Is Poor Scalability Bitcoin’s Next Problem?

March 29, 2023 Profitable Investing Tips

Bitcoin is showing signs of life as it appears to emerge from crypto winter hibernation. Since the first of the year the senior cryptocurrency is up 67%. Along with investors in the Nasdaq market, Bitcoin investors and traders have the opinion that the US Federal Reserve is going to stop raising interest rates so fast and perhaps stop completely due to a banking crisis. Crypto winter showed that Bitcoin and other cryptocurrencies are subject to the same economic forces as stocks and other investments. This could be a long term problem for Bitcoin when, for years, it was touted as the alternative investment free from such influences. Now there is another issue as Bitcoin returns to economic viability which is scalability. Is poor scalability Bitcoin’s next problem and why?

Bitcoin Scalability Issues

Because record blocks in Bitcoin have size and frequency limits, the Bitcoin scaling problem is that transactions move more slowly than users would prefer. The original purpose of Bitcoin was to facilitate economic transactions on the internet free of third party control. However, real world competitors in this arena like VISA and MasterCard process transactions in fractions of seconds while Bitcoin transactions can take minutes or hours. The issue lies in how blockchain transactions work in processing Bitcoin.

How Bitcoin Transactions Work

Blockchain transactions for Bitcoin processing take place across a network of computers (nodes). Transaction processing takes place on mining nodes while data storage takes place on full nodes. Each transaction has inputs and outputs whose number depends on how many parties are involved in a transaction, where the usual number is at least two inputs and two outputs. Data involved in a transaction includes amounts, addresses, fees, and keys which identify transactions. Along the way another group of nodes validates transactions, reaches consensus, and then broadcasts the details to the entire Bitcoin network where they are recorded into another block in the chain. This is a very secure system with checks and balances but it pays a price in lower transaction speed.

What Slows Down a Bitcoin Transaction?

The speed of Bitcoin transaction processing depends on solving cryptographic puzzles which in turn requires computational speed. When the most powerful, fastest nodes are unavailable, the task falls to slower ones. As transactions progress, new blocks must be created and it takes, on average, ten minutes to create a Bitcoin block. Block size affects speed as large blocks can accommodate more information and smaller ones cannot, which slows things down as well. Small blocks of 1 MB versus the original 32 MB size have a slowing effect on Bitcoin transactions. The bottom line is that the system allows for about seven to ten transactions per second which results in total transaction time being about an hour and a half for Bitcoin.

Ethereum Scaling

We have written about Ethereum maintaining efficiency by scaling as Ethereum’s reach grows. As we noted then, Bitcoin, Ethereum, and other tokens have two choices, upgrade to allow for faster processing speed or remain a niche token with limited services and reach. This latter option would not seem to be a viable way to go for Bitcoin, so they need to look for solutions before Ethereum passes Bitcoin in value due to more efficient processing and a lot more useful services within the crypto realm.

Potential Bitcoin Scaling Solutions

In order for Bitcoin to speed up its programming needs to change. One solution, called a hard fork, is to upgrade software to the extent that older version nodes are not valid in the update. This is essentially creating a new crypto token which is what happened with Bitcoin Cash (BCH) which increased block size to 8MB and then to 32MB. Another hard fork as BSV or Bitcoin Satoshi Vision which upped block size to 4GB with the goal of competing with VISA and MasterCard in speed.

Alternatively, a soft fork is an upgrade that creates nodes that run on an updated protocol while not requiring older nodes to be upgraded unless a user wants to use the new features. The best example of a soft fork for Bitcoin is SegWit or Segregated Witness. This approach uses new data in a separate memory cache which is not visible from nodes used in the old Bitcoin system.

Another approach is similar to what is being done with Ethereum. The Lightning Network performs as a parallel channel to the standard Bitcoin system. Small amounts can be funneled through “cooperative nodes” that skip some of the stops in the typical Bitcoin processing chain. This “two-layer” solution is scalable, faster, and has the potential to do with lower transaction fees.

An Unscaled Bitcoin Is Still a Store of Value

The reason for creating Bitcoin was to have a way to buy and sell things via the internet. Along the way Bitcoin became an impressive store of value. At the root of debates about scaling Bitcoin or not is whether one can simply leave well enough alone and let Bitcoin remain a store of value as other tokens take over functions that require faster and more cost-efficient processing.