'Ordinals' could signal the beginning of a new generation for Bitcoin. Here's what investors need to know

Published Wed, May 10 202310:35 AM EDT

In the past few days, the value of transaction fees on the Bitcoin blockchain have been skyrocketing – and crypto watchers are taking it as a signal that a new era of Bitcoin could be upon us. Analysts ascribe the spike in fees to users minting BRC-20 tokens, new experimental tokens that let users create different assets on the Bitcoin network, including Ordinals – a protocol that makes it possible to store and trade digital content on the Bitcoin blockchain. That digital content is similar to nonfungible tokens, or NFTs, with some technical differences. Ordinals are the hot new thing of the moment in crypto but they're just one example of how developers can build on Bitcoin the way they build on Ethereum. "Bitcoin Ordinals demonstrates that bitcoin is capable of more than just serving as a store of value and showcases the network's ability to have NFT architecture," JPMorgan strategist Nikolaos Panigirtzoglou said in a recent note. "In a way, Bitcoin Ordinals add more diversity and utility to the Bitcoin network, which could elevate the Bitcoin network utility to that of other blockchains, such as Ethereum." "Ordinals, by boosting network activity, increase the revenue earned by bitcoin miners beyond that earned from block issuance reward, which in turn helps to secure the network," he added. Here's what the recent interest in Ordinals says about the future of Bitcoin: Bitcoin can be more than a cryptocurrency However you value the biggest cryptocurrency by market value – as a speculative risk asset, as digital gold, as an alternative to a bank or anything else – most agree that the purpose of the Bitcoin blockchain is to host the bitcoin token. There's one population in crypto, however, who have long believed the Bitcoin network could and must do more than that. "Everything that's getting built on Ethereum and in other parts of crypto, we've always said, is ultimately going to end up coming back and getting built on top of Bitcoin as well, and that is what you are seeing right now," said Alex Miller, CEO of Hiro, a Bitcoin developer tools company. Bitcoin wasn't designed for building applications and the "core" bitcoin community have resisted attempts to financialize the Bitcoin economy in the way of Ethereum, explained Gautam Chhugani, an analyst at Bernstein, in a note Tuesday. The blockchain has "severe technical limitations" and "spikes the [transaction] fees to an unsustainable level, making the network unusable," as the market witnessed over the weekend. That's where so-called Layer 2 applications come in. "You have these additional layers that sit on top of [Bitcoin] and provide all kinds of extra capacity and functionality, but ultimately are settled back to and secured by the Bitcoin chain," Miller said. The Lightning Network is perhaps the best known of these, and is focused on settling payments faster on Bitcoin. Stacks is a Bitcoin layer for smart contracts that could help maximize Bitcoin's potential for decentralized finance (DeFi). "In the long run this can raise user interest in BTC, raising its value and enhancing its usefulness to everyone," according to Chhugani. "The 'store of value' property (digital gold) has been Bitcoin's clear market positioning, so far," he said. "It is still early days, but is it the start of the utility phase of Bitcoin?" Better paid miners, better security More activity on Bitcoin could also mean higher fees for miners, who receive a "block reward" as an incentive to mine new bitcoins and keep the network secure in the process. Over time, however, that reward goes down in value – as designed in the Bitcoin code as a way to reduce the bitcoin supply. This feature has become a market event called the "halving." However, "that means that for miners to be willing to keep doing the same amount of work every four years, the value of bitcoin needs to go up or the money needs to come from somewhere else – and that somewhere else is transaction fees," Miller said. In the past few days, and for the first time in Bitcoin's "modern history," the value of the transaction fee in some blocks was greater than the block reward, Miller said. Binance cited Bitcoin network congestion on Sunday as the reason for pausing withdrawals, and bitcoin dropped 7% between then and Monday. The phenomenon is a big deal for the long-term viability of the network. "At some point there will stop being new bitcoin to mine, and it will only be the transaction fee," Miller said. "Congestion, or lots of demand for the block space, is not just good, it's a critical thing for the future of Bitcoin," Miller added. "If people are not willing to pay to use it, people will not be willing to pay to mine on the chain. And if nobody's willing to do that, it would make it possible for someone to take over the entire network." A sneak peek Ordinals and spikes in transaction fees are just a glimpse of what may be on the horizon. It's unlikely that the level of demand Bitcoin saw last week will continue unabated, Miller said. Plus, there's a bit of a land grab when it comes to new tokens and coins emerging as the first examples of new applications in an untested landscape. "This is just a sign of what is to come," Miller said. "A year or two from now, you'll see that level not just sustained but exceeded on an ongoing basis. It'll follow standard tech development cycles but ... This is the start of the next iteration or generation for Bitcoin." —CNBC's Michael Bloom contributed reporting