Leveraging DLCs for Ordinals Auctions, Trading and Lending

Introduction

The pace of innovation within Bitcoin is breathtaking, with new and transformative developments consistently expanding our understanding of digital currencies. Just a few months since their creation, the explosive popularity of ordinals have attracted interest to bitcoin and have changed our understanding of what’s possible. 

But what are ordinals? Similar to the concept of NFTs on alternate chains, ordinals represent unique assets on Bitcoin. In essence, they are ordered satoshis that bear inscribed data (inscriptions) in the witness data, a feature that grants them the ability to uniquely identify and represent data on the bitcoin blockchain. 

However, as a new technology, ordinals currently have far less functionality and present a worse UX than what NFT holders and traders have available on Ethereum and other blockchains. Ordinals protocols have been implemented using Partially Signed Bitcoin Transactions (PSBTs), mostly out of necessity, but PSBTs are fairly simple and are limited in many ways. 

But what if we could change that? At DLC.Link, we see enormous potential in Discreet Log Contracts (DLCs) and their ability to revolutionize how we interact with ordinals.

DLCs: A Brief Overview

First, let's recap what a DLC is. A Discreet Log Contract involves:

  1. Locking of Bitcoin funds between two parties native to the Bitcoin blockchain
  2. Generating a set of partially signed outputs representing how the locked collateral will be paid out between those two parties (similar to an “if-then” statement on Bitcoin)
  3. One of those outputs being executed when a DLC Attestor signs a certain outcome

At DLC.Link, we implement DLCs into DeFi and CeFi protocols. We also power a DLC Attestation Layer, thus enabling cross-chain compatibility with smart contracts on various chains.

DLCs: The Perfect Solution for Ordinals?

DLCs enable conditional logic, which is a critical building block in more complex systems. Conditional “if-then” statements are a cornerstone of trading systems, and DLCs can incorporate an off-chain instruction (such as from a smart contract) to govern their behavior.

In contrast to PSBTs, DLCs also improve the user experience significantly. For example, when setting up a Dutch auction using PSBTs, users have to pre-sign multiple PSBTs at various price points. With a DLC, the user only pre-signs a DLC once. The DLC behavior can be governed by one or multiple logical flows, enabling multiparty transactions, sophisticated auction and trading behavior, and the ability to perform financial operations such as using an ordinal as collateral for a loan.

DLCs also present a safer way to use ordinals in transactions. For starters, with a DLC, the ordinal is never held custodially, nor is it wrapped or bridged to another blockchain. Sats in a DLC are kept separate from gas fees and are never pooled, which is critical for ensuring that a valuable inscription attached to a sat doesn’t get spent accidentally.

How Can DLCs Empower Ordinals?

At DLC.Link, we see four major opportunities where DLCs can be paired with ordinals to improve the UX and offer innovative ways to represent, sell, and trade ordinals across multiple chains.

  1. Support for Complex Auction types:  DLCs open the door to complex auction types that were previously impossible or impractical. By enabling intricate logical flows, users can utilize sophisticated bidding strategies and can adapt dynamically to real-time market conditions.
  2. Cross-Chain Compatibility: By locking ordinals into DLCs, users can mint ordinal-backed NFTs that can be loaned against or traded on Ethereum, Solana or other chains. This provides an easy way for existing NFT marketplaces to implement ordinals and trade them alongside their other assets.
  3. Lending Against Ordinals on Bitcoin: Just as we lend against other types of collateral, DLCs can facilitate lending against ordinals on Bitcoin.
  4. Creating Derivatives Against Ordinals: Derivatives provide a valuable financial instrument for managing risk and speculation. Creating derivatives against ordinals could open up entirely new avenues for financial interaction.

Example of a DLC-enabled Ordinals Auction Platform

Let’s walk through an example of a DLC-enabled ordinals auction.

One intrinsic characteristic of Discreet Log Contracts (DLCs) is the restriction that the same ordinal or UTXO cannot be locked in multiple DLCs concurrently. This is by design, so as to avoid any double-spending. In an auction setting, this means that, before locking the ordinal, a smart contract needs to separately identify the winning bid. 

With that understood, let's delve into the proposed workflow for a better understanding of this process:

1. Ordinal Collection Creation: An ordinal creator studio initiates the process by minting the ordinals collection on BTC into a collection.

2. Bid Registration: Bids are initially recorded through a web3 smart contract (e.g. Ethereum or Stacks), denominated in BTC. This smart contract is in charge of the auction logic and simultaneously opens a corresponding DLC as the Bid Contract. Participants place their bids using their web3 wallet and lock their BTC into the DLC within their wallet.

3. Bid Acceptance: A bid is only officially accepted once the bidder's Bid Contract has been funded (i.e., the transaction is mined on the BTC chain). This initial DLC consists solely of the user's BTC and not the ordinal. At this stage, the BTC bid is locked on-chain.

4. Automated Bid Management: The smart contract is equipped to automatically close and refund bids that fall below the current highest bid(s). This feature is crucial as it allows bidders to re-enter the auction with a higher bid value if they choose to do so. Participants can open multiple bids if they wish.

5. Auction Closure: Once the auction duration expires and a winning bid is determined, a second Ordinal Contract is initiated. The user receives an offer to accept the ordinal transfer in their wallet. They can review the details of the ordinals and confirm that the seller is indeed transferring the correct ordinal as per their bid.

6. Bidder Acceptance: The bidder approves the transfer. The smart contract releases the funds from the bid escrow in the original DLC to the seller only when the Ordinal Contract is fully completed.

7. Buyer Protection: (Not represented in the graphic) If the buyer decides not to accept the ordinal, perhaps due to dishonesty on the part of the seller, they can decline the offer. This action sends the ordinal back into the bidding pool and the buyer's money is refunded. Alternatively, the issue could be escalated to a mediator. 

This proposed flow safeguards both the bidder and the seller, ensuring a fair, transparent, and efficient auction process for ordinals with the help of DLCs.

Summary

Just in a few months, we've seen a meteoric rise in the popularity of ordinals, BRC-20s, stamps, and other Bitcoin-based assets. Still, the current ordinal landscape on the Bitcoin blockchain presents ample opportunities for growth. Functionality, usability, and the overall user experience are areas that demand enhancement, especially when compared to sophisticated NFT ecosystems elsewhere.

DLCs are a groundbreaking solution with the power to transform the ordinal landscape. They cut through the limitations of double-spending issues, enable intricate logical systems, and massively boost the user experience, setting the stage to redefine the way we engage with, trade, and auction ordinals.

Looking ahead, we at DLC.Link envision a digital landscape where ordinals are not just mere satoshis but versatile financial assets. Join us on this journey as we push the boundaries of what’s possible with Bitcoin.

Join us as we enable a Trillion dollars of Bitcoin capital to be used in smart contracts. Contact us:

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