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Bitcoin’s Growing Pains

By: Franco Daniel Amati - @franamati - May 14, 2015, 12:29 pm

EspañolThe bitcoin network processes approximately 100,000 transactions every day, or on average around one transaction per second. It seems like nothing by comparison with popular payment methods. PayPal says it handles 11 million daily transactions (127 per second), while Visa nears 216 million (2,500 per second).

Bitcoin is a long way from achieving such heights, but it’s growing. Around this time last year, the network processed half the volume it does today: transactions have doubled.

The concern is that bitcoin, as it stands today, can manage three transactions per second at most. This limit during peak times or specific scenarios is already a problem, delaying transactions and sparking controversy among developers: not only about the possible solutions, but also who gets to decide on them in a community that has always strived to be as decentralized as possible.

Varias propuestas se manejan para elevar el límite de procesamiento de bitcoin (Flickr)
Every 10 minutes, a block containing users’ transactions is added to bitcoin blockchain.  (Flickr)

Why Is There a Limit in the First Place?

Bitcoin works through a distributed database that is stored, updated, and audited by decentralized nodes. Given the necessary infrastructure, anyone can join them. Every 10 minutes, these nodes add a “block” to the database containing the users’ new transactions.

In exchange for this task, the nodes receive the new bitcoins created by the system at that point, as well as the transaction fees included in that block. This database or ledger is called the blockchain because every block is tied to the previous one.

By design, all blocks must have a maximum size of 1 megabyte. If a node creates a larger one, the rest of the nodes will reject and rule it invalid for inclusion in the blockchain. Considering how long the average transaction takes, the blocks start reaching their maximum allowed size when there are three transactions per second.

If there are more transactions than there are places for them in a block, then the nodes will probably choose to include those that carry a higher fee with them, leaving out the rest for future blocks when demand is lower. Left to its own device, over time the fees will continue to rise in a race to get included in the blocks and the cost of using bitcoin will increase. A caveat is that, with an augmented price, eventually the volume of transactions will fall; the market will clear either by adjusting the fees or the quantity of transactions included.

Proposed Solutions

Increasing the maximum block size: one proposal aims to expand it to 20 megabytes. This doesn’t mean we’ll see blocks that size overnight, only that they could reach it if need be. Similarly, others propose not to set a fixed size but rather implement a rule that gradually increases it over time.

Reducing the block rate so that instead of the blocks being generated every 10 minutes, they could spawn every one minute. This solution would entail reducing the nodes’ reward to avoid modifying bitcoin’s crucial controlled-supply expansion. Blocks would remain the same in size but there would be many more in a given interval, thus allowing the network to process more transactions.

Sidechains: alternative blockchains would connect to the main ledger and “synchronize” with it.

Transactions outside the blockchain: decentralized services could be set up where users could trade with each other without registering those transactions in the blockchain. Then, if necessary, the service would send a single transaction to the blockchain with the result of all the internal transactions among its users.

Lightning Network: a string of transactions that, while being performed off-blockchain, are decentralized and can be enforced by transmitting them later to the bitcoin network for its inclusion in a block.

Political and Economic Effects

Some solutions are problematic because they alter the incentives system already in place, and tinker with what makes bitcoin tick. They can tilt the balance of profits and losses among those who provide the network infrastructure, or even make it more or less decentralized. Many argue that too large a block size could dramatically increase the costs of maintaining a node in terms of bandwidth and equipment, leading to fewer nodes.

A smaller amount of nodes generating blocks implies less decentralization, and increases the likelihood of a successful attack on them, be it government intervention or just dishonest nodes trying to take over the network.

Who Rules Bitcoin?

The bitcoin protocol’s rules are implemented in the software used by wallets, nodes, and users around the world. A change comes through a software update.

But who decides to change those rules? There is a consensus among bitcoiners that some rules should not change, like the limit of 21 million bitcoins to be created in total. Some changes benefit everyone or add features that practically no one would refuse to add to the protocol (e.g., multisig transactions).

In practice, when nodes with differing rules coexist, depending on the case, either those with a majority prevail (soft fork), or parallel networks with another set of rules emerge (hard fork).

There is still time to agree upon the best solution. However, we should get used to the fact that bitcoin, for better or for worse, is not and will not remain a static technology.

Translated by Daniel Duarte.

Franco Daniel Amati Franco Daniel Amati

Based in Buenos Aires, Franco Amati is an IT consultant who specializes in digital currencies, blockchain solutions, and cryptography as means for greater decentralization, individual freedom, and privacy. He's the co-founder of Bitcoin Argentina and Espacio Bitcoin. Follow @franamati.