The essence of inscription token is SFT

Summer of inscriptions

Previously, everyone was speculating on which track the bull market would start from, social, gaming, or ZK? Now there should be no suspense, without a doubt, it is “Inscription”.

However, how to view “inscription” seems to be confusing. Builders, investors, old OGs, retail investors, different people have different views. For a long time, I have been instilled with a wrong view that “Inscriptions are just a new way of issuing assets, similar to the craziness of MEME coins”, so that I had a wrong understanding until I saw articles of Mr. Wang Feng ( @wangfeng_0128) and jolestar (@jolestar) that I realized the true meaning of the inscription.

In this article, I will explain why “the essence of inscription is actually SFT, the third form of token that is different from NFT and FT” and the $ORDI valuation model brought about by this recognition. Finally, I will comment on several common perceptions. mistake.

What is SFT?

For a long time, we have formed several fixed understandings about token Token, which are generally divided into two types: FT and NFT.

The English term for fungible tokens is “fungible token”, abbreviated as FT. The term “fungible” in English means “interchangeable”. As the name suggests, FT is characterized by the complete identity of any two units of tokens, which can be mutually substituted, so it is “homogeneous” as a whole. Because FT directly corresponds to value units in the real world, such as currency, common stocks, and points, and can be added or subtracted, it is easy to understand and therefore appeared the earliest. As early as when Ethereum was just launched in 2015, Vitalik Buterin proposed the idea of implementing FT through smart contracts, and Fabian Vogelsteller proposed the ERC-20 standard recommendation in November 2015. After 2016, ERC-20 has become the most widely used and well-known token standard, paving the way for a huge industry worth billions of dollars.

The English term “non-fungible token” (NFT) is the opposite of fungible tokens (FT) in all aspects. While any two units of FT are completely identical and interchangeable, each NFT is unique, one-of-a-kind, and irreplaceable, and cannot be used for calculations. FT represents abstract quantity units, while NFT represents specific digital items such as virtual artworks, domain names, music, game equipment, and more. In order to showcase their uniqueness, each NFT has its own unique ID (determined by the creating contract address and serial number) and metadata. The main standard for NFT is ERC-721, which was proposed by William Entriken and two others in January 2018. NFT remained a relatively unknown supporting role in its first three years. It wasn’t until 2021, with the popularity of crypto art, that the NFT industry suddenly exploded. In the first five months of 2022, the new asset scale of NFT reached 36 billion USD. Today, NFT is considered one of the most important infrastructures for Web3 and the metaverse.

SFT, also known as “semi-fungible token,” is a new type of token that stands alongside FT and NFT as the third type of general-purpose digital asset. As the name suggests, “semi-fungible token” is a token that falls between FT and NFT, as it can be divided for calculations and yet retains uniqueness.

It’s worth noting that because BTC lacks smart contract functionality, token issuance was previously “defined” from the perspective of the ETH technology stack. For example, the token standard for FT is ERC20, and for NFT it is ERC721. So, what about SFT? In September 2022, the team at Solv Finance, led by Meng Yan (@myanTokenGeek), proposed ERC3525, which defined the SFT token standard within the ETH ecosystem for the first time.

Although ERC3525 in the Ethereum ecosystem has been proposed for nearly a year, it has not caused a lot of waves in the market. One reason is of course the bear market, but another reason is that the SFT tokens jointly issued by Solv are all financial assets of some institutions, or in other words It belongs to the bond market and is aimed at institutional traders and has nothing to do with ordinary retail investors.

How to Issue FT on the BTC Chain?

Before the emergence of various smart contract platforms, many people had already experimented with issuing FTs and NFTs on the BTC chain. The most famous one is the Colored Coin scheme.

Colored Coins refer to a similar technology that uses the Bitcoin system to record the creation, ownership, and transfer of assets other than Bitcoin. It can be used to track digital assets as well as tangible assets held by third parties and facilitate ownership transactions through colored coins. The term “coloring” refers to adding specific information to Bitcoin UTXOs to distinguish them from other Bitcoin UTXOs, thus bringing heterogeneity to homogeneous Bitcoins. Through the technology of colored coins, the issued assets possess many of the same characteristics as Bitcoin, including prevention of double spending, privacy, security, transparency, and resistance to censorship, ensuring the reliability of transactions.

It is worth noting that the protocol defined by Colored Coins is not implemented by typical Bitcoin software, so specific software is required to identify transactions related to Colored Coins. Obviously, Colored Coins only have value within the community that recognizes the Colored Coins protocol; otherwise, the heterogeneous Colored Coins will lose their coloring properties and revert to pure satoshis. On one hand, Colored Coins recognized by small-scale communities can utilize the numerous advantages of Bitcoin for asset issuance and circulation. On the other hand, it is almost impossible for the Colored Coins protocol to be merged into the consensus Bitcoin Core software through a soft fork.

The Mastercoin project conducted an initial token sale (today we call it an ICO or initial coin sale) in 2013 and successfully raised millions of dollars in what is considered the first ICO in history. Mastercoin’s most famous application is Tether (USDT), which is the most well-known fiat currency stablecoin and was originally issued on Omni Layer.

The biggest difference from Colored Coins is that Mastercoin will only publish various types of transaction behaviors on the chain and will not record relevant asset information. In Mastercoin nodes, a database of state models is maintained in off-chain nodes by scanning Bitcoin blocks. Compared with Colored Coins, the logic it can complete is more complex. And since the status is not recorded and verified on the chain, there is no requirement for continuity (continuous coloring) between transactions. But in order to implement the complex logic of Mastercoin, users need to trust the status in the off-chain database in the node, or allow the Omni Layer node to verify it themselves.

How to issue NFTs on the BTC blockchain?

The two protocols mentioned above mainly focus on issuing FT assets on the BTC chain. However, when it comes to NFT assets, Counterparty must be mentioned.

Counterparty was launched in January 2014 and initially served as a platform for FT financial asset tokens. However, it quickly became the birthplace of some of the earliest NFTs, such as Spells of Genesis, Rare Pepes, and Sarutobi Island. In Counterparty, you must relinquish a special Counterparty transaction to transfer ownership of the token. Counterparty nodes parse the data of this transaction off-chain and update a ledger/database stored within the Counterparty nodes. This is achieved using OP_RETURN, a method for storing arbitrary data in a Bitcoin transaction (thus allowing data to be stored on the Bitcoin blockchain).

Counterparty truly took off after the release of the 1774 NFTs in the Frog Pepes series. Collectors use Counterparty wallets to store these NFTs, and Counterparty utilizes OP_RETURN outputs to anchor the index of these NFTs to the Bitcoin blockchain. The data size that can be attached to OP_RETURN outputs is limited to 80 bytes, which is sufficient for Counterparty to include the description, name, and quantity of the NFTs (but for ordinal NFTs, the only limitation on data volume is the size limit of the Bitcoin blocks, which we will discuss later).

In addition to using OP_RETURN, BTC itself has also evolved, and the technological changes brought about by SegWit (2017) and Taproot (2021) updates have paved the way for the introduction of Ordinals.

The Ordinals protocol is essentially created for NFTs existing in the Bitcoin ecosystem. In January 2023, Casey Rodarmor introduced Ordinals, describing it as digital art. Its principle is also simple. Satoshi (sat) is the smallest unit of Bitcoin, named after Bitcoin’s creator, Satoshi Nakamoto. Since there are 100 million sats in one Bitcoin, each sat is equal to 0.00000001 BTC. When all 21 million bitcoins have been mined, there will be 21 quadrillion sats. Typically, each sat is indistinguishable from other sats. Because each sat is equivalent to another sat - and can be exchanged on an equal basis - they are considered fungible.

The Ordinals protocol is a system that can differentiate and track individual sats. When a new Bitcoin block is mined and creates new bitcoins as mining rewards, the protocol assigns a unique number to each Bitcoin based on the time of its mining, with smaller numbers corresponding to earlier sats.

When a transaction occurs, the Ordinals protocol tracks each transaction in subsequent transactions in a “first in, first out” manner. The number assigned to the sats is called Ordinals because the identification and tracking mechanisms of the numbers depend on the chronological order of creation and transactions. Once a sat is identified by the Ordinals protocol, users can engrave arbitrary data on the sat to give it unique characteristics, defined as encrypted art. This functionality can only be achieved after the SegWit (2017) and Taproot (2021) upgrades to Bitcoin Core.

When an Ordinal is inscribed, inscriptions are bound to a special type of taproot code. While this approach makes storing arbitrary data on Bitcoin more restrictive than before, it allows inscriptions to contain more and larger data. Creating and interacting with Inscriptions requires running a full Bitcoin node and a special wallet that supports Ordinals. Finally, we have:

Ordinals + Inscriptions = NFTs

Ordinals theory can be thought of as a way of looking at the Bitcoin blockchain while wearing special goggles, allowing users to create, view and track additional information related to each sat.

So the final question is, how do we issue SFT assets based on the BTC chain?

The essence of inscription token is SFT

The BTC chain lacks smart contract functions, so the issuance of any assets must use a script area such as OP_RETURN or TAPROOT. Then there are two theoretical ways to issue SFT:

1. “Add” some kind of “uniqueness” on the basis of FT tokens,

2. “Add” some kind of “homogeneity” on the basis of NFT tokens.

So, the BRC-20 token was created using the second method. As mentioned in the previous chapter, “users can engrave arbitrary data on sat to give it unique characteristics.” Therefore, if we engrave a piece of text, it becomes a text NFT (corresponding to Loot on Ethereum). If we engrave an image, it becomes an image NFT (corresponding to PFP on Ethereum). If we engrave a piece of music, it becomes an audio NFT. But what if we engrave a piece of code, specifically, code for “issuing fungible tokens (FT)”?

BRC-20 deploys Token contracts, mints, and transfers Tokens by using the Ordinal protocol to set inscriptions as JSON data format. The JSON contains executable code snippets that can be implemented on the Bitcoin network, describing various properties of the Token, such as its supply, maximum minting capacity, and unique code.

So, we see something that seems strange: when inscribing, we use the term “一张” (one card), which is 100% an NFT. However, “一张” can be split, and the homogeneous tokens inside can be distributed individually. This is similar to the concept of “wholesale and retail” in the real world. No wonder some people believe that “inscriptions are NFTs that can be split.” But this combination of NFT properties and FT properties is exactly what we previously referred to as SFT!

Domo (@domodata) inadvertently achieved the issuance of SFT assets using this seemingly retrogressive technical method, without the use of smart contracts. This is truly a great accomplishment!

How to Issue SFT on Ethereum?

In the previous section, we briefly discussed how non-smart contract public chains (such as the BTC chain) issue FT and NFT. However, for smart contract platforms like Ethereum, the issuance of FT and NFT is well-known, which is through the common ERC20 tokens and ERC721 tokens. Now, the question arises, how can SFT be issued on the ETH chain? There are two token standards to choose from: ERC-1155 and ERC-3525.

ERC-1155 is a multi-token standard. Based on its essence, we prefer to call it a multi-instance NFT standard. It is suitable for a relatively narrow use case, where the same NFT has multiple identical instances. Note that these instances must be exactly the same, with no differences whatsoever.

ERC-3525 is a semi-fungible token standard, which is a general standard with a wide range of applications. It can identify multiple similar but not identical tokens as “of the same kind”, and then allows special operations such as transfer between tokens of the same kind. In effect, it allows for mathematical operations such as merging, splitting, and fractionalization among tokens of the same kind.

The main difference between the two lies in how they define “of the same kind”.

• ERC-1155 believes that objects of the same type must be exactly the same, and they are not the same type if they are slightly different.
• ERC-3525 believes that objects of the same type can seek common ground while reserving differences, and be harmonious but different. They have the same key properties, but differences are allowed in non-key properties. \
  For SFT tokens that only have the MEME attribute, ERC-1155 is sufficient. For assets with more financial attributes, ERC-3525 is more appropriate. However, unfortunately, whether it is 1155 or 3525, the Ethereum ecosystem has not seen widespread adoption, with only a few institutional users issuing a small amount of debt-based SFT tokens.

Why are inscriptions successful?

Inscriptions are a large and general word. The original definition is “a piece of content is engraved on the blockchain.” Looking back at history, we can clearly see that the inscription version of NFT was not successful and caused very little impact. The focus of discussion at that time was whether it was worth issuing NFTs based on the BTC chain, considering the existing smart contract version of NFTs (ERC-721).

Drawing inspiration from the concept of fully on-chain games, we can introduce the concept of fully on-chain NFTs. As we all know, NFTs based on Ethereum’s ERC-721 store only the address of the metadata, which is either a web link if the content is stored on traditional cloud servers or a hash value if the content is stored in a distributed storage. It’s no wonder that Musk has continuously mocked NFTs by saying, “At least encode a small image onto the blockchain.” Therefore, we can say that NFTs on Ethereum are “off-chain content storage, on-chain address storage.” If the centralized storage server or distributed storage server disappears, the NFT disappears as well.

And the Inscription version of NFT is a true on-chain NFT, with its content directly stored in the on-chain space of BTC, only using sequenced sats to point to the content. This is indeed an advantage, but this advantage is not enough to convince everyone. So before March, Ordinals NFT was lukewarm, just a small-scale market for little pictures, until the emergence of BRC-20.

I think the BRC-20 is successful for the following reasons:

1. BRC-20 uses a stupid method to implement the issuance of SFT assets on a non-smart contract public chain. SFT tokens are a new asset form that is different from FT and NFT tokens. This is the most essential reason for its success (Ordinals NFTs were not successful in their early days).
2. BRC-20 adopts the principle of fair offering, which is different from the “VC model” of the Ethereum ecosystem. It can open up the market through a wider wealth effect in a short period of time and trigger FOMO (a sharp contrast is Solv Finance).
3. SFT’s leading ORDI token is an experimental MEME token. This token without a valuation model brings more imagination (or consensus value).
4. SFT combines the advantages of both FT and NFT, allowing it to directly utilize the existing infrastructure of FT and NFT. Therefore, we can find that inscription tokens can be traded on NFT marketplaces like OpenSea, similar to NFTs. They can also be traded on centralized exchanges like Binance and OKEx, and even on decentralized exchanges like Uniswap. In the initial stage, when traded as NFTs, they exhibit low liquidity characteristics, which can easily cause price increases (pump). However, after being listed on centralized exchanges, there is a substantial amount of liquidity to support them, maximizing the benefits.
5. Received the overflow funds from the BTC ecosystem. For a long time, BTC holders who wanted to participate in DeFi, NFTs, games, and social activities on the blockchain could only do so through cross-chain operations. Now, there are finally native BTC products available to play.

Valuation of ORDI

$ORDI is the first SFT token in the BTC ecosystem. It is a MEME attribute, so there is no Intrinsic valuation model. In other words, the only limit is your imagination. But we can still make an estimate by reviewing BAYC, the leader in the NFT market.

BAYC has always been the leading project of NFT tokens, similar to a fair sale (low-price Mint), and then rose thousands of times, reaching a maximum market value of approximately US$4.6 billion in May 2022.

$ORDI, as the first token of BRC-20, only requires a small amount of Gas to mint for free, and then it can increase by thousands of times. Currently, the price (December 2023) is stable at $70. Assuming ORDI continues to maintain the leading position of SFT tokens in the future, the peak of the bull market should at least align with the market value of BAYC, which is $220 per unit. However, because $ORDI can be traded on centralized exchanges and has higher liquidity than NFTs like BAYC (many speculative investors only trade on centralized exchanges and do not use wallets), the total market value can reach 3-5 times that of BAYC, which is also acceptable. Therefore, we have the following table:

This horizontal comparison valuation method is of course relatively rough, so just take a casual look. After all, when emotions come, you have the final say in the price.

Several misconceptions

Blind Men and the Elephant: When a new thing with many new features appears, each person may only see a leg or a long trunk of the elephant, but never assume that is the whole elephant. In the past six months, I have read many explanations that have skewed my understanding, until I read articles by Wang Feng and Jolestar, did I truly understand the essence of inscriptions.

1. Inscriptions are a new token distribution method.
   This understanding is completely wrong. The so-called “engraving” is simply uploading content to the blockchain space, a method that has existed for several years. There were even a few mining pools that offered engraving services. Moreover, when Ordinals first started engraving NFTs, it wasn’t popular until they switched to engraving JSON format homogeneous tokens. Therefore, the correct understanding should be: Inscription tokens are a new form of token called SFT.

2. Inscriptions are just a capital-driven MEME wave.
   This view is my previous understanding, and it is both right and wrong. After all, the bull and bear cycles of the entire Web3 are too obvious. Any race, including the previous DeFi and NFT, can be seen as “narrative + pump + dump” within a four-year cycle. ORDI does indeed possess the attributes of a MEME coin. However, this understanding only sees the first leg of the elephant and does not grasp the essence of “Inscription tokens are a new form of token called SFT.” It is a case of generalization based on partial information.

3. Inscriptions are a backward technology, a regression.
   This view is partially correct and partially wrong. Within the current public chains, the BTC chain without smart contracts and the ETH chain with smart contracts should not be lumped together. For the BTC chain, the only way to issue SFT seems to be through BRC-20 or similar protocol variants. However, for smart contract public chains, issuing SFT in the form of inscriptions is indeed a regression from a technical perspective, as there are better ERC-1155 and ERC-3525 standards available. It can only be seen as a speculative hype.

4. Inscriptions are a counterattack by the BTC ecosystem against the ETH ecosystem.
   This view is partially correct. The ETH ecosystem already has SFT standards, but they have not been widely developed because they only involve VCs and institutions, without benefiting retail investors. Retail investors can only choose BRC-20 protocol tokens issued through fair launches in the BTC ecosystem, which is both a resistance against VCs and a resistance against the “orthodoxy” of Ethereum. However, this “resistance” is only the second leg of the elephant, not the elephant itself. Do not generalize based on partial information.

5. The inscription is carved on gold
   This view is either right or wrong. If you compare BTC to digital gold, this metaphor is very vivid, but it still ignores the essence of inscription tokens as a new asset form such as SFT, which is a partial generalization.

Through the above discussion, we can see that the essence of Inscription track is an eruption of a new form of token called SFT. For non-smart contract public chains, SFT can only be issued through the “postscript” method of BRC-20 , as for the smart contract public chain, there are two ways, one is to call the VM and use the smart contract to issue, the other is to use the “postscript column” to issue without calling the VM. In the next article, we will explore the two evolutionary directions of “Inscription tokens”: Recursive Inscriptions and Smart Inscriptions.

This article was originally written by @hicaptainz

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