Bitcoin works better as money than for NFTs

There are now thousands of NFTs being written directly into the Bitcoin network’s blockchain, potentially damaging bitcoin’s long-term value as a digital currency.

The latest innovation that crypto fans are buzzing about, also referred to as Ordinals and Inscriptions, allows users to enter up to four megabytes of data directly onto the Bitcoin blockchain. This has divided the Bitcoin community as it raises some existential questions about the purpose and future of Bitcoin.

To be fair, the Bitcoin blockchain has always contained random, non-financial data – one could argue that the secret message in the genesis block is the first example. The last two major upgrades to Bitcoin, SegWit and Taproot, included more of this data in the Bitcoin blockchain. Inscriptions simply provided the tool to easily enable the loading of such data, along with a manufactured ordering system that aims to create an aura of non-fungibility over satoshis, tiny bits of bitcoin almost like a penny is to a dollar. Bitcoin’s fungible unit of account, the satoshi, is inherently different from these bitcoin-inscribed NFTs. But is turning Bitcoin into a public data store good or bad? In short, it’s not good if the goal is to keep the “coin” aspect of bitcoin.

Bitcoin NFTs

To answer the question about bitcoin NFTs, let’s classify transactions in Bitcoin into two groups: financial transactions and non-financial transactions (NFTs, pun intended). Financial transactions are transfers of value from party A to party B. These types of transactions serve Bitcoin’s original purpose as a peer-to-peer electronic cash system. These transactions use the core computational scaffolding of Bitcoin: transfers of value (satoshis) combined with digital signatures that can unlock that value.

In contrast, NFTs load arbitrary data into the transaction that can greatly exceed the normal components of the transaction. Digital monkeys are examples of such data, but there are also medical records, 3D printed designs, land titles, audio files, pornography and political images.

Limited block space

Since inscriptions were launched, these NFTs have taken up a larger portion of the scarce Bitcoin block space. When the blocks fill up, as they have recently, the market for Bitcoin transaction fees will clear by adjusting prices upwards. In short, it becomes more expensive to use bitcoin for financial transactions.

Are higher transaction fees a problem? Proponents of inscription will say no. These fees accrue to miners and require users to run multiple nodes. Some of these new users may start using Bitcoin for money. Rising transaction fees also increase the network’s security budget, preparing Bitcoin for the future when the block grant to miners disappears. Third, this bitcoin NFT trend will inspire future Bitcoin developers and entrepreneurs to build better financial tools to compete with all the new attention Bitcoin blocks are now getting from the art world. Fourth, NFTs can drive more traffic to the Lightning Network.

Higher transaction fees

However, my main criticism of these arguments is that they ignore the equilibrium effects between different bitcoin users. The demand for Bitcoin block space comes from two different sources, financial transactions and NFTs. Nevertheless, they both manage in a single market. If the fee market disappears at a higher price from greater NFT demand, all users will face the higher price.

These higher fees will drive financial users away from Bitcoin and towards other alternatives, likely in the legacy financial system. The Lightning Network is still experimental, and most financial use cases still rely on the underlying Bitcoin blockchain.

Inscriptions may increase bitcoin adoption among NFT users, but will, all things being equal, decrease adoption among financial users. An art collector in Tribeca can now store a Bored Ape in Bitcoin, but a bank in Dhaka is also less able to settle a transaction with bitcoin.

What matters for the security budget is not the transaction fee alone, but the miner income. Miners can earn income from high fees and low transaction volume, or alternatively low fees and high transaction volume. The former describes a Bitcoin that serves elite art collectors, the latter a Bitcoin as global base money. When framed in this way, the choice is not between large and small blocks, but between large and small transactions. In the end, inscriptions made the job of every Bitcoin founder more difficult. The increase in transaction fees will only increase the customer acquisition cost for any entrepreneur looking to build a product that facilitates bitcoin payments. Fees matter.

The Future of Bitcoin

Instead of rushing to perform a software update or advocating for a soft fork, now is the time to start the hard conversation about what kind of Bitcoin we, as users, want. There is no doubt that inscriptions will increase the demand for bitcoin. But which Bitcoin? NFT Bitcoin or Financial Bitcoin?

I have nothing against NFT artists and the creative work they do. Additionally, I am sympathetic to the financial abuses and scams that NFT artists unwittingly face in the broader cryptocurrency space. But I believe that in the pantheon of problems facing humanity, a distributed, secure and immutable art gallery does not fulfill Bitcoin’s highest purpose. Bitcoin is uniquely positioned to serve as the base money of the world, capable of freeing billions of people from the iron grip of central banks. And it is actually the most poetic usage.

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