We owe the topic of today’s discussion to Casey Rodarmor. On January 20, 2023, he announced a new feature called inscriptions and introduced it to the Bitcoin mainnet. This caused heated debate among different groups of Bitcoin users on Twitter. While some enthusiasts believe that this will be a solution to the security budget concern, others think that significant challenges remain to be overcome.
The analysts at Grapherex have prepared an overview of what this means to the crypto space and how Bitcoin Ordinal NFTs could potentially fix Bitcoin’s security budget. The overview is based on the daily digest of the most important developments in blockchain and crypto news posted on the CoinDesk website.
Bitcoin’s Security Budget Relies on Transaction Fees
Let’s start with how the system was organised before the introduction of Bitcoin NFTs. Currently, transaction fees make up a substantial part of miners’ revenue.
Miners are responsible for processing and validating transactions on the Bitcoin network, thus securing it. Network users who want to process transactions quickly pay fees. Miners, who include those transactions in the next block they mine, collect these transaction fees. They also receive block rewards — newly minted Bitcoins for each new block; however, the block rewards are programmed to decrease over time and will sooner or later reach zero, which means that transaction fees will become the only source of income for miners.
Since decreasing block rewards could compromise the security of Bitcoin, transaction fees will become a major component of its security budget. But would maintaining the transaction fees we have right now be sufficient to continue encouraging miners to keep the system strong and functional? Some don’t believe so, and then there’s a need to add a new source of demand to the Bitcoin network.
The Ordinal Protocol Explained
Rodarmor’s tweet referred to the Ordinal protocol. This is a modification to the Bitcoin protocol that allows users to attach arbitrary data to individual units of Bitcoin, called satoshis or sats. The protocol assigns a unique sequential number to each satoshi, making it easier to navigate.
Now you can inscribe sats with any kind of data, including messages, images, and files. The only restriction is not to exceed the 4-megabyte block size limit. If you thought this sounded like NFTs, you’d be right.
The ability to attach arbitrary data to sats has several potential use cases, like creating decentralised digital identity systems, proving the existence of files at a particular time, and creating decentralised messaging platforms.
NFTs on the Bitcoin Blockchain
NFTs are unique digital assets created on the blockchain. Initially, they were designed to protect the copyright of their owners. Between 2020 and 2022, the idea developed at a whole new level, making NFTs more popular than ever.
With this in mind, blockchain specialists who work with the Bitcoin network decided to introduce Bitcoin NFTs based on the Ordinal protocol. They are supposed to increase users’ involvement and demand, generating a rise in transaction numbers. The more transactions are executed, the more fees go to miners. Also, since Ordinal NFTs involve unusually large sums, they’ll almost always generate larger fees than conventional peer-to-peer transactions. And Bitcoin’s security budget will grow.
However, some influencers don’t like the idea of creating NFTs on this blockchain — there are concerns about illegal data inclusion and chain bloat (the blockchain gets too large to function normally). Others think it will be great to implement this new feature as long as it follows Bitcoin’s concepts. Illegal data inclusion is technically possible but unlikely due to the technical requirements and the transparent nature of the blockchain. Chain bloat is also a minor problem, thanks to advances in hardware.
How NFTs Could Attract Users to the Bitcoin Ecosystem
There are three main ways that Ordinal NFTs could positively influence the Bitcoin network. The first and most important thing is that by creating a new source of demand for blockchain, Bitcoin NFTs indirectly increase the total fees paid to miners. This will potentially boost the network’s security.
Secondly, NFTs can be a gateway for those interested in digital art and collectables but don’t yet know much about Bitcoin. New creators and traders then become more familiar with the technology and may start using Bitcoin for other purposes as well. This will add value to the Bitcoin ecosystem.
Thirdly, NFTs bring in new investors and users, which could increase the global adoption of Bitcoin. For more than two years already, NFTs have been mainstream, so the visibility of Bitcoin could also rise. This will attract even more people interested in investing in crypto assets to consider this particular chain.
Bitcoin NFTs and the Security Budget Problem: The Main Challenges
We know that many solutions to one problem may cause even more problems in related areas. In our case, there are also some challenges associated with using NFTs to support Bitcoin’s security budget. In theory, the plan we discussed above may fall apart, as there is a possibility that users won’t pay higher fees for NFT transactions on the Bitcoin network.
According to Colin Harper, head of content at Luxor, the impact of ordinal NFTs on Bitcoin transaction fees isn’t straightforward. Since these NFTs benefit from the SegWit data discount, blocks full of them could have lower fees. Only if a large number of users start inscribing ordinal NFTs and competing for blocks with those who make regular transactions will the fees for both types increase. Here, miners will prioritise transactions with higher fees per byte of data.
Bitcoin’s security budget concern is not yet solved due to the size of the Bitcoin NFT market (rather small), the additional fees users would be prepared to pay, and potential regulatory issues. But remember that the potential of new technologies, especially in the cryptocurrency space, is enormous, so we are yet to see what the future brings.
Key Takeaways
- Today, the income of Bitcoin miners is already hugely dependent on transaction fees. In the future, they will become the main source of profit because block rewards are programmed to decrease over time.
- The Ordinal protocol allows users to connect arbitrary data to single units of Bitcoin (sats), which is similar to the concept of NFTs.
- Bitcoin NFTs could create a new wave of demand in the Bitcoin network, which will cause a rise in transaction numbers and extra income from transaction fees.
- Additional fees or increased transaction fees could boost the security of the blockchain.
- NFTs can increase the global adoption of Bitcoin because they attract new investors interested in digital collectables.
- Implementing NFTs to support Bitcoin’s security budget comes with challenges that we still need to overcome.
- Bitcoin NFTs highlight the dynamic and innovativeness of the cryptocurrency space.
