24.04.2024
Happy halving! In honor of this milestone, we are digging into bitcoin innovations for a second consecutive week, focusing on Runes in this entry. The concept and spirit of Runes draws inspiration from the ancient symbols used in religious ceremonies. To cast a spell, the symbols that are inscribed in the rune (a small tone, even a bone) represent letters, and the right letters must be placed in the right order. Each rune and symbol hides a secret meaning, a concept that doesn’t change over time, a transcendental and deeper meaning that overcomes the symbol itself and acts as a way to transmit wisdom that reaches us even today.
Source: Photo by Håkan Sundblad on Unsplash
The rise of runes on bitcoin.
Designed by Casey Rodarmor, the creator of the Ordinals protocol, Runes represents a significant step forward in the functionality of the bitcoin blockchain. This protocol facilitates the creation (etching), minting, and transfer of fungible tokens directly on bitcoin, similar to assets built on platforms like Ethereum or Solana. Unlike other tokens which might exist on secondary layers or different blockchains, Runes operate within the main bitcoin blockchain, ensuring they benefit from the same robust security and immutability that bitcoin itself enjoys. Rodarmor's creation, while termed somewhat dismissively by the man himself as a space for "shitcoins" for “degens”, aims to bring a new layer of utility to Bitcoin. These tokens can be seen as part of a broader exploration of what Bitcoin can support beyond simple financial transactions, incorporating elements of fun and meme culture into the blockchain at the very least.
And let’s face it, the first look at Runes is quite mem-y rather than revolutionary:
Source: DoggfatherCrew on Twitter via Coingecko
A deeper look at how Runes function.
The Runes protocol leverages Bitcoin's existing blockchain infrastructure to etch, mint, and transfer fungible tokens. Each token created under the Runes protocol is known as a Rune, with each Rune carrying a unique identifier or 'Runestone.' This process begins with etching, where the token's fundamental properties—name, symbol, and supply—are defined and inscribed onto the blockchain. The minting phase follows, utilizing an OP_RETURN transaction to embed these properties within specific unspent transaction outputs (UTXOs), effectively making these UTXOs the carriers of the Rune. This is markedly different from Ordinals, which are assigned to specific Satoshis. Runes are not related to Satoshis, but to UTXOs which may carry different amounts of Satoshis and which pass the rune from one UTXO to another as prescribed by the sender of the transaction.
While both Runes and Ordinals protocols are designed to enhance the functionality of bitcoin and provide high-value activities that make mining attractive in a setting of falling subsidies, they serve distinctly different purposes. The Runes protocol facilitates the creation of fungible tokens, where each unit is identical to another and can be used interchangeably, much like traditional currency and bitcoin satoshis themselves. This fungibility makes Runes particularly well-suited for broad financial applications, from representing digital assets to potentially facilitating complex financial transactions within the decentralized finance (DeFi) space. The ability of Runes to utilize Bitcoin’s UTXO model for tracking ownership and transfers ensures that each transaction remains secure and verifiable, a critical requirement for financial operations on the blockchain. Of course, with the creator of Runes doing heavy expectation management, we should be wary of such lofty use cases emerging on Runes, particularly if they are being shilled to us on social media.
In any case, Runes are not just passive entries but active components of bitcoin’s ledger, able to be traded or transferred with full traceability and security afforded by bitcoin’s core features. The OP_RETURN mechanism, while marking the UTXOs, does not alter bitcoin's operations in any way. Full bitcoin nodes can completely ignore the whole Runes protocol without any problem, as just like Ordinals, Runes are only visible by an interpreter that translates “waste” data on the blockchain.
Impact of Runes launch on bitcoin's halving.
The strategic launch of Runes around the time of bitcoin’s halving event was a success in terms of hinting at the longevity of bitcoin’s proof of work algorithm even with new bitcoin emission trending towards zero. Halving events reduce the income miners receive from block rewards, making transaction fees a more crucial component of their earnings. Well, block 840,000 - the first block post-halving, showed that in the near term the inflationary bitcoin emission can amount to a joke for miners in comparison to the block reward.
Look at the “total fees” line in the breakdown of the first post-halving block:
Source: Mempool.Space
Now compare this to the most recent block as of writing:
Source: Mempool.Space
If enough worthwhile applications emerge from Runes and Ordinals, any concerns about miners not being incentivized to secure the network vanish. However, this also leads to increased network congestion and higher transaction costs for regular users, who now have a higher incentive than ever to move to layer-2 solutions like the lightning network to conduct their normal bitcoin transactions. So, while the Runes protocol offers significant benefits by expanding Bitcoin's capabilities, it also presents challenges that need to be managed to maintain the network's accessibility.
How Runes incentivizes layer-2 innovation and a word on Stacks.
By enabling the creation and management of fungible tokens directly on the blockchain, Runes not only expands the functionality of Bitcoin but also opens up new avenues for user engagement and financial innovation. As we explored, this expansion brings its challenges, challenges that currently look like chaos with occasional transaction fees of over US$2 million in a single block. But chaos is a ladder. And the surge in activity on bitcoin due to the Runes protocol is a clear signal of the need for scaling solutions! One such solution, next to the Lightning Network, may be Stacks: A protocol that we have touched upon in the past. Stacks act as a separate layer built on top of Bitcoin: Imagine it as a highway that alleviates traffic on the main road (the bitcoin blockchain), reducing congestion on the main network by processing significant transactions off-chain. Stacks initiated its Nakamoto upgrade after the halving. The upgrade ensures its off-chain transactions are ultimately anchored to Bitcoin's security, allowing for faster and cheaper settlements compared to the congested main chain. With projects like Runes and Ordinals generating long term miner demand, migrating as many operations as possible to layer-2 innovations like Stacks can, if done well, significantly improve user experience while still enjoying the increased security of the main chain. In our view, just like with Ordinals, any friction that Runes generate is positive friction for bitcoin.