How did Bitcoin go from zero to Runes?

Original title: "The Road to Runes"

Original author: Shlok Khemani

Original translation: Peisen, BlockBeats

Editor's note:

This article delves into the innovation and development in the Bitcoin ecosystem, especially the progress made in the development of non-interchangeable tokens (ordinals) and interchangeable tokens (Runes). The article analyzes in detail how ordinals and Runes have become important standards on the Bitcoin blockchain and explores their performance in the market and the impact of social recognition.

The article first introduces the background and application of the theory of ordinals, explains the way each satoshi is uniquely numbered, and explores its impact on the Bitcoin community and market. The article then turns to discuss the launch of Runes and its acceptance and market performance in the Bitcoin ecosystem. Runes not only improve transaction efficiency by storing data in the OP_RETURN field and supporting multiple tokens stored in the same UTXO, but also demonstrates its compatibility with the Bitcoin Lightning Network, which makes it stand out in the market.

In the week not far from the latest Bitcoin halving, Runes became a hot topic in the cryptocurrency world as a new interchangeable token standard on Bitcoin. As I tried to understand Runes and their importance, I realized that I knew very little about the early development of Bitcoin and how it basically works. Yes, this admission is a bit unexpected considering that I work in cryptocurrencies and Bitcoin is the largest cryptocurrency.

However, I thought that if I was in this situation myself, many others might be too. Therefore, I decided to dig deeper and write about it.

I reviewed the process of Bitcoin from its inception to how it developed to Runes. Along the way I discovered early on-chain DNS implementations, Vitalik Buterin’s first token project (no, not Ethereum), perpetual ASCII art, and a blockchain game from 2015, as well as the disagreements in the community that led some to call Bitcoin a “failed experiment,” and the lone developer who changed the face of a trillion-dollar asset, and more.

This is the story of Bitcoin’s past and future. It deals with failed experiments and false starts. It explores the challenges of introducing innovation in a protocol that often resists change. It explains why one ten-millionth of a Bitcoin can sell for over a million dollars. Most importantly, it discusses how social consensus is just as critical to digital assets, if not more so than code.

Let’s dive in!

UTXOs

We’ll start by understanding one of the fundamental building blocks of the Bitcoin protocol: Unspent Transaction Outputs, or UTXOs.

UTXOs are how the Bitcoin protocol tracks ownership of currency. Think of each UTXO as a receipt for ownership — an indivisible portion of a Bitcoin that can only be spent by a specific address (owner). When ownership of a Bitcoin transfers (one user sends it to another), it is recorded on the blockchain as a UTXO associated with the recipient’s address.

In the Bitcoin protocol, there is no inherent concept of account balances. Instead, Bitcoins owned by a certain address are captured as UTXOs scattered across the blockchain, with each UTXO being the output of a transaction. When an application (like a wallet) displays their BTC balance to a user, it does so by scanning the blockchain and aggregating the UTXOs that belong to that user.

If my Bitcoin wallet shows that I own 20 BTC, that means the total value of the UTXOs associated with my public key is 20 BTC. This could be one UTXO worth 20 BTC, or four UTXOs worth 5 BTC each, or any other combination that adds up to 20 BTC.

Transactions on Bitcoin are structured as a set of input UTXOs that are consumed (or destroyed) to create output UTXOs. Imagine that Joel has the following UTXO values associated with his address: · 10 BTC · 5 BTC · 1 BTC Now, if he wants to pay Saurabh 14 BTC, his wallet application creates a transaction with the following characteristics: · The UTXOs of 10 BTC and 5 BTC as inputs (the UTXO of 1 BTC remains unchanged) · 14 BTC as an output sent to Saurabh’s address · 0.9998 BTC as a second output sent back to his address

The second UTXO is the change he receives from the transaction. Why 0.9998 BTC instead of 1 BTC? He also needs to pay a transaction fee to the Bitcoin miners as an incentive to include his transaction in the block. The difference between the sum of the input UTXOs and the output UTXOs (0.0002 BTC in this case) constitutes the fee for the transaction. In most cases, the heavy lifting of creating a valid transaction by setting up the appropriate inputs, outputs, and fees is abstracted away by the user and handled in the background by the wallet application.

To better understand UTXOs, think of them as monetary notes, with a Bitcoin wallet being analogous to a physical wallet. Each monetary note (like a UTXO) has a fixed, indivisible amount, while the total value stored in a physical wallet (as in the case of a Bitcoin wallet) is the sum of the values of all the monetary notes in it.

A Bitcoin transaction is similar to purchasing an item using cash. If I buy a $14 cocktail at a bar in New York City, I can hand over a $10 and a $5 bill and receive a $1 bill in change. The difference in the analogy here is that while currency notes only exist in fixed denominations (like $1, $5, $10, etc.), UTXOs can be associated with any number of Bitcoins.

(In contrast, other blockchains like Ethereum act as a ledger for debits and credits, and track user balances in the protocol. This is similar to how a bank account tracks user balances.)

Bitcoin’s choice to use UTXOs instead of other blockchain accounting models lays the foundation for future token protocols to be built on top of it.

OP_Return

Satoshi Nakamoto originally created Bitcoin to create a censorship-resistant peer-to-peer electronic cash system. However, in the process, he also inadvertently created the world’s first immutable, forgery-proof, transparent, and time-stamped ledger.

Soon after Bitcoin was released, early cryptocurrency enthusiasts began to realize that such a ledger would not only be useful for payments, but could be extended to protect any important digital data stored on a resilient and distributed ledger. Applications discussed included stock certificates, digital collectibles, property ownership records, and bringing the Domain Name System (DNS) to Bitcoin.

Hal Finney, legendary computer scientist, prominent Bitcoin contributor, and recipient of the first Bitcoin sent by Satoshi, proposed the solution of bringing DNS to the blockchain on the BitcoinTalk forum.

The question of whether Bitcoin should be used to store non-payment data sparked one of the first major debates in the Bitcoin community. One side saw Bitcoin as merely a payment system, and considered storing other data (or "garbage") to be an abuse of its core purpose. The other side saw it as a way to demonstrate Bitcoin's power, and believed that building new applications was essential to the long-term importance of the blockchain and the gradual reduction of security subsidies.

The debate also had short-term practical consequences.

In the absence of a way for the Bitcoin protocol to specifically store non-payment data, early experimenters found a workaround. Recall from our previous discussion that a Bitcoin transaction consists of a series of input and output UTXOs. Each output UTXO has fields for the amount and the destination Bitcoin address. Developers took advantage of this 20-byte destination address field to store arbitrary, non-payment data.

What does this arbitrary data include? As documented in this blog post , it ranges from the mundane to the creative. From tributes to Nelson Mandela to ASCII portraits of then-Federal Reserve Chairman Ben Bernanke, from links to WikiLeaks’ Cablegate documents to a PDF of Bitcoin’s original whitepaper, enthusiasts have preserved any text they deem worthy of permanent digital presence on the ledger.

This practice has a significant unintended consequence. Typically, the data in the destination address field is a public key (or destination address), which the protocol maps to a private key that can control the resulting UTXO. When developers began using this address field to store arbitrary data, these transactions created UTXOs that could not be mapped to private keys and therefore could never be spent. Such transactions are marked as "fake payments."

For example, the transaction containing the PDF of the original Bitcoin whitepaper stores data in nearly 950 output UTXOs, none of which are spendable.

The problem of storing data in UTXO outputs.

Fake payments are a problem for anyone running a full Bitcoin node. A full node maintains a list of all valid UTXOs in the blockchain history (called the full UTXO set) and uses these UTXOs when validating new transactions. Ideally, the UTXO set should be as small as possible so that transactions can be quickly validated. However, because UTXOs created by fake payments can never be spent, they contribute to "UTXO bloat," an increase in the size of the UTXO set. As a result, nodes must permanently incur the cost of storing data that the blockchain was not designed to carry.

While payment purists frown upon using Bitcoin to store non-payment data, they cannot prevent users from adding arbitrary data to UTXO outputs. As a compromise , in 2014 they reluctantly allowed inclusion of the previously banned OP_RETURN script functionality into Bitcoin transactions.

Their position (from what I understand from the Bitcoin 0.9.0 release notes ) is basically: "Look, we don't want you to store random data on Bitcoin. That's not what it's for. But we can't stop you from using outputs to do so. So let's limit the damage you've done. We'll give you a limited amount of space to continue your shenanigans, but in the meantime we strongly recommend that you don't use Bitcoin this way. That's not what it was designed for."

OP_RETURN accepts a user-defined sequence of 40 bytes of data. Although this data is stored on the blockchain, these outputs are provably unspendable and can be excluded from the UTXO set. This means that full nodes can ignore outputs marked as OP_RETURN when validating payments, partially solving the UTXO bloat problem. I call this problem only partially solved because these transactions still exist on the blockchain and take up disk space.

40 bytes isn’t a lot of data. One English character typically takes up one byte of data space, which means that an OP_RETURN can only hold a string of 40 characters at most, which is obviously not enough to store an image or a complete document. Therefore, the main use case for OP_RETURN is to store hashes of larger blocks of data.

Any digital data, once processed by a hashing algorithm, is mapped to a unique alphanumeric string, called a hash. These hashes can be stored in the OP_RETURN field and used to timestamp externally stored pieces of data on the Bitcoin blockchain. For example, I can create a piece of art and store the hash of an image file on the blockchain. Anyone in the future can use the transaction to verify the authenticity of the image.

Proof of Existence services allow users to upload a document, generate a hash, and store it on Bitcoin for a fee (currently 0.00025 BTC or about $18).

A chart that clearly shows the “hockey stick” shape. (Source)

The chart above shows the number of transactions containing OP_RETURN outputs over time. Notice the recent parabolic growth in the number of such transactions? We’ll discuss why shortly.

The OP_RETURN data limit was increased to 80 bytes in 2015.

Early Token Experiments

As Bitcoin matured, developers began dreaming of building other applications that could benefit from blockchain technology. A common application is to create alternative currencies or tokens with custom properties and functionality. One approach is to start a blockchain from scratch, a path taken by early alternative coins such as Namecoin and Dogecoin. However, this approach requires starting a miner base and carries the risk of the token being centralized, at least initially.

For some, a more attractive proposition would be to create a token on the Bitcoin protocol itself, benefiting from its security and existing distribution.

Today, Vitalik Buterin is best known for being the co-founder of Ethereum, the second largest cryptocurrency after Bitcoin. However, before he founded Ethereum, Vitalik was very active in the Bitcoin community. He began his career in crypto by writing for Bitcoin Weekly. After the magazine closed, Vitalik co-founded Bitcoin Magazine , considered the first official publication in the industry.

Cover of the October 2013 issue of Bitcoin Magazine. You can purchase these original prints using BTC at the Bitcoin Magazine Store. This issue is currently on sale for $1,000!

In 2013, Vitalik and four other authors published the Colored Coins whitepaper, which described a way to store "alternative currencies, commodity certificates, smart assets, and other financial instruments" on the Bitcoin blockchain. This is achieved by marking or "coloring" Bitcoins and attaching information that specifies their intended use.

What is "marked" Bitcoin? Recall that BTC is stored on the blockchain as UTXOs, which are created and destroyed when BTC is transferred from one wallet to another. This mechanism makes it possible to trace the origin and ownership history of Bitcoin because it leaves a trail of transactions as it moves between wallets.

Suppose I receive a 5 BTC UTXO from Saurabh. Then, I transfer 7 BTC to Sid, consisting of a 5 BTC UTXO I received (from Saurabh) and another 2 BTC UTXO in my wallet. Now, Sid transfers 10 BTC to Joel, consisting of two UTXOs - one he received from me, and one he already had. Joel's BTC can now be traced back to Saurabh, Sid, and me by following the path of transactions that led to the UTXOs in his wallet.

Let's revisit the analogy of Bitcoin UTXOs and currency notes. Each currency note has a unique serial number that is preserved as it moves from one holder to another. The difference is that while I may not know the complete history of all the currency note holders before me (because there is no place to record this information), all Bitcoin transactions occur on a public ledger, and every satoshi (sat, the smallest unit of Bitcoin, 1 BTC = 100 million sats) can be traced back to its original owner. If there was a way to record the movement of currency notes according to their serial numbers, we would be able to trace them back to the printing press, just as we can trace each BTC to the block in which it was created.

Since BTC can be traced in transactions, metadata associated with a specific UTXO is also propagated with it. This is the basis of the process of "tagging" or "coloring" BTC. The Colored Coins protocol utilizes a combination of inputs, outputs, and OP_RETURN to create and transfer tokens from one address to another.

The structure of a colored coin transaction. This is an example of a colored coin transfer transaction. The data in the OP_RETURN field defines the properties of the colored coin, while the input and output values (and some other fields not shown in this diagram) define the flow of tokens between different wallets.

There are two key points to note about the implementation of external tokens on the Bitcoin blockchain.

First, the values in the input and output fields represent the actual bitcoins transferred from one wallet to another, with the colored coin label attached. This means that if I want to send x colored coins, I must also send x satoshis. The value actually transferred is the value of the colored coins plus the value of the satoshis. This is clearly a shortcoming of the protocol.

If you are creating a new currency, you almost certainly want it to be independently valued and not mixed with another currency. For example, the value of a piece of fiat currency should be what is written on it, independent of the value of the paper it is printed on. I think this is one of the reasons why colored coins have never caught on as a way to issue new tokens. For non-monetary use cases, such as issuing shares of ownership, colored coins still make sense.

Second, Bitcoin does not recognize colored coins and their metadata as part of the protocol. We saw earlier that nodes can choose to ignore the information in the OP_RETURN field, which is critical to interpreting the movement of colored coins. This means that to participate in the creation and trading of colored coins, users must use a dedicated wallet that recognizes the rules of the protocol.

If a user uses a regular wallet (designed to send and receive BTC) to interact with UTXOs that have previously participated in colored coin transactions, they run the risk of losing or corrupting the metadata associated with their UTXOs. Even in future implementations of Bitcoin standardized tokens, incompatibility between wallets will continue to be a problem, as we will soon see.

Another early project that allows users to create digital tokens on Bitcoin is Counterparty . Counterparty also uses OP_RETURN to store metadata associated with the token, but unlike colored coins, Counterparty tokens are not pegged to an address's BTC balance. This separation allows these tokens to be traded and price discovered independently.

Independent token prices enabled Counterparty to create one of the earliest decentralized exchanges on the Bitcoin protocol. Users can submit their orders via messages (e.g., "I want to buy 10 A coins for 20 B coins"), and the protocol holds their funds in trust escrow until the order is executed or expires.

Counterparty's native token, XCP, was initially launched through a fair launch via Proof-of-Burn, where users must destroy BTC to mint the token. XCP acts as a utility token, allowing developers to pay for the costs of creating named Counterparty coins. Counterparty also provides developers with a simple API to create tokens, transfer assets, issue dividends, and more.

Notable projects created with Counterparty include Spells of Genesis, the first blockchain-based NFT mobile game (yes, blockchain games were around back in 2015!), and Rare Pepes, an NFT collectible that retains its value even today (the lowest price for a 298 supply set is nearly $1 million as of early June 2024).

Segwit

While OP_RETURN, Colored Party, and Counterparty made it possible to store tokens on Bitcoin, their growth was hampered by a fundamental limitation of the protocol: the 1MB block size limit.

1MB is not a lot of data capacity. A typical Bitcoin transaction is about 300 bytes, which means that a single 1MB block can accommodate about 3,000 transactions. Since Bitcoin blocks are generated every 10 minutes, the network's transactions per second (TPS) is around 5. This throughput is far from enough for a payment network. Take Visa, for example, which processes 1,700 transactions per second and has a peak capacity of more than 24,000 transactions.

The discussion about increasing Bitcoin’s block size, like the previous debate over payment and non-payment data, has divided the community into two camps.

On one side are the so-called big blockers, who advocate a hard fork (a protocol change that requires all nodes and users to upgrade their software) to permanently increase the block size to 2MB, and subsequent periodic hard forks to continue to increase the block size. These people argue that in order for Bitcoin to be an effective payment system available to millions of users, it needs higher transactions per second and lower fees. The only way to do this is to continue to increase the block size as demand grows.

On the other side are the small blockers, who oppose hard forks and other drastic changes to the protocol. To them, Bitcoin’s value lies in part in its stability. They believe that increasing the block size will make it harder for users to run full nodes, thereby reducing Bitcoin’s decentralization and weakening its appeal as a powerful, revolutionary currency.

The Block Wars became one of the main topics of the time. This is a headline from the Wall Street Journal.

The big blockers eventually created Bitcoin Cash, a fork of the Bitcoin blockchain with an 8MB block size limit. On the other hand, the small blockers pushed for an upgrade called Segregated Witness (SegWit) to increase the block size without the need for a hard fork.

In addition to a series of inputs and outputs, Bitcoin transactions contain another structure that we haven't discussed yet - witness data. Witness data includes cryptographic signatures and other verification information, and accounts for up to 65% of the transaction size.

The Segregated Witness upgrade changes the structure of blocks. After the upgrade, blocks no longer put all data (inputs, outputs, signatures) in a single 1MB block, but split it into two parts: the base transaction block, which contains all inputs and outputs; and the extension block, which stores witness data.

Along with this change, Segregated Witness (SegWit) also changes the metric for calculating block capacity from data size to weight units. The weight of a block is calculated by the following formula:

Weight = Base Size × 4 + Witness Size

For example, a transaction with a base size of 100 bytes and a witness size of 200 bytes will take up 600 weight units [(100 × 4) + 200]. The new block size cap increases from 1MB to 4 million weight units, effectively quadrupling the block size without requiring a hard fork.

Importantly, the base block size remains around 1MB, preserving the original block size limit. This allows the protocol to accept both legacy and SegWit blocks, ensuring miners and nodes can adapt to the change without having to upgrade their software immediately.

SegWit was not adopted by miners overnight; it took almost five years for 90% of Bitcoin blocks to be SegWit blocks. On the surface, this gradual adoption would seem to justify the decision to implement a soft fork. However, we can only speculate how this might have developed and affected miner behavior had a hard fork been adopted.

Source

Nevertheless, Segwit gave Bitcoin a much-needed TPS boost and was a key milestone in the network’s ability to scale and support use cases beyond BTC payments.

What’s next?

The 2021 Taproot upgrade is the most significant upgrade to the Bitcoin protocol since Segwit. However, unlike the contentious block size war, the changes proposed by Taproot were almost unanimously accepted by the Bitcoin community.

The Taproot upgrade combines three Bitcoin Improvement Proposals (BIPs) to implement several changes that make Bitcoin more secure and efficient. While these changes cover multiple aspects of the protocol, we will focus on those that lay the foundation for future on-chain token protocols.

The first major change brought about by the Taproot upgrade is the replacement of the Elliptic Curve Digital Signature Algorithm (ECDSA) with Schnorr signatures. Blockchains rely on digital signatures — messages cryptographically signed by a user’s private key and verified using their public key — to operate. Digital signatures come in various forms, each following a different cryptographic scheme, some of which are more efficient than others. Moving to Schnorr signatures provides two key improvements to scalability.

First, recall that witness data, which includes the signature, takes up the majority of transaction space. Compared to ECDSA, Schnorr signatures are smaller, which directly leads to space savings, allowing more transactions to fit into a single block.

Second, Bitcoin supports complex payment types like multi-signature transactions, transactions that multiple parties must approve before they can be executed, subject to specific conditions. Prior to Taproot, multi-signature transactions required that each individual signature be included as a transaction input. With Schnorr signatures, multiple signatures can be combined into a single signature (and therefore a single input), making multi-signature transactions more efficient and private.

The Taproot upgrade also expands Bitcoin’s scripting capabilities, allowing developers to create more complex transaction conditions. The upgrade also provides a new way to store arbitrary data on the Bitcoin blockchain, providing greater flexibility than the OP_RETURN opcode discussed earlier.

In practice, this means that the amount of arbitrary data that developers can store in a Bitcoin transaction is now limited only by the maximum size allowed for a transaction, which is 400,000 bytes. This is five thousand times the amount of data that OP_RETURN allows.

By making transactions more efficient and allowing for more flexibility in their content, the Taproot upgrade paves the way for the most exciting experiment in introducing tokens on Bitcoin.

Ordinal Theory

My best friend’s father, Kanwaljeet, is a numismatist, or someone who collects currency. His collection features not only historic and limited editions, but also a unique category of currency notes that he collects specifically for their serial numbers. For example, he owns a 500 Indian Rupee (INR) note with the serial number “001947,” which corresponds to the year India gained independence. He paid 750 INR for the note, which is now worth 1,000 INR because of its serial number.

Money has a special place in society, serving as both a medium of exchange and a symbol of status, freedom, and power. We work for it, it sparks conflict, and some cultures hold it in awe, all of which underscores its importance. This explains why money is a popular collectible and highlights the work of numismatists.

Bitcoin is the first instance of a new form of money: cryptocurrency. Now over fifteen years old and a trillion-dollar asset class, Bitcoin has become popular enough that enthusiasts have assigned it provenance and historical value. But how can one determine the historical value of a digital currency?

That’s where Casey Radamor and his theory of Ordinals come in.

When a central bank issues currency, each is assigned a serial number in the order in which it was printed. Similarly, the Ordinals theory is a conventional numbering system used to assign a serial number to each Bitcoin satoshi (sat), whether they already exist or are mined in the future. Let's see how it works.

Recall that the origin of each satoshi can be traced back through the UTXO model. Satoshis are created as rewards when miners mine Bitcoin blocks and are numbered in the order in which they are mined.

For example, the first mined block, the genesis block, rewards the miner with 50 BTC. Since each Bitcoin contains 100 million sats, the reward for the first block contains sats numbered from 0 to 4,999,999,999. The second block contains sats numbered 5,000,000,000 to 9,999,999,999, and so on. Therefore, the last satoshi will be numbered 2,099,999,999,999,999.

Ordinals use a first-in, first-out (FIFO) system to track the numbering of sats between UTXOs. When a Bitcoin transaction consumes a UTXO, sats are split into newly created UTXOs in the order they appear in the output.

For example, if the genesis block miner received a UTXO containing sats numbered from 0 to 4,999,999,999, and they wanted to isolate a specific satoshi, such as the 21 millionth satoshi, they would construct a transaction structure like this:

Ordinals assign a unique number to each satoshi, thus making them somewhat non-interchangeable. I say “somewhat” because when making a bitcoin payment, merchants generally don’t care about the specific satoshis that make up the payment, thus maintaining fungibility in that transaction scenario. However, for collectors like Kanwaljeet who are looking for a specific numbered satoshi, satoshis are very much non-interchangeable.

As the theory of Ordinals gained popularity, the emergence of BTC collectors — people who seek out rare Bitcoins — became inevitable (Wired magazine once published an excellent article documenting their world). What is the definition of rare Bitcoin? It covers a range. Casey Radamor provides a framework for evaluating rarity:

In reality, rarity is largely subjective and depends on what numbers are collectively considered valuable. Kanwaljit collects notes numbered 150847 because it represents the date of India’s independence. For currency collectors from other countries, the number may be completely insignificant. Similarly, Bitcoin hunters prize Satoshis for a variety of reasons, from the obvious, like they were mined by Satoshi Nakamoto, to the more mysterious, like the Satoshi numbers forming a palindrome.

Rare satoshis are traded not only on marketplaces like Magic Eden and Magisat, which provide users with icons and guides to help them accurately assess the value of the satoshis they are purchasing, but also at traditional auction houses like Sotheby’s, where a rare satoshi sells for more than $150,000 .

Recently, bitcoin mining pool viaBTC auctioned an epic satoshi (the first satoshi from the most recent halving) for 33.3 bitcoins, equivalent to over $2 million. This amount compares favorably with the most expensive fiat currency note sale ever, a rare $1,000 Treasury note issued in 1890 that sold for at auction in 2014. href="https://currency.ha.com/heritage-auctions-press-releases-and-news/1890-1-000-grand-watermelon-note-brings-world-record-3.29-million-at-heritage-auctions.s?releaseId=2474#:~:text=January%2013%2C%202014-,1890%20%241%2C000%20Grand%20Watermelon%20Note%20Brings%20World%20Record%20%243.29%20Million,Orlando%2C%20FL%20auction%20on%20Jan." target="">Over $3 Million

Remarkably, the “Big Watermelon” note, named for the shape and color of the back, remains valid legal tender to this day!

In addition to creating a class of digital currency collectors, the Ordinal Theory, by assigning a number to each satoshi, also opens up the next step in Casey Radamor’s plan: introducing “digital artifacts” to Bitcoin.

Inscriptions

The release of the Taproot upgrade in 2021 coincides with a major wave in the crypto industry: the wave of NFTs (Non-Fungible Tokens). In 2021, over $25 billion in NFTs were traded, with the majority of that happening on Ethereum. Pixel art, monkey pictures, sports moments, photos, music, sneakers, coffee coupons, even simple English words—there’s an NFT for just about everything. This movement marks the biggest intersection of crypto with mainstream media and brands, and has attracted more new people to crypto than any other use case to date.

Now, much has been written and discussed about the debate over whether NFTs, or even digital art as a category, are intrinsically valuable, so we won’t get into that. What’s important is that at least a portion of the Bitcoin community, including Casey, saw what was happening on other chains, notably Ethereum, and decided to bring it to Bitcoin as well.

If Bitcoin is going to have a standard for NFTs, Casey wants it to be “unencumbered by its predecessors.” His solution: inscriptions. From Casey’s blog post on inscriptions:

Inscriptions are digital artifacts, and digital artifacts are NFTs, but not all NFTs are digital artifacts. A digital artifact is an NFT that is required to approach its ideal standard. To be a digital artifact, an NFT must be decentralized, immutable, on-chain, and unrestricted. The vast majority of NFTs are not digital artifacts. Their contents are stored off-chain and can be lost, they exist on centralized chains and have backdoor admin keys. Worse, because they are smart contracts, they must be audited one by one to determine their properties.

Inscriptions do not suffer from these flaws. Inscriptions are immutable and on the oldest, most decentralized, and most secure blockchain in Bitcoin. They are not smart contracts and do not need to be audited one by one to determine their properties. They are true digital relics.

Here’s how they work.

Inscriptions inscribe data onto individual satoshis, which are then tracked by Ordinal Theory. To tag a specific satoshi with certain data, developers must create a transaction that isolates that satoshi and places it in the first output of a Bitcoin transaction. The data itself is stored in the transaction witness (an upgrade introduced by SegWit) and in the script path append script introduced by the Taproot upgrade.

Since inscriptions are inscribed onto satoshis, they can be moved, traded, bought, or sold with simple Bitcoin transactions. However, as with previous token standards, they require a wallet that recognizes the protocol and structures transactions accordingly. In other words, you don’t want your wallet to accidentally send an inscribed satoshi as part of a normal transaction.

Each inscription is also assigned an index number that is numbered in the order in which it was created. As a result, we know that over 70 million inscriptions have been created to date. Furthermore, while you can create collections of inscriptions (like you can do on Ethereum), each inscription in a collection requires a separate transaction to create (and therefore a fee). These properties eliminate what Casey sees as weaknesses with NFTs on smart contract blockchains like Ethereum.

What content can an inscription store? Almost any content format supported by a web page, including PNG, JPEG, GIF, MPEG, and PDF files. It also supports HTML and SVG files that can be executed in a sandboxed environment (they can’t interact with external code). Furthermore, inscriptions can be linked to each other, so content from other inscriptions can be remixed. While most users choose to simply inscribe a satoshi into a JPEG, some enterprising individuals have experimented with inscriptions like full video games.

Some developers realize that this flexibility in content can be used to create further token standards for Bitcoin.

One of the most notable experiments is the BRC-20 protocol created by domodata. While inscriptions were originally conceived as a way to introduce non-fungible tokens to Bitcoin, the BRC-20 standard (a play on words for Ethereum’s ERC-20 token standard) used them to create Bitcoin’s standard for swappable tokens.

The mechanism itself is pretty simple: deploy, mint, and transfer swappable tokens in satoshis using JSON data blocks. For example, this is what an inscription for deploying ORDI (the first BRC-20 token) looks like:

This inscription defines the parameters of the ORDI token, designating it as a BRC-20 token, setting a maximum supply of 21 million units at deployment, and limiting each minting transaction to 1,000 units. By inscribing JSON data like this onto Satoshi, developers can create, manage, and transfer fungible tokens directly on the Bitcoin blockchain.

Similarly, BRC-20 tokens can be transferred by creating a new inscription containing data like this:

The inscription and the underlying BRC-20 protocol built on top of it have together driven a massive wave of attention, capital, and activity onto the Bitcoin blockchain. Multiple meaningful on-chain metrics have risen dramatically, including miner fees, the percentage of full blocks (defined as blocks that completely fill the 4MB limit), the size of the mempool, the adoption rate of the Taproot upgrade, and the number of pending transactions in the mempool.

Number of Inscriptions over time (source)

This surge in activity means that Inscriptions can be considered the first meaningfully adopted token standard on Bitcoin. Top Ordinals (another name for Inscription Collections) still hold a strong floor several months after launch. These include NodeMonkes (0.244 BTC), Bitcoin Puppets (0.169 BTC), and Quantum Cats (0.306 BTC). The first BRC-20 token, ORDI, has a market cap of over a billion dollars and is listed on top exchanges such as Binance.

Why did Inscriptions succeed while Colored Coins, Counterparty, and other experiments failed? I think there are two reasons.

First, Inscription was launched after the Segwit and Taproot upgrades, which meant that Inscription benefited from a more mature Bitcoin protocol. Larger block sizes, lower fees, and greater data flexibility allowed Inscription to avoid the complex, circuitous implementation routes of its predecessors.

Second, the timing was perfect. Inscription’s creation coincided with the cycle of 2021, and almost anyone who paid attention to internet trends had heard of NFTs. Crypto traders were already accustomed to trading them. Even ORDI, which launched at the bottom of the bear market, benefited from perfect timing. Just weeks before its launch, the memecoin PEPE on Ethereum set off a short-lived memecoin frenzy in a dry market, and ORDI took advantage of this opportunity to achieve market capitalization.

Runes

Finally, all this background brings us to our destination: Runes.

In addition to BRC-20, a whole host of other protocols have attempted to leverage Inscriptions to bring fungible tokens to Bitcoin. This has created a fragmented token landscape, with each implementation having its pros and cons. The opportunity was there to create an excellent fungible standard like Ordinals did for non-fungible tokens.

And it was seized! Casey Radamor has stepped in again, this time with the Rune Protocol (Runes for short), which aims to become the de facto fungible standard for Bitcoin tokens. His motivation is simple: “Bitcoin deserves a decent token standard.”

So, how does Runes differ from other standards like BRC-20? A few weeks ago, my colleague Saurabh wrote an excellent article explaining Runes and what they improve upon in detail. For a deeper dive, read his article.

Here are the key points.

Recall that a BRC-20 token creates a new rune every time it is deployed, minted, or transferred. Additionally, each token is stored in a separate UTXO. The protocol does not specify how to include multiple tokens in a single UTXO. This leads to UTXO bloat, or in other words, UTXO inflation.

UTXO Quantity Over Time (Source)

Runes simplify this process. First, it no longer uses inscriptions, but instead stores data in the OP_RETURN field. Second, it allows users to hold multiple tokens, including Bitcoin, in the same UTXO, which makes transfers more efficient and reduces UTXO bloat. Third, it is compatible with the Lightning Network, Bitcoin’s scaling solution. (Remember that surge in OP_RETURN transactions we saw earlier? Now you know what caused that.)

Runes’ launch was timed to coincide with the latest Bitcoin halving event, and came with considerable hype. This was despite Ordinals having proven to be successful (albeit with a slow start), and during a bear market. Runes launched as the price of Bitcoin more than tripled.

Given the hype, many (including me!) felt that its aftermath was less than satisfactory, at least according to the buzz on Crypto Twitter (CT). It was not uncommon to hear comments such as “runes failed” or “runes is dead.”

However, data on the blockchain paints a very different picture.

Source: @cryptokoryos on Dune

Source: @cryptokoryos on Dune

Runes dominates non-payment Bitcoin activity. On most days since launch, it has seen more trading than ordinals and BRC-20 combined, seemingly replacing the latter as the most popular fungible token standard on Bitcoin. This is also reflected in Runes’ market cap, which has surpassed BRC-20. Despite this, it is not yet listed on any major centralized exchange.

We are still early in Runes’ journey. Without the presence of centralized exchanges, Runes (and other fungible tokens) are still traded on slow order book systems. Transactions are slow due to Bitcoin’s 10-minute block time, which limits high-frequency trading. Given the lack of decentralized exchanges on Bitcoin, it is also not currently possible to directly exchange one Rune for another (it must first be settled into BTC). Additionally, the user experience remains complex. As with previous token standards, holding and trading Runes requires special wallets.

These challenges have hindered its wider adoption.

Some Parting Thoughts One of the reasons Bitcoin is valuable is that it is the first purely digital currency that is fully backed by code and uninfluenced by centralized actors or power brokers. However, it is striking to what extent innovation around token standards built on top of Bitcoin relies on social consensus.

For example, Runes or ordinals are not part of the Bitcoin protocol. They are, as Casey likes to call it, "an opt-in lens through which to look at Bitcoin." You can think of them as a convention that exists because of social coordination. Yet, they are worth billions of dollars because enough people agree that they are socially acceptable.

Yes, Runes are a vastly improved fungible token standard compared to its predecessor. However, a big reason for its widespread adoption is Casey Radamor's support and the social capital he has built over the years. This also explains why people are happy to accept unorthodox rules like the initial 13-character limit on Rune names.

We also believe that NFTs on Bitcoin have found product-market fit. Because NFTs are relatively illiquid and trade infrequently, Bitcoin's 10-minute block time is not an obstacle to their existence. Furthermore, given that Bitcoin blockspace is the most valuable in the industry, and inscriptions reside entirely on-chain, the appeal of owning digital art on this new medium will continue to exist.

I looked at the top ten NFTs and tokens on Ethereum and Bitcoin. The full analysis is here

On the other hand, fungible tokens are severely limited by Bitcoin’s slow block times and lack of an automated market maker. Despite this, their market cap already exceeds ordinals. The top ten ERC20 tokens on Ethereum have a market cap 64x greater than the top ten NFT collections. For Bitcoin, the ratio is still only 7.7x. Once we find ways to make them more efficient to trade, the potential upside could be huge. What might those methods look like? Perhaps Bitcoin’s Layer 2 solutions could provide the answer.

But that’s another story.

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