You have some bitcoins in your wallet and want to spend them on your daily purchases. What would that look like in a world where Visa, Mastercard and other financial services still dominate the market?
The ability of bitcoin to compete with other payment systems has long been debatable in the cryptocurrency community. When its mysterious creator Satoshi Nakamoto limited Bitcoin’s block size to 1 Megabyte (MB) in 2010 to prevent people from spamming the network, he also limited Bitcoin’s scalability.
Since each block takes an average of 10 minutes to process, only a small number of transactions can go through at a time. For a system many hoped could replace fiat payments, this presents a significant hurdle. An increase in demand would inevitably lead to an increase in fees, and bitcoin’s utility would be limited even further.
The scaling debate has unleashed a wave of technological innovation in the search for workarounds. While significant progress has occurred, a sustainable solution is still far from clear.
The Bitcoin block size debate
A simple solution initially appeared to be an increase in the block size. Yet that idea turned out to be not simple at all.
Increasing the block size could weaken the protocol’s decentralization by giving more power to miners with bigger blocks. Plus, the race for faster machines could eventually make bitcoin mining unprofitable. The number of nodes able to run a much heavier blockchain could also decrease, further centralizing a network that depends on decentralization.
Second, not everyone agrees on this method of change. How do you execute a system-wide upgrade when participation is decentralized? Should everyone have to update their bitcoin software? What if some miners, nodes and merchants don’t?
And finally, bitcoin is bitcoin, why mess with it? If someone didn’t like it, they were welcome to modify the open-source code and launch their own forked coin.
The arrival of SegWit
One of the earliest solutions to this issue was proposed by developer Pieter Wiulle in 2015, called Segregated Witness (SegWit.)
This process would increase the capacity of bitcoin blocks without changing their size limit by altering how the transaction data was stored. More specifically, SegWit involves removing signature data (the witness information) from the base transaction block (the main 1MB block) and adding it to a separate block, known as an “extended block.” This allows more transaction data to be added to the main block.
SegWit was deployed on the bitcoin blockchain in August 2017 via a soft fork to make it compatible with network contributors that did not upgrade. A soft fork is a change to the software protocol that makes previously valid transaction blocks invalid. While many wallets and other bitcoin services are gradually adjusting their software, others are reluctant to do so because of the perceived risk and cost.
Several industry players argued that SegWit didn’t go far enough. It might help in the short term, but sooner or later bitcoin would again be up against a limit to its growth.
In 2017, coinciding with CoinDesk’s Consensus conference in New York, a new approach was revealed: Segwit2X. This idea combined SegWit with an increase in the block size to 2MB, effectively multiplying the pre-SegWit transaction capacity by a factor of 8.
Far from solving the problem, the proposal created a further wave of discord. The manner of its unveiling (through a public announcement rather than an upgrade proposal) and its lack of replay protection (transactions could happen on both versions, potentially leading to double spending) rankled many. And the perceived redistribution of power away from developers towards miners and businesses threatened to cause a fundamental split in the community, despite being ultimately avoided.
Alternative bitcoin scaling solutions
Other technological approaches are being developed as a potential way to increase capacity.
Schnorr signatures: These offer a way to consolidate signature data, reducing the space it occupies within a bitcoin block (and enhancing privacy). Combined with SegWit, this could allow a much greater number of transactions, without changing the block size limit.
The Lightning Network: A second-layer protocol that runs on top of bitcoin. The Lightning Network opens up channels for fast microtransactions that only settle on the bitcoin network when the channel participants are ready.
Adoption of the upgrade is slowly spreading throughout the network, increasing transaction capacity and lowering fees. To date, more than 74% of bitcoin transactions use SegWit. Up from 44% last year.
Progress is accelerating on more advanced solutions such as Lightning, and the potential of Schnorr signatures is attracting increasing attention, with several developments working on detailing functionality and integration.
While bitcoin’s use as a payment mechanism has been superseded by its value as a speculative investment asset, the need for a greater number of transactions is still pressing as the fees charged by the miners for processing are now more expensive than fiat equivalents. Enhancing scalable functionality is crucial to unlocking the potential of the underlying blockchain technology as it continues gaining traction as a viable form of currency.