Bitcoin NFTs Gain Popularity, Fueling Debate on Network Capacity and Fees

02.06.2023

This Week in DeFi:

Duel for Layer-2 Dominance!

DeFi has been on the rise recently as the broader financial markets show positive sentiment going into February. This week has been especially positive for Ethereum layer-2 rollups Arbitrum and Optimism. Rollups are blockchains built on top of Ethereum Mainnet (layer-1) which aim to solve Ethereum’s scaling issues while maintaining its security and decentralization. They aim to increase throughput while reducing gas fees by executing transactions on their respective chains, then sending them in bundles to be settled on Ethereum Mainnet. Thus, layer-2 is also known as the execution layer, while Ethereum Mainnet is known as the settlement layer.

To begin 2023, both Arbitrum and Optimism saw signs of growth and innovation that we believe are notable. Since the beginning of the year, Optimism Total Value Locked (TVL) is up 54% to $786 million, while Arbitrum TVL is up 36% to $1.37 billion. To put this into perspective, these chains have a higher TVL than several major household cryptocurrencies including Fantom ($438 million), Solana ($261 million), and Bitcoin ($139 million). It’s important to note that TVL inherently rises when the underlying assets held on the chain increase in price. This is why we must go deeper to understand the real growth of these chains. First, let’s take a look at daily transactions.  For Arbitrum, the number of daily transactions has jumped to around 400,000 per day, up from less than 200,000 to start the year. This is an indication that natural usage is up, not just asset values.

DEX volumes are another indication of natural on-chain activity. Arbitrum has seen a 30% increase and Optimism has seen a 20% increase in DEX volumes over the week, while both chains have seen a steady, almost linear increase in volumes since the beginning of the year. To compare, Ethereum DEX volume has increased at a slower rate since the beginning of the year and is actually down 2% this week.

The rise in popularity in layer-2 scaling solutions has prompted a discussion of what the best, most sustainable path forward is for Ethereum as a whole. With EIP-4844 (Proto-Danksharding) in the pipeline for Mainnet, scalability will see a significant increase on layer-1, which will create even more competition for roll ups to create the fastest, cheapest, and most secure product.

So, will there be a clear-cut winner in the layer-2 space? Will several rollups coexist, each with their own value proposition? Or will Ethereum Mainnet scale to the point where it can even sustain itself?

NFT Market News:

Bitcoin NFTs Surge in Popularity Sparking Heated Debate

Ordinals, a project that allows NFTs to be created on the Bitcoin blockchain, is experiencing an apparent surge in popularity. On Thursday 2/2, Ordinals recorded its largest number of single-day mints to date, with 420 new inscriptions added to the blockchain. The increased activity has also resulted in higher Bitcoin network fees, which many oppose. The launch of the project has sparked a heated debate in the Bitcoin community. Many question whether NFT transactions are legitimate, and whether Bitcoin was designed to handle the increased volume NFTs create. The debate grew louder with the recent  “Taproot” upgrade that allows for digital artifacts on the Bitcoin network. To do this, a Bitcoin transaction must be created that includes additional data (the Inscription) in one of the output addresses. The Inscription can be in the form of text, images, SCG, or HTML, with its size limited only by the block size limit.

One reason that many oppose Bitcoin NFT’s is because of the increase in transaction fees it creates. Transaction fees on Bitcoin are determined using the volume of data in the transaction, the traffic of the network,  and the desired speed of completion. Users who want transactions processed quickly during periods of high traffic must pay higher fees in order to do so. The increase of NFT activity on Bitcoin’s mainnet led to more network traffic, resulting in higher transaction fees, peaking at 3.86% as a percentage of the block reward for miners on Thursday 2/2.

Some Bitcoin users view Ordinals as a threat to the Bitcoin ethos. They argue it is spamming/clogging the decentralized network. Ordinals’ developer Casey Rodarmor argues that full blocks are crucial to incentivizing users to pay above the minimum fee. Rodarmor also stated that he does not support increasing the block size. Opponents fear that should Bitcoin NFT popularity increase, network fees for Bitcoin may become too high for the network to function as designed. It will be interesting to see if there will be a sustainable NFT ecosystem on Bitcoin or if the network will prove to be unable to support the added network volume that NFT trading brings and it’s just last week’s news.

Latest News:

Hundreds of institutions and prominent individuals have invested directly in crypto, adopted the digital asset/blockchain value thesis, or started building technology to support digital assets since Wave started tracking this metric in late 2020. Now the rise of the Metaverse, Decentralized Finance (DeFi), Non-Fungible Tokens (NFTs), and Decentralized Autonomous Organizations (DAOs) is driving mainstream adoption of blockchain technologies everywhere we look. We’re continuing to keep track of it every week here:

• The U.S. Air Force (USAF) has selected SIMBA, a leading enterprise blockchain solutions provider based in Indiana, for a $30M strategic technology initiative, following up on multiple projects the company has completed for the military branch in recent years.
• Pick n Pay, the South African grocery retailer, is now accepting Bitcoin in all of its 1,628 stores following a three-month pilot testing phase in 39 locations. As part of the rollout, customers will be able to pay for items using crypto via smartphones apps or by scanning a QR code and accepting the South African rand’s conversion rate at the time of payment.
• Membrane Finance has released a fully-reserved stablecoin backed by the euro. The company is licensed by the Finnish Financial Supervisory Authority (Fin-FSA) and claims that the new ”EUROe” coin is “the first and only EU-regulated crypto stablecoin.”
• Russia’s largest bank, Sberbank, will release a decentralized finance (DeFi) platform by May. The platform will initially be based on the Ethereum network, with users being able to access it using the MetaMask wallet extension.

REGULATORY ROUNDUP

We’re living through the era of regulatory recognition of digital assets. The legislation, litigation, and regulation happening today will dictate the entire future of our industry, and we have a historic chance to shape those changes by staying informed and exerting political influence.

• Lawmakers in the European Parliament have amended their proposal on digital data, easing some of the onerous requirements for smart contracts. The text will need to be adopted by the industry committee on Feb. 9.

Disclaimer: The views and opinions expressed herein are those of the author alone and do not represent Wave Digital Assets LLC or any of its affiliates (collectively, “Wave”). The author and/or Wave may hold investment positions in some of the assets discussed. Nothing in this material or linked information should be interpreted as an offer or recommendation to buy, sell or hold any security or other financial product. This material is not intended to provide accounting, legal or tax advice. Certain information contained herein has been obtained from third-party sources, has not been independently verified and should not be viewed as being endorsed by Wave. Such information is believed to be accurate as of the date of its publication. No representation or warranty is made, express or implied, with respect to the accuracy or completeness, and readers should not place undue reliance on the information contained or linked to herein. Certain statements in this material provide predictions and there is no guarantee that such predictions are currently accurate or will ultimately be realized. Past performance is not indicative of future results.

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