BRC-20

BRC-20 Fever

Ordinal transactions on Bitcoin have skyrocketed in the last few months, leading to an all-time high for daily transactions and pushing Bitcoin network fees to 2-year highs. The activity throttled BTC’s network so much that Binance was forced to temporarily shut down withdrawals and implement Lightening Network to service outflows without paying excessive fees.

There are currently two types of Ordinal transactions on the network: 1) Ordinal NFTs and 2) BRC-20 token transactions. Our team recently covered the meteoric rise of Bitcoin-native NFTs, this report will focus on the second. While both are technically on-chain NFTs, BRC-20s differ from the first iteration of art NFTs since they are created to be fungible. This gives them properties more resembling tokens than NFTs, leading to their adoption as the most common token standard on Bitcoin.

BRC-20 transactions have been gaining and frequently surpassing non-ordinal transactions as a percentage of daily activity. Non-ordinal transactions last peaked at a 77% share on April 25th, and have generally trended down since. A day before on April 24th the total market cap of all BRC-20 tokens was ~17.5m^[1], as of May 24th it stands at ~$250m, growing 14x in one month.

With the BRC-20 standard originating two short months ago, growth and activity have been parabolic by many measures. But looking at both volume and unique daily users on Unisat (the primary on-chain BRC-20 exchange) for the past two weeks it seems that on-chain activity has potentially peaked. Transaction fees have also fallen, albeit to a lower base than before.

Now that the initial hype has died down, there are still compelling reasons to look closely at investment opportunities arising from BRC-20 adoption. This piece will cover why BRC-20 tokens could potentially be the next evolution of Bitcoin and the investment opportunities that present the best risk-reward should the thesis materialize. 

What is BRC-20?

BRC-20, short for “Bitcoin Request for Comment,” is a new experimental token standard used to issue and transfer fungible tokens on Bitcoin. Launched in early March by pseudonymous on-chain analyst Domo, it uses the Ordinal protocol to “inscribe” metadata directly on satoshis (sats), the smallest unit (one hundred millionth) of Bitcoin. Instead of images relating to NFTs, text files with JavaScript Object Notation (JSON) are embedded into sats to carry out three types of token operations: deploy, mint, and transfer. These operations allow different fungible tokens to be attributed to specific sats. Unlike tokens that exist on other L1s, BRC-20s do not use smart contracts and rely completely on inscriptions to transfer and represent ownership of the underlying supply between wallets.

While the JSON file inscription is technically an NFT minted on Bitcoin as an Ordinal, there are a few properties the BRC-20 protocol enables which allow the related ticker to function as a fungible token. Upon deployment, the text variables set the 4-character ticker, corresponding max supply, and token limit per mint. Tickers are limited to four character combinations, putting a ceiling on the combination of tickers that can be minted.

After deployment, the only way to get allocated supply is to mint tokens. This is the case even for the deployer of the ticker, who becomes the rightful owner of the ticker after it gets minted out. All deployments are technically fair launches since any participant has an equal opportunity to obtain the supply. Whoever mints a ticker first owns the minted tokens. No mint fees accrue to the deployer and there are no other costs associated with minting other than network fees. Due to BRC-20’s “first-in-first-out” model, when the ticker has finished minting the protocol will not recognize new deployments using that same ticker.

Once issued, the tokens can be purchased and sold on BRC-20 marketplaces, which currently operate similarly to NFT markets. Users list and buy tokens through self-custodial Bitcoin hot wallets, similar to how Metamask works for other L1 chains. Rather than trading on an order-book exchange that matches buyers and sellers, tokens are sold in lots with a certain number of tokens at a specified price. Users cannot bid for one unit and must pay for the whole lot to purchase tokens from the marketplace. Thus tickers have a “floor” price similar to NFTs, indicating the cheapest value that a token may be obtained.   

UniSat Wallet, Ordinals Wallet, Hiro Wallet, are among the Bitcoin wallets that currently support tokens issued using the BRC-20 standard. A few centralized exchanges have also begun to support deposits and markets for select BRC-20 tokens.

Unique Value Proposition and Differentiation

Due to the inherent lack of programmability and wildly speculative price action that followed the inception of BRC-20, many have dismissed the phenomenon as just another meme coin pump and dump. While we concur that BRC-20 tokens currently have no utility other than speculation, whether this will remain the case remains to be seen, as many development teams are already attempting to add utility to their tokens.

Even if these attempts are unsuccessful, perhaps the market’s hunger for speculation alone is enough to justify consideration for exposure to BRC-20, and we will dive into our rationale for this in a later section.

The BRC-20 token model has unique attributes that create appeal and differentiation from prior iterations of altcoins. These qualities may attract development teams and users that value them above the programmability offered on other smart contract platforms:

• Inscriptions are issued directly chain
  • Token data resides directly on the oldest, largest, most secure, and most valuable network, the Bitcoin blockchain
  • This makes tokens more censorship-resistant and immutable than ERC-20 and other standards
  • No smart contract or “rug” risk from hacks
  • No admin or multi-sig keys that give a small team of developers complete control over token contracts
• Decentralized Distribution
  • Fair launch mechanisms enable more equitable token allocations
  • Max supply is issued from inception which means there’s no inflation overhang from issuance or token unlocks related to pre-sale deals
  • Provable scarcity since there can be no change to supply
• Premissionless Deployment
  • Deploying a ticker takes seconds and requires no technical ability since it’s as simple as writing one line of code
  • Open source standards and tokens allows anyone to build or create communities around them
• Self-custody centered
  • Tokens reside in self-custody hot wallets, which have direct control of token functions
• Less regulatory risk
  • The lack of fundraising by deployers from minters may make these tokens more commodity-like than tokens issued through other protocols
  • If a BRC-20 is minted fairly, there is no exchange of capital with an expectation of profit, potentially exempting them from the SEC’s Howey Test classification

Despite the industry’s promise to build a more decentralized and inclusive version of finance, the most common use case for crypto after payments is providing vehicles for speculation. Speculation is a prerequisite for adoption and innovation since it attracts new users who hope to capitalize on being early, and builders who create products for them.

Even in their current speculative iteration, we posit BRC-20s represent a different, perhaps better way to speculate than current vehicles due to the qualities above. BRC-20 removes risks currently ingrained into altcoins on other chains, including developer rugs, smart-contract risk, and manipulative tokenomics. Thus a better casino has been built for the degens in crypto, and the only thing stopping them is the friction and lack of tools to get their hands on chips.

A New Casino: Sizing Up The Opportunity

While useful products may eventually be built and create value around the BRC-20 ecosystem, the development timeline is uncertain. Thus, our investment thesis centers around BRC-20’s current usefulness as an instrument of speculation, and we would consider any value created outside of that as incremental to this opportunity.

Given the market’s inclination toward meme coins as the preferred crypto assets to speculate on and the similarities they have with BRC-20 tokens, they provide an appropriate measure for the potential addressable market.

The combined BRC-20 market cap is currently estimated at ~$250m. This gives minters of ORDI ($155m MC), the first most valuable token deployed, a massive 5166x return from the estimated mint cost of ~$30k. This is after a substantial drop from the total market’s recent peak of over $1 billion.

The total market cap for meme coins is estimated to be ~$16.8 billion by CoinGecko. BRC-20 could begin to compete for capital and capture market share of this substantial market. Our bull case assumption is that the differentiators we outlined above will help in growing adoption and winning market share in the meme coin market. It is difficult to imagine that the BRC-20 market has peaked when the entire value of all tokens on Bitcoin is less than half of just PEPE’s market cap on Ethereum ($609m).

Assuming BRC-20 adoption is able to grow to similar values as existing meme coins, we project several possibilities for the growth of the total market cap and potential ROI under various scenarios:

• Bear Case: BRC-20 fails to capture a substantial share of the meme coin market, fading into irrelevancy but maintains half its market cap.
• Base Case: Total market cap is assumed to peak at similar levels to PEPE’s recent top, limiting growth to the last measure of peak demand for the newest viral meme coin.
• Bull Case: Total market cap is able to grow to similar levels as SHIB (largest meme coin on ETH), as a percent of the base chain’s market capitalization. SHIB’s total market cap is 2.3% of ETH’s total market cap. ROI in this case is calculated assuming BRC-20 tokens can rise to the same 2.3% value as their host chain (BTC).

These assumptions should not be looked at as exact price targets, but rather directionally helpful guideposts. The projections also assume improvements for more user-friendly marketplaces and wallets, and exchange adoptions to facilitate fiat on-ramps, factors we believe are temporary bottlenecks putting a ceiling on BRC-20 adoption. The timeline for the scenario’s to play out depends on how fast user-friendly tools for adoption and exchange support are released, but we are seeing positive momentum on that front.

Moonshot Scenario

In the moonshot scenario, we contemplate what could happen if innovative developers succeed in bringing DeFi applications that exist on other chains to Bitcoin. There is a non-zero chance that a portion of Bitcoin’s market cap of half a trillion will one day flow to Bitcoin native tokens when productive applications are built, as seen in other L1 ecosystems.

Even a conservative 1% allocation of BTC’s market cap into the BRC-20 ecosystem would 20x the current market. While some aspirational developers are beginning to develop early attempts at this, we do not consider catalysts from this scenario in our assumptions.

Remaining Catalysts

Several outstanding catalysts can potentially bring our market growth assumptions to fruition. These are events and trends to keep track of as they could trigger new capital flows to BRC-20.

Exchange Adoption

Several top exchanges have announced or are planning on adding support for BRC-20 in some form. These include Crypto.com, Gate.io, KuCoin, OKX, and  MEXC Global, among others. It is likely competitors will want a piece of the volume that these exchanges are already seeing. Huobi has also announced a strategic partnership with the leading BRC-20 self-custodial marketplace Unisat. Unisat’s COO recently mentioned that the team is conversing with dozens more exchanges interested in adding support for BRC-20 in a recent Twitter space.

Binance has already announced it’s working on an Ordinal NFT marketplace, BRC-20 integration could be the next logical step. The impact Binance’s support would have on the market cannot be understated.

L2 Support and DeFi Applications

Due to Bitcoin’s limited block space and highly elastic fee model, L2 integration and support will likely be needed to bring BRC-20 to the masses. The main players building solutions for Bitcoin scalability and off-chain execution include Stacks, Rootstock, Trustless Computer, Liquid Network, and Lightning Labs. These teams are well-capitalized and have some of the best talent in the Bitcoin ecosystem working for them.

Given the influx of users and demand for BRC-20 transactions, expect them to begin designing products that create better user experiences and appeal to the BRC-20 market. Solutions to existing frictions in BRC-20 issuance and trading models will probably be their first areas of focus. Products that result in cheaper fees and streamlined token operations have already started to be announced, with more likely to be rolled out in the coming months. 

There are also a few teams working on products that integrate DeFi functionality into BRC-20 in some way, usually relying on a Bitcoin L2 such as Stacks. Alex Lab already has a live beta product that allows for BRC-20 token trading, while BitFlow is planning on launching this week. We expect healthy competition to launch BRC-20 DeFi products among teams building on L2, given the blue ocean opportunity it presents to attract users.

Exposure

Our estimates contemplate the potential growth of the entire BRC-20 market cap. There is no way to gain direct exposure to this, but a good proxy could be the first BRC-20 deployed by Domo himself, ORDI. Due to its position as the first token minted using the new standard, ORDI has a strong lead in liquidity and network effects.

Despite only being live for two months, the token is already listed on ten exchanges, many of which are in the top 20 by volume. Any exchange that adds support for BRC-20 tokens will look at ORDI first because it has the most trading volume and, therefore, can make them the most fees. If the catalysts above come to fruition, ORDI could be one of the primary beneficiaries.

At a market cap of $155m, it captures 62% of the total BRC-20 market cap, estimated at ~$250m as of this report. Thus its position in the BRC-20 ecosystem parallels Bitcoin’s in crypto in that it will likely capture a portion of any flows that come into the BRC-20 market, just as Bitcoin does for all of crypto.

Note that this probably does not apply to any other BRC-20, and even though its dominance may trend lower over time, it will likely remain a substantial portion of the total BRC-20 market cap. Other BRC-20 tokens could have higher returns but will be higher risk due to having lower liquidity and adoption than ORDI, essentially representing high beta exposure to ORDI. ORDI has no development team, roadmap, or utility behind it other than being the first token minted using BRC-20.

Risks

As with any new technology, substantial risks could undermine the bull case for BRC-20. While crypto is riskier than other asset classes, new crypto protocols are even riskier. The BRC-20 market cap is still so low because it’s a new and unproven protocol. It should be expected that even in the bullish scenarios, the BRC-20 market will be highly volatile due to the uncertainty surrounding their adoption and integration into the broader crypto ecosystem. The market has already shown signs of this, with a 75% retracement from its peak of over $1 billion to its current market cap of ~$250m today. We’ve narrowed down the top risks facing BRC-20 tokens today:

Centralized Indexer

Centralized indexers represent the most significant existential threat to the current BRC-20 model. While the inscriptions representing wallet balances and activities reside directly on Bitcoin’s immutable blockchain, blockchain indexers make these inscriptions readable and useful. The BRC-20 indexers provide consensus on the network’s historical activity and the current state of all BRC-20 tokens. There are only a handful of indexers today, the most common being Unisat’s open-source indexer, given its prominence as the leading decentralized marketplace.

Unisat is incentivized to avoid running a malicious indexer due to the doubts it would raise around the integrity of BRC-20s, which would be detrimental to its business interests. Yet, while the data on Bitcoin can’t be changed, relying on a handful of parties for consensus on the historical state of BRC-20 activity is contrary to the ethos of decentralized blockchains. BRC-20 founder Domo has stated that his top goal is to release a fully decentralized and on-chain indexer. Unisat and Alex Lab are working towards building a trustless solution, among others. 

Hype fades Without Substantial Infrastructure Being Built

As mentioned earlier, BRC-20 could be considered on the tail-end of its initial hype faze. Solutions such as user-friendly wallets, L2 infrastructure, and exchange adoption must continue seeing traction to translate this initial hype into actual adoption from meme coin market participants. If more user-friendly tooling isn’t built, BRC-20s risk a slow bleed of liquidity and users as they devolve into irrelevancy.

BTC Core Developer Hosility

The rise of BRC-20 and Ordinals has created a schism in the Bitcoin community. Some core developers have even called for censoring Ordinal related transactions due to the ‘bloat’ they add to the Bitcoin network, leading to higher fees during increased activity. They argue that using the Bitcoin network for utility other than ‘real Bitcoin transactions’ in the form of peer-to-peer currency exchanges should be considered spamming the network. While it is unlikely that this gains consensus, it is a risk that should be monitored.

Community members in favor of keeping Ordinal transactions argue that Bitcoin’s block space operates in a free market, and it is up to the participants that pay the network transaction fees to determine how the blockchain space they pay for should be used. Given that Ordinal transactions do not violate any of Bitcoin’s current parameters, they are considered legitimate transactions by the network and miners. Ultimately these developers likely face an uphill battle since the rise in fees and activity has led to a windfall for miners, and they may not share the ideals of Bitcoin block space being used exclusively for monetary transactions. 

Bottom Line

The emergence of BRC-20 tokens and Ordinals has sparked renewed developer interest in crypto’s oldest and most valuable network. Whether this will result in substantial innovation remains to be seen. The current market infrastructure and token models leave much to be desired, yet they offer distinct qualities not seen from tokens on other protocols. For longer-term investors that are comfortable with higher risk and volatility, BRC-20 tokens can potentially serve as a proxy for growing adoption from speculative meme coin investors.

Special thanks to Henry Contreras for his help in crafting this piece

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^[1] https://milkroad.com/brc-20-tokens

Tickers in this Report: $BTC, $ORDI, $PEPE, $SHIB, $STX, $ALEX