Andrés Márquez
January 10, 2024
Investor Insight

Introduction


Bitcoin has been the blockchain by excellence since its creation. Satoshi Nakamoto, Bitcoin’s creator, envisioned a new electronic cash system that's fully peer-to-peer, with no trusted third party. Since then, Bitcoin has marked a revolutionary moment in the financial landscape and has made waves with the concept of decentralised currency. Bitcoin has grown significantly and has positioned itself as the number one cryptocurrency by market capitalization, however, the current state of this crypto has moved from what its creators envisioned mainly due to scalability and functionality challenges.

Bitcoin’s Scalability Challenges 


Bitcoin’s challenges related to adoption and real-world use cases are mainly due to the blockchain’s limited scalability which is primarily caused by the Proof-of-Work (PoW) consensus mechanism.

  • Bitcoin’s consensus results in a relatively low transaction throughput since it takes significant time to confirm transactions with a TPS of 5-7tx/s. This gets worse when the network has high demand, leading to bottlenecks and increased fees.
  • As the number of users and transactions increases, scalability becomes a growing concern. The network’s PoW consensus also requires substantial computational power which leads to high energy consumption, which has turned into a point of criticism as climate change has gained more global attention. 

While Bitcoin’s security and decentralization are still an example in the cryptocurrency industry, its limited scalability has led several alternative cryptocurrencies to emerge over the years. By focusing on improving the consensus mechanism and integrating new technologies, most alternatives offer higher throughput and lower fees.

Nevertheless, other alternatives have stumbled upon the problem of maintaining network security and decentralization, and this has caused some enthusiasts and developers to steer back to Bitcoin instead of building new solutions from zero.

Scalability challenges, the catalyst for innovation


Due to Bitcoin’s scalability issues, enthusiasts have introduced and supported new technologies that have the potential to address Bitcoin’s adoption challenges. The introduction of BRC-20 tokens opens the Bitcoin landscape to more diverse applications which include DeFi, tokenized assets, and other financial assets.

Ordinals is a protocol that was developed by Casey Rodarmor in 2022 and went live on January 21, 2023. Ordinals allow the submission of digital assets onto the Bitcoin blockchain.

After Ordinals, a new standard was introduced to allow the creation of fungible tokens directly onto the Bitcoin blockchain, something that was not possible with Ordinals as they only allowed the creation of NFTs.

How do Ordinals work?


As is already common knowledge, Bitcoin records all the transactions ever made on the blockchain as a long chain of connected blocks where each block contains a list of transactions. Every transaction can be seen as a digital receipt that shows who sent Bitcoins to whom and how many.

Ordinals assign a unique number or index to each of these transactions based on the order in which they were included in the block, this allows one to refer to a specific transaction by its ordinal number and easily find it within all the blocks in the blockchain. 

Pioneers kept innovating, leading to a recent addition of what’s known as ‘inscriptions’, the foundation of the new BRC-20 tokens.

What are BRC-20 tokens?


Inscriptions are made possible thanks to Ordinals and they consist of adding data like images and other files to a specific Satoshi. In early 2023, a developer that goes by the handle @domodata on Twitter proposed inscribing JSON (JavaScript Object Notation) into Satoshis to allow the creation of a fungible token standard into Bitcoin; Ethereum’s ERC-20 token standard but for Bitcoin, BRC-20.

With this development, it is now possible to inscribe a JSON file into a Satoshi. This means that the on-chain Satoshi, the smallest denomination of a Bitcoin, now has a sticker on it. This sticker has whatever information on it that people want, including, essentially, basic token traits like name, supply, etc. In order for this sticker to be utilised as a "token", it needs an off-chain interpreter which will scan the entire Bitcoin blockchain for the stickers from this particular set, and derive any information it can to turn it into some sort of tangible difference on whatever app is used for BRC-20 tokens.

In other words, BRC-20 is just inscriptions with off-chain interpreters.

Example: 

> I create BRC-20 "sticker pack" called ABC, with 100 tokens.
> I inscribe 100 stickers, all called "1 x ABC token", onto 100 Satoshis.
> When these Satoshis change hands, off-chain interpreters will read the entire Bitcoin blockchain for ABC stickers to confirm whether one wallet has enough ABC-inscribed-Satoshis to send to another wallet.

This is where the entire BRC-20 ecosystem comes into play - it is a set of off-chain interpreters, reading blockchain data and confirming off-chain activities. This also means that the Bitcoin nodes and validators do not validate any BRC-20 transactions because they are inscriptions and not anything actually on-chain.

The polarized future of BRC-20


There are contrasting opinions regarding BRC-20 tokens and Ordinals as many Bitcoin and crypto enthusiasts state that these assets are far away from what Bitcoin was initially envisioned to be - a fully peer-to-peer electronic cash system with no trusted third party. BRC-20 is of great importance for this vision as never-before-seen use cases on Bitcoin arise, but there are several ways in which BRC-20 and Ordinals can affect the Bitcoin ecosystem and its users:

  1. Bitcoin congestion: a polarizing aspect as the network being congested is not good for Bitcoin users, but can be highly rewarding for miners. Thanks to high network activity, miners can earn more mining rewards which can in turn make them not sell Bitcoin as often.
  2. Bitcoin’s purpose: many argue that Bitcoin should be utilized for financial transactions only, saying that the meme-fuelled narratives atop Bitcoin only fill up precious Bitcoin blockspace and increase transaction costs.
  3. BRC-20 improves Bitcoin’s use case, but that doesn't solve scalability issues, making other scalability solutions like Lightning network still necessary.
  4. BRC-20 is not EVM-compatible, making it difficult for Bitcoin to achieve interoperability.

Compared to other chains, Bitcoin tokens offer limited functionality, raising concerns about this standard’s reason for success (hype or value). While BRC-20 tokens are considered fungible tokens, some say it would be more accurate to classify them as semi-fungible since they can only be exchanged in limited increments.

Simple transactions with BRC-20 tokens are also archaic for a few reasons.

  • BRC-20 tokens are immutable, meaning that once a new BRC-20 token is created, traits like supply, minting limit, and ticker are immutable after the initial deployment. This can be seen as a strength or a weakness, as tokens cannot be updated once launched.
  • Users must use off-chain indexers to determine the balance of a wallet.
  • BRC-20 tokens use a fair minting model meaning that to mint these tokens, the creator has to mint a JSON NFT where all token traits are defined and then compete with others through gas, whoever pays for the most blockspace gets an allocation. This could also be seen as an advantage in the name of fairness.
  • To transact BRC-20 tokens sellers have to create transfer-NFTs to break up the original mint NFT into smaller chunks. Sellers have to find a buyer who is looking to buy the exact amount of tokens they’re selling which isn’t productive.

BRC-20 Impact on Bitcoin


BRC-20 tokens were created in March of 2023 and they have gained significant traction. Nonetheless, we can appreciate a considerable surge in values that were not seen since 2021, which indicates there has been an increase in network congestion and higher demand for blockspace which can be a double-edged sword.

Source: “Bitcoin Core Metrics”, Dune Dashboard by Reportbly.


We can also appreciate that Ordinals are now almost solely used as BRC-20 tokens meaning inscriptions already displaced Ordinals and the hype they had created.

Source: “Bitcoin Tokens : BRC-20 (brc20 Ordinals)”, Dune Dashboard by cryptokoryo.


In conclusion, the conception of BRC-20 tokens has sparked a debate in the Bitcoin community as there are potential risks like unnecessary network congestion and the perception that these tokens may not stick entirely to Bitcoin’s original purpose as a P2P electronic cash system.

Simultaneously, while BRC-20 tokens are a step forward in terms of adoption and real-world utility, they are not a solution for Bitcoin’s innate scalability issue, as it can hinder its capacity. Without a doubt, BRC-20 tokens can be the first step to diverse applications built atop Bitcoin like DeFi and asset tokenization, but as stated previously, this comes with drawbacks. The future of these assets and their role within the Bitcoin network will most likely continue to be polished in the upcoming years, as community discussions and technical advancements take place to better adhere to Bitcoin’s original vision.


All posts: https://www.simplicitygroup.xyz/blog

Twitter: https://twitter.com/SimplicityWeb3

Telegram: https://t.me/SimplicityGroup

Newsletter: https://thoughts.simplicitygroup.xyz/subscribe