NFTs are inflating Bitcoin, creating risk and opportunity for crypto investors

What happened

Ordinals, a controversial new protocol deployed on Bitcoin, allows non-fungible tokens (NFTs) to be added to Bitcoin transactions, effectively bringing NFTs to the largest crypto network by market capitalization.

Launched in January, the Ordinals project allows images and other types of data to be entered directly into satoshis (the smallest denominational units of Bitcoin – each worth 0.00000001 BTC) on the Bitcoin blockchain without requiring a separate sidechain or token. JPEG images, New Profile Picture Projects (PFP), digital art, and even the 1993 first-person shooter DOOM have been written into Bitcoin using the Ordinals protocol.

Each Ordinal Inscription is considered a “digital artifact” because it is claimed to be immutable and forever enshrined on the Bitcoin blockchain. This is unlike most other NFT projects on Ethereum, Solana and Stacks, whose metadata can later be changed or deleted by the smart contract’s creator. Although not trivial, certain types of mutable data can be changed, such as the image associated with the token, the description of the item, the category of the token, the universal resource identifier of the contract, and other information, especially if data is hosted on a centralized database. Conversely, Ordinals store the entire image or content of the chain, not just a link pointing to a server hosting the data.

To date, over 50,000 ordinals have been minted on the Bitcoin blockchain, with some projects already garnering high prices. Ordinal Punks is a spin-off project originating from the ground-breaking Ethereum-based CryptoPunks NFT collection. Ordinal Punk pictured below sold for 9.5 BTC (~$218,000), highlighting how some of these early projects are already achieving significant value.

Broader context

Taproot and SegWit, Bitcoin software upgrades that took place in 2021 and 2017 respectively, opened the door to new forms of metadata that can be stored on the Bitcoin blockchain. SegWit increased Bitcoin’s block size from 1 megabyte to 4 megabytes and Taproot loosened data limit requirements, allowing the entire 4 megabyte block to be entered with ordinary NFTs.

The popularity of the Ordinals project has ignited an intense debate in the Bitcoin community. Bitcoin purists who oppose the Ordinals project argue that ordinal inscriptions are spam that inflates space and displaces more legitimate financial transactions on the network. Conversely, proponents of Ordinals argue that inscriptions increase the demand for block space and drive a healthy fee market that compensates miners for securing the network. Supporters also point to libertarian principles of the free market where the market determines the best use of block space.

Some critics of Ordinals have tried to appeal to Bitcoin node operators and miners to censor inscriptions. Ultimately, it is up to nodes and miners to decide which transactions are legitimate and included in the blockchain. They have the ability to censor certain transactions. However, it is in their best financial interest to support any use cases that bolster fee revenue, especially as transaction fees make up a larger percentage of miner revenue over time.

Ordinals is not the first project to bring non-fungible assets to Bitcoin, with previous attempts including defunct projects such as Counterparty and Mastercoin. In addition, Stacks is a Bitcoin sidechain that leverages Bitcoin’s security and has its own growing NFT ecosystem.

The founder of Gamma, a Stacks-based NFT marketplace, Jamil Dhanani commented: “Stacks is a blockchain where the transactions are settled on Bitcoin – you can always go back and verify the history of transactions on the main Bitcoin chain. However, the actual images are not stored on The Bitcoin layer. This differs from inscriptions, where we store the raw image data directly in a transaction on Bitcoin L1. Even on Ethereum, it would cost hundreds to thousands of dollars to do this, but it’s relatively cheap right now to do that on Bitcoin.

Stack’s NFT collections first launched in late 2021, and trading volume has increased in recent days, perhaps driven by interest in the Ordinals protocol and Bitcoin NFTs. Interestingly, daily trading volume increased 3000% from ~10,000 STX ($3,000) in late January to ~312,500 STX ($94,000) on February 9th. The all-time trading volume for Stacks NFTs is $36.2 million, and the last thirty day volume is $211,000.

Key quote

“There is a subset of the Bitcoin culture that sees Bitcoin as a pure way to settle transactions; they see any other use of Bitcoin as an ‘abuse’ of the system. There will always be a contingent of people who oppose to use the base layer for anything but those transactions. But since Bitcoin is an open, permissionless system, anyone can submit a transaction with any data they want—and we’ve historically had an incredible amount of creativity and innovation to expand Bitcoin beyond its original use cases.” – Jamil Dhanani, founder of Gamma.io

Key statistics

To date, over 50,000 ordinary inscriptions have been stamped, with the vast majority embedded in the form of image files. Since Bitcoin has a maximum supply of 21 million coins, and each coin is divisible into 100 million satoshis, the network can theoretically store a maximum of 2.1 quadrillion NFTs.

Prospects and implications

Currently, the majority of miner income comes from the Bitcoin block grant, where 6.25 BTC (currently $136,556) is rewarded to miners approximately every 10 minutes. The block grant is halved every four years, and the next halving event is scheduled to take place in the spring of 2024, when it will fall to 3,125. To ensure the network’s security and longevity, transaction fees must increase and replace the diminishing block grant.

Ordinals have already boosted revenue from mining transaction fees and ensured that blocks are full. Cumulatively, 13 BTC (~$285,000) have been spent on transaction fees involving inscriptions since the protocol was launched. As a percentage of total transaction fees on the network, inscriptions have accounted for approximately 12% of total transaction fees in recent days.

Ordinals have caught the attention of a new audience of Bitcoin users and developers. Embedding inscriptions into Bitcoin transactions can encourage further experimentation and development of the network, and spur new innovation within the Bitcoin ecosystem. Inscriptions can rejuvenate the excitement to build on Bitcoin again, challenging society’s culture of technological rigidity and ossification.

Additionally, we may see prolific artists and NFT collectors on other chains deploy new NFTs on Ordinals, leveraging Bitcoin’s permanence and immutability. The most prominent Stacks NFT project, Megapong Ape Club, recently announced their intention to launch a new Ordinals collection, called Megapunks.

Given that the project was just launched last month, the infrastructure to support the creation, storage, trading and transfer of Ordinal NFTs is very nascent. In the coming weeks and months, we expect wallets and marketplaces to begin offering native support for Ordinals, expanding the design space of what can be done with the protocol.

Decision points

Part of the reason why Ordinal NFT projects like Ordinal Punks are rising in value is that they represent a “first” project to be distributed on the protocol. Many of these collections also have a low supply, Ordinal Punks have a total supply of 100 vs CryptoPunks 10,000, thus this relative “scarcity” makes it easier to push the price higher.

Buyers of these assets must beware that they are still largely speculative investments, and early projects can be usurped by newer projects that promise more utility, stronger narratives, more aesthetically pleasing artwork or other attractive features. However, if the Ordinals protocol proves to have staying power and gains more functionality and attention, some of these projects could serve as an early-adopter high-status symbol for collectors and accrue significant value, similar to CryptoPunks or Autoglyphs. Nevertheless, most inscriptions will turn out to be worthless and trend towards zero, showing power-law dynamics in value increase.

For investors looking to gain exposure to the growing popularity of NFTs on Bitcoin, one option may be to purchase STX or NFTs issued on the Stacks network. Since regular subscriptions began to take off in late January, STX has outperformed BTC by 8%, partly due to investors seeking alternative projects that deploy NFTs on Bitcoin.

Like other NFT standards, Bitcoin NFTs still have open questions about intellectual property and copyright infringement. Copycat projects are guaranteed to be inscribed on Bitcoin, and some of these cases may be resolved in court. Full use of inscriptions has also not yet been realized. Ethereum-based NFT projects have been able to develop innovative royalties and auction mechanics, and it remains to be seen whether these structures can be replicated on Bitcoin.