Ordinals Protocol: Impact on Transaction Fees & Miner Revenue

The emergence of the Ordinals protocol has not only spurred a new class of digital collectibles but has also profoundly influenced Bitcoin’s economic model. It has created a massive impact on transaction fees and miner revenue. This blog analyzes how Ordinals leverages the two major technological upgrades, Segregated Witness (SegWit) and Taproot, and how it is reshaping the profitability structure for miners. After reading this advanced analysis, you will fully understand this new opportunity within the Bitcoin ecosystem.

Why Did Ordinals Emerge?

The birth of the Ordinals protocol is an inevitable consequence of the Bitcoin network's development reaching a certain stage. This protocol allows users to create unique digital assets directly on the Bitcoin blockchain, fundamentally altering the traditional perception of the network.

The Ordinals protocol was primarily made possible by two key Bitcoin technological upgrades: Segregated Witness (SegWit) and Taproot. These upgrades changed the structure of Bitcoin transactions, carving out extra space within the block that could be used to store more data. The Taproot upgrade was especially critical, enabling users to attach data to transactions more cheaply and privately. Someone discovered this available space and realized it could be used for more than just sending currency. The Ordinals protocol utilizes this technical space.

The protocol's author envisioned a concept: Satoshi (Sat) numbering. A Sat is the smallest unit of Bitcoin. The Ordinals protocol sequentially numbers every single Sat, giving each one a unique identity. The protocol then allows users to "inscribe" arbitrary data—be it images, text, or programs—onto these specific Sats. Through this process, digital assets are permanently recorded on the Bitcoin blockchain. This process is called Inscriptions. Simple in execution yet powerful in effect, it transforms Bitcoin from solely a currency into a data layer capable of carrying artwork and digital collectibles.

The Technical Foundation of Ordinals: SegWit and Taproot

The emergence of the Ordinals protocol is inseparable from two critical Bitcoin technological upgrades, SegWit and Taproot. These two upgrades provided the technical feasibility and space for Ordinals.

The Contribution of Segregated Witness (SegWit)

SegWit was activated in 2017. Its primary goal was to address the transaction congestion issues on the Bitcoin network. SegWit successfully separated the signature data from the transaction data and placed it into a separate section called the "witness." This allowed a single block to accommodate more transactions. Crucially, SegWit’s design made the fee calculation for the signature data significantly cheaper. This laid the foundation for attaching extra data to transactions in the future.

The Aid from Taproot

Taproot was activated in 2021. It is one of the most significant upgrades in Bitcoin’s history. Taproot delivered two major benefits: first, it enhanced transaction privacy, and second, it substantially lowered the cost of complex transactions. For Ordinals, Taproot provided the key data space. Taproot allows users to store a large amount of data within the script portion of a transaction. Moreover, this data is treated as witness data. Since witness data is cheaper than regular transaction data, users can store images or text at a relatively low cost. The Ordinals protocol fully exploits the ample space provided by Taproot.

Economic Impact I: Transaction Fees and Network Congestion

The most direct impact of the Ordinals protocol on the network is the spike in transaction fees and network congestion.

Surging Transaction Fees

Ordinals created a new category of transaction demand. People are no longer just sending Bitcoin; they are actively competing to inscribe digital collectibles. To ensure their inscription transactions are confirmed faster, users are willing to pay higher fees.

This has led to an intense competition for block space on the network. Bitcoin block space is finite. When demand suddenly exceeds supply, fees rise sharply. Ordinary users conducting routine Bitcoin transfers are also forced to pay higher fees.

The Debate on Congestion Mitigation

This phenomenon has sparked debate within the community. Some argue that rising transaction fees are a sign of Bitcoin's healthy economic development, as miners earn higher revenue. Others contend that high fees hinder Bitcoin's growth as a payment instrument. This issue has also accelerated the development of Layer 2 solutions, such as the Lightning Network, which are expected to handle everyday small-value transactions.

Economic Impact II: Reshaping the Miner Revenue Structure

The Ordinals protocol has had a profound and positive effect on the miner revenue structure. It has significantly shifted the miner's reliance on the block subsidy.

Increase in Miner Revenue

Miner revenue primarily comes from two sources: the Block Reward (newly issued Bitcoin) and Transaction Fees. With the explosion in Ordinals transaction volume, the transaction fee revenue received by miners has increased dramatically. During some peak periods, transaction fees have even exceeded the amount of the block reward. This pushed miners' daily revenue to historic highs.

Mitigating Halving Shock

Bitcoin undergoes a Halving event approximately every four years, which directly cuts the block reward in half. This poses significant pressure on miners. The emergence of the Ordinals protocol provides miners with a new, sustainable revenue stream. The increase in transaction fee income can effectively offset the future revenue shock caused by the Halving, thus enhancing the mining industry's economic resilience.

Strengthening Network Security

The rise in miner revenue is essential for the security of the entire Bitcoin network. Miners are the cornerstone of network security. Higher revenue incentivizes more hashrate to participate, making the network harder to attack. Through market demand, the Ordinals protocol indirectly strengthens Bitcoin's long-term security.

Learn More at the Bitdeer Learning Hub

The Ordinals protocol is a major experiment in Bitcoin technology and economics. It has fully utilized the technical space provided by the SegWit and Taproot upgrades, proving Bitcoin’s vast potential as a data layer.

This protocol has injected new economic vitality into the Bitcoin network. It has drastically increased miner transaction fee revenue while simultaneously driving a re-evaluation of the value of block space. In the future, Ordinals-like transactions are likely to become a crucial component of miner income, a sign of the Bitcoin ecosystem's continued growth and maturity.

If you wish to delve into more advanced analyses of mining costs, visit the Bitdeer Learning Hub to view more professional blog posts on blockchain and cryptocurrency.