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Bitcoin Ordinals And Inscriptions
A recent and somewhat controversial use of Bitcoin is an innovative application of the Taproot soft fork that was merged into the protocol in 2021. The ordinal theory is a way of serializing each individual unit of bitcoin and labeling these specific satoshis as “ordinals.” The creator of this numbering scheme, Casey Rodarmor, described it in his Blog saying: “Satoshis are numbered in the order they are drawn and are transferred from transaction inputs to transaction outputs in order in, first out.”
By serializing these individual satoshis and using the Taproot update, Bitcoin users can also include arbitrary data directly into the blockchain. While this was already possible with text using the OP_RETURN function, these new “inscriptions” can be anything from jpegs, short sound clips, and even simple games.
There is a growing debate in the development community about the implications of storing all of this data directly in Bitcoin and what that means for users who want to run a full file node. While this discussion is important, we want to dig deeper into how signups are currently impacting the Bitcoin fee market and what it might look like in the future.
Efficient use of block space
By their nature, inscriptions are larger files and therefore take up more finite space in each Bitcoin block. Users creating enrollments must pay the necessary fees to submit their transactions; however, signups are included in witness data which are given a slight fee discount thanks to the SegWit fork in 2017.
Ordinals officially launched on January 21, 2023. Less than three weeks later, signups already occupy 50% of Bitcoin’s block space, according to Pierre Rochard, Riot Platforms’ vice president of research.
The Bitcoin fee market is an ever-changing landscape. The fees increase when the demand for on-chain transactions is high and users want their transaction to be included in the next block. Conversely, the fee rate falls when demand is low and users do not need their transactions to be confirmed in a timely manner.
Whether or not these entries are considered an “acceptable” use of Bitcoin, the market will decide the price of the appropriate fee for those who wish to include this arbitrary data in each block. If transaction fees get high enough, smaller or lesser bitcoin transactions are likely to be removed from the market and moved to layer 2 protocols, such as Lightning. These additional layers were always the game-theoretical assumption of Bitcoin’s fee structure, even predicted by Hal Finney in 2010.
Historical block weight
This is not the first time that a significant number of transactions have filled the mempool. As noted, the Bitcoin fee market is dynamic and the cycle of high fees creates efficient uses of block space, creates low fees, creates inefficient use of block space, creates high fees, and will repeat itself ad infinitum.
Below is mempool data and fee prices dating back to early 2017. Blockspace tends to command a premium during bull runs as many people send bitcoins from exchanges or cold storage or spend them at a relatively high exchange rate.
Zooming in on the last three months, it is clear that there was a significant amount of trading in the second half of November, as Bitcoin exited exchanges with users shielding themselves from any further potential contagion events.
Beyond edge cases, transaction fees have been low for long periods of time and have raised questions about Bitcoin’s long-term security budget as the block subsidy declines and fees need to be converted to a higher percentage. of the income of bitcoin miners. Again, the hypothesis of Bitcoin proponents is that the demand for block space will increase over time as Bitcoin gains adoption and scales, causing more usage to migrate to other layers built on top of the protocol.
In recent weeks, the average block size has seen a massive increase.
Even with this large increase in block size, competition in the fee market has yet to intensify. Those who want to send monetary transactions are likely to increase their fees so that their transaction is listed faster or those who want to mint an inscription without waiting will do the same. Either way, if the fees increase, so will the profitability for the miners who would collect additional revenue in the block reward in the form of higher transaction fees.
Transaction fees are still a negligible percentage of the mining block reward, falling between 1% and 3%. Will the fees start to rise as more and more people try to use bitcoin to send money and mint signups?
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