May 2023

The New and Renewed Bitcoin Narrative

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Bitcoin has had a phenomenal start to 2023, with the asset up over 70% year-to-date. It is outperforming the rest of the crypto market and is benefiting from both an old and new narrative.

The old narrative centers around the original raison d'etre for Bitcoin. Released in the wake of the 2008 banking crisis, Bitcoin was created to provide an alternative financial system that would not rely on the existing and (at the time) failing banking system. That narrative has renewed significance today as we are once again in a banking crisis. At the same time, a fresh Bitcoin narrative is emerging, centered on a new NFT use case deployed on Bitcoin called Ordinals. This month we will dive into both this new and the renewed narrative that is supporting Bitcoin. This month we will dive into both this new and the renewed narrative that is supporting Bitcoin.

Attached to the first Bitcoin block ever created was a headline from the Times newspaper. It reads “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” Satoshi Nakamoto, the infamous and unknown creator of Bitcoin, never commented on the meaning of this text, although it is clearly a mission statement of sorts. The purpose of Bitcoin was to create a digital asset and payment system that exists outside of the traditional financial system. Importantly, Bitcoin does not rely on any centralized third parties like banks.

In 2009, Bitcoin was a niche experiment known about by a small handful of cryptography hobbyists. Its mission did not gain any significant attention. Today, Bitcoin has a market cap of over USD500bn and is regularly discussed by the media worldwide. The purpose of Bitcoin is once again highly relevant given the current banking crisis and state of financial markets. Today, interest rates are at their highest since 2006, US credit card debt is set to cross USD1 trillion for the first time, multiple banks are on the brink of collapse, and we are one month away from a potential US default. Bitcoin proponents point to these facts as evidence of an unhealthy financial system. Bitcoin offers an alternative solution, and this narrative has helped to drive up the price of BTC.

There is also a technical reason that explains why Bitcoin has performed so well as the banking system has been in turmoil. Most companies in the crypto industry with US bank accounts held these accounts at either Silvergate Bank, Signature Bank or Silicon Valley Bank. With all three banks collapsing, there have been few alternative venues for crypto companies to hold money. Whilst we have confidence in Tether as a stablecoin, many companies do not share our conviction. USDC also briefly de-pegged from 1 USD in March this year, as it had deposits in Silicon Valley Bank, leading to a loss of conviction in it as a stablecoin. The result was that as these three banks collapsed, crypto companies in need of a safe haven turned to Bitcoin, as it is accessible and exists outside of the banking system.

To put the scale of current bank failures into perspective, the chart below shows that just three of the recent bank collapses equals the combined failure of 25 banks in 2008 (when the Bitcoin white-paper was published):

The continued failure of centralized financial institutions highlights the value proposition of decentralized systems, where users can own decentralized currencies that can be self-custodied. In addition, many Bitcoin supporters question the credibility of regulators who are tasked with regulating centralized institutions. In the US, for example:

An alternative to appointing fallible regulators is to create a system that is regulated by maths and cryptography. The rate of Bitcoin issuance is pre-determined and cannot be changed. There is no central bank with the ability to manipulate the money supply. One of the greatest achievements of the twentieth century was to separate the church from the state. It may be that the greatest achievement of this century will be to separate the state from money.

While the original narrative for Bitcoin has been regaining global traction, there is another more controversial narrative that is picking up speed within the Bitcoin community. The purpose of the Bitcoin blockchain has been hotly debated for years. The title of the original white paper was “Bitcoin: A Peer-to-Peer Electronic Cash System”. Over time, Bitcoin has become less of a payment solution and more of a store of value, rarely transacted. This divergent identity led to the contentious fork of Bitcoin in 2017 into what became Bitcoin and Bitcoin Cash. Today the identity of Bitcoin is again being questioned, as a new feature called Ordinals has been developed on Bitcoin, allowing NFTs and more complex data to be deployed to the chain.

The Ordinals project works by tracking satoshis, the smallest possible denomination of Bitcoin, worth 0.00000001 BTC. It inscribes arbitrary data to the satoshi token, making the token no longer fungible (interchangeable with other satoshis), but instead non-fungible and an NFT. This process is known as “inscription” and is now possible because of the combination of the Segregated Witness (Segwit) upgrade from 2017 and the Taproot upgrade from 2021.

The Segwit update reduced data storage costs on Bitcoin by 75% and addressed its scalability problem by reducing the amount of data needed to process transactions. The Taproot upgrade then allowed single transactions to reach the full size of a Bitcoin block. The way that Ordinals works is that the protocol assigns a number to each Bitcoin satoshi. It then attaches inscriptions such as images, text or code, to the numbered satoshis, which creates a unique NFT and one-of-a-kind digital object. All data for these NFTs are stored on the Bitcoin blockchain with no requirement to pull data from external sources.

The impact of Ordinals on Bitcoin has been fast and significant. Over 3.7 million ordinals have been created since it was released, and these have cost almost USD10m in fees to inscribe. The reason that ordinals are now contentious in Bitcoin circles is that they are so popular that they are taking up a significant amount of Bitcoin block space, leading to network congestion. Before ordinals appeared, many Bitcoin blocks would be up to half empty with plenty of capacity for transactions. Today, there is significant competition for block space, which is pushing up fees and making it slow and expensive to process regular Bitcoin transactions.

The Ordinals project may not be liked by everyone in the Bitcoin community, but it is undeniably increasing demand to use the network. As with Ethereum and other smart contract platforms, every Bitcoin transaction has a fee associated with it. As demand for block space on the Bitcoin network increases, so too do fees and the need for participants to have BTC to pay these fees. In addition, some developers are innovating beyond Ordinals and are starting to deploy smart contracts directly onto the Bitcoin blockchain. This is now possible because of the Taproot upgrade. Bitcoin’s narrative may be moving on from being just peer-to-peer cash.

The narrative for Bitcoin has never been stronger. News of financial market turmoil feeds directly into the story of Bitcoin’s creation. At the same time, technical improvements to the protocol are giving it new life as a network that can handle more than just transactions. In our digital asset funds, we have a BTC position, although it makes up only a small part of the portfolio. We view Bitcoin as a bell-weather for the broader crypto ecosystem. At times like today it leads the way, but over the longer-term other platforms (with significantly lower market caps) have the potential to outperform. We are excited to see Bitcoin regain momentum and bring attention back to the broader crypto space. As new users enter the space, they will use Bitcoin and then look beyond to the Web3 platforms that are reshaping the Internet and pioneering a new digital world.