Bitcoin has a scale problem. Here's how to fix that.
Although the bitcoin network is nearing its 10th anniversary, we have yet to see the use of bitcoin, the currency, as a common method of payment. How likely is this to change in the future? It will largely depend on whether the bitcoin community can successfully scale the system.
The primary innovative characteristic of the bitcoin network is its decentralized nature, by which I mean that power over the activities on the network and the rules that govern it is distributed among a community, rather than in the hands of a single entity, or a small group of entities. It is essential to the fundamental value proposition that bitcoin could potentially offer, namely that of “sound digital money.”
Nevertheless, bitcoin’s decentralized character has substantial costs in terms of efficiency. Although concerns over bitcoin’s energy usage are generally overblown—much of bitcoin mining, for example, seems to take advantage of surplus energy that cannot, or cannot easily, be channeled elsewhere—such a decentralized system does require substantial energy consumption for its security.
In addition, it requires transactions to be validated and stored in a world-wide network of thousands of nodes, which explains why the throughput on the Bitcoin Block Chain is currently only at roughly 10 transactions per second. For comparison, major global payment systems process upward of 50,000 transactions per second.
Ultimately, then, for bitcoin to become a mainstream payment system, the current system will need to be scaled.
One option is to scale the current system by improving the throughput possible on the Bitcoin Block Chain directly. Recent advancements to that effect have been the introduction of Segregated Witness—a protocol upgrade that has eliminated the possibility for “transaction malleability,” which also has scaling benefits due to smarter management of digital signature data—and the incorporation of better transaction processing practices by many major exchanges.
Importantly, however, such “on-chain” scaling will only have limited direct implications, due to the severe constraints on the amount of data the bitcoin network can feasibly process in a decentralized fashion. Hence, via only on-chain scaling, bitcoin could never come close to realizing the throughput needed for a major modern payment system.
The only real way to scale bitcoin, therefore, is via “off-chain” transactions. One way to attempt to achieve such scaling is by introducing custodians that can also move representations of bitcoins, rather than only actual bitcoins. This is what most major bitcoin exchanges do, and they thereby greatly increase the overall number of bitcoin transactions. However, bitcoin’s design constrains the applicability of this type of scaling and it also undermines its primary value proposition.
Hence, the primary ambition is to scale bitcoin in ways that is aligned with its decentralized character. In that regard, we are seeing a very exciting development in the Lightning Network. This is a higher layer network which enables nearly instantaneous, very low-cost bitcoin transactions, which are not processed and registered directly in the Bitcoin Block Chain, but nevertheless anchored in it for security. Transactions only take place on the Block Chain directly when a party pushes bitcoins to or pulls them from the Lightning Network. For illustrative purposes, you could think of the Lightning Network as a multilateral netting system for the blockchain that does not require a centralized clearing house. Though still in development, the Lightning Network is growing exponentially and already capable of handling the many thousands of transactions per second expected from a modern payment system.
Importantly, the energy footprint required per transaction within the Lightning Network is far lower than the energy needed to secure transactions within bitcoin’s base layer. The best way to view the base layer is as a settlement layer—not a payment system—that is highly secured through energy consumption. Off-chain scaling methods for payments (and other applications) such as the Lightning Network can, then, take advantage of this layer without requiring the same level of energy consumption.
Although bitcoin still has challenges to overcome in scaling, with initiatives such as the Lightning Network, I am becoming more and more convinced that it’s just a matter of time. You may indeed soon find yourself paying for that coffee in your local café with bitcoin.