while ideally all value should flow into Bitcoin.
Bitcoin, currently the gold standard of cryptocurrencies, may have to continue to deal with high transaction demand, either because of hype periods like the one created by the Ordinals protocol, or simply because Bitcoin naturally becomes more popular as a payment medium.
Bitcoin may have to adapt and innovate further, and utilizing layer 2 solutions like the Lightning Network, Stacks, ck-BTC, and Liquid may be key to solving the network’s current scaling issues, optimizing transaction costs, and ensuring growth and expansion.
As Bitcoin continues on its journey, the lessons learned from the Ordinals incident will undoubtedly be invaluable in shaping its future.
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