Is there a solution for the scalability of Bitcoin?

This May, the launch of the trial version of Taproot is expected, a solution that aims to expand the capacity of the Bitcoin blockchain system.

The initiative was born as one more response to the scalability problem that accompanies this cryptocurrency since its creation, for which a definitive solution has not yet been found. A difficulty that could affect the viability of Bitcoin in the future, and that we analyze in detail in this article.

Access and security

“As we have explained previously, the more people can participate in data mining, the more secure the transactions will be.”

As we explain on Economipedia, Bitcoin is a cryptocurrency based on blockchain technology. This means that all transactions are recorded in data blocks shared by the computers participating in the system through data mining. In this way, users can collaborate in maintaining a historical record of all transactions made with Bitcoin, while being rewarded with balances of this cryptocurrency.

The advantage of this system is evident: if all the information were located in a single record, it would be enough to modify it. However, this is not the case, because, being present in millions of servers around the world, the possibility of changing them all at the same time is negligible. This is, without a doubt, one of the great advantages that Bitcoin presents, generating a secure and accessible record of data blocks for the entire network.

Precisely, to ensure that this participation is as universal as possible, Bitcoin uses relatively small blocks of data. In this way, the network can be accessed, even from simple computers or areas where bandwidth is limited. Remember that, as we have explained previously, the more people can participate in data mining, the more secure the transactions will be.

The scalability problem

«Stock exchanges can record 80,000 transactions per second and VISA 20,000, while Bitcoin can only process 7«.

In this sense, the fact of using small blocks is a great advantage, although on the other hand it also creates problems. The reason is that, as each block has a relatively low capacity to store records, it becomes more difficult for Bitcoin users to operate at the same time, as the number of transactions increases.

Currently, the blocks are 1 megabyte in size, which allows an average of 2,000 transactions to be stored (the number is approximate and depends on the sources, since each transaction has a different size). It is, without a doubt, a relatively low volume; especially if we take into account that the main means of payment in the world register millions of transactions per minute.

In fact, to understand the dimension of what we are explaining, it is enough to compare some numbers.

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If the stock exchanges can register up to 80,000 transactions per second, and the multinational financial services VISA some 20,000, Bitcoin, for its part, can only process 7. This means that if its trading volume continues to grow, there may be a risk of collapse in the network and that users suffer delays in their transactions.

There is, therefore, a capacity limit that hinders the scalability of Bitcoin, for which its developers have proposed multiple solutions. Even more so if we take into account that this cryptocurrency does not stop gaining users and its use is spread throughout the world. Scalability, therefore, is not only a technical issue but, in our opinion, one of the keys for Bitcoin to be a global success.

There are no easy solutions

“Although there have been proposals to reduce this waiting time, for now, and it should be remembered, these have not gone ahead.”

In principle, when we think about possible solutions to end this problem, two solutions come to mind that, although not easy to apply, could end this problem. And it is that, among the solutions, one of them could be the fact that, if there is a limit of transactions that can be stored in a data block, try to increase the capacity of each block or the speed at which they are generated.

The first option, in principle, may seem the most obvious, but this does not tell us that it is without risks and problems. In fact, as we have mentioned before, Bitcoin seeks to operate with small blocks so that as many users as possible participate in data mining. Conversely, increasing the size of the blocks could exclude many people, centralizing records and impairing security.

One of the proposals that were made in this regard was Bitcoin Classic, which promoted an increase in blocks to 2 MB. However, after a few months, the new capacity limit was no longer fixed and passed into the hands of data miners. Despite this, centralizing records was an obvious risk, and in 2017 the initiative was abandoned, encouraging users to migrate to Bitcoin Cash.

On the other hand, the option of generating more blocks does not seem very feasible either. Remember that data mining consists of mathematical problems that take time to solve, which limits the creation of blocks. Today, each block takes, on average, about 10 minutes to be generated.

Although there have been proposals to reduce this waiting time, for now, and it should be remembered, these have not gone ahead. The reason is that by reducing the time and having more users, the problems should be more complex and the necessary capacity of the computers involved in data mining would increase. In this way, the blocks could be generated faster but again security would be lost by excluding participants.

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Alternative proposals

However, there are also other alternatives to the scalability problem.

Without a doubt, one of the most interesting is Segwit, also known as Segregated Witness (Segregated Witness). Broadly speaking, this proposal is that part of the transaction information is stored in a separate data structure. In this way, the size of each transaction could be reduced, allowing more transactions to be stored in each block. And all this, without the need to increase the limit of 1 MB.

A similar idea is the use of parallel strings (side chains), that is, alternative data blocks. These blocks would be connected to the Bitcoin blockchain network, while reducing the pressure on it. However, its use could be more oriented to specific situations than to definitively solve the scalability problem.

Another alternative is the Lightning Network, a network based on payment channels outside the blockchain. These channels are opened by both parties (payer and beneficiary), through an initial transaction to a multi-signature address that is registered in the blockchain network. This initial movement is called the «funding transaction», and it is the starting point to leave the payment channel open.

From then on, either party can use the payment channel, only the validation of the other user being necessary to complete the transactions. It is important to remember that these do not pass to the block network until the channel is closed.

The Lightning Network therefore offers a possible solution to the problem of network capacity, but in return it also has some drawbacks when it comes to transaction security. In fact, these are revocable precisely for this reason. Still, there is no consensus among Bitcoin users about the Lightning Network as a definitive solution.

Can we wait for a solution?

«The current scenario is a growing demand over a rigid supply, generating a risk of relative scarcity in the future«.

In conclusion, the scalability of Bitcoin is thus presented as an important obstacle to overcome for those who think of this cryptocurrency as a reference currency in the future.

It is true that for this there is a long way to go, as we have explained in other publications. However, the objection we raised at the time is based on the price of Bitcoin. That means that it could be exceeded if its price grows exponentially in the markets. Perhaps an unlikely scenario in the coming months or years, but not impossible in the long term.

On the contrary, the problem that we expose in this article is of a technical nature, based on the limited possibilities that Bitcoin offers today. In this case, it would not be enough to trust markets that are more likely to buy this cryptocurrency, but rather specific solutions that will be subject to user validation.

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Does this mean that Bitcoin can never be scalable? Absolutely. It is true that, at present, this asset suffers from a technical limitation, but that does not mean that it will not be able to overcome it in the future.

It is important to note that the problem of scalability of Bitcoin is nothing more than a risk of excess demand. In other words, if the growth trend continues, there may come a time when the market demands many more transactions in Bitcoin than those offered by the current network.

In economic terms, we would say that the current scenario is a growing demand over a rigid supply, generating a risk of relative scarcity in the future.

Bitcoin in spontaneous market order

According to the Austrian economist Friedrich von Hayek, the progress of societies is based on spontaneous order, that is, on the simultaneous action of people who cooperate with each other; without any centralized direction and even unconsciously. In the field of economics, this spontaneity would take place in the markets, where continuous changes in supply and demand give rise to gaps between both variables.

According to Hayek, the spontaneous appearance of these gaps generates, every day, incentives to direct human ingenuity towards the new needs of people. In short, innovation in the market would be explained as a continuous process by which supply tries to adapt to demand. As economic history shows, when in a free economy there is an excess demand for a good or service, it is when more alternatives emerge to overcome that shortage.

As economists that we are, part of our work consists of observing reality and contrasting it with the theoretical constructions that try to explain it. In this case, the scalability of Bitcoin seems like a clear example of a service that is getting closer and closer to suffering from excess demand that could not be satisfied under current conditions.

We cannot predict whether what will happen to Bitcoin will end up being a test for or against the spontaneous order theory, but we can observe the first steps of the market in this regard. Without the need for a centralized management or a state mandate, users have long cooperated to find long-term solutions, showing more vision of the future about their currency than many central banks, but will they be able to achieve it?

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