Bitcoin’s leaders don’t know what’s next for Bitcoin

Bitcoin is at a crossroads. The digital currency and its deregulated network is maturing, but members of the community are lost — they can’t decide what the network should look like when it grows up.

Bitcoin is a decentralized currency that’s transacted on a public ledger called the blockchain. Transactions are verified and posted to the blockchain by a group of people called miners, who are rewarded with Bitcoin for their work. Not just anyone can be a miner, because of the intense computing power required to verify transactions.

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Last week a Bitcoin company incited a flood of transactions on the network to give fellow Bitcoin users a sense of what will come to pass if the currency goes mainstream. The offending company, CoinWallet, put 200 Bitcoin up for grabs, initiating a torrent of transactions as people raced to claim the money. The following day there were 190,000 unconfirmed transactions. Today, the miners have a backlog of 145,000 transactions on the Bitcoin network.

A surge of users could break Bitcoin

CoinWallet’s exercise proves that Bitcoin’s processing standards will not be adequate should the number of transactions increase substantially over time. Currently miners process Bitcoin transactions in blocks, with each block carrying 1MB of data.

In 2010, alleged Bitcoin designer Satoshi Nakamoto limited the block size to 1 MB. The idea was to enable some micropayments, but nothing less than a penny, as well as to prevent spam from getting through. When the number of Bitcoin owners was relatively small, this ensured that transactions happened quickly. People trading Bitcoin wouldn’t have to wait a long time for a block of transactions to fill up and be processed. However, now the community is fast approaching a critical capacity at which Bitcoin blocks will fill too quickly, causing a backlog of transactions like what’s happening right now. Miners can’t process them fast enough.

However, today’s backlog is just a taste of what’s to come if the Bitcoin community cannot reach an agreement on how to address the issue. Everyone agrees there’s a need for consensus, but coming to one is proving difficult.

The options: Bitcoin XT vs. Lightning

There are a few different ideas floating around about how the Bitcoin size should be changed. Bear in mind that at its core, Bitcoin is about providing an alternative to the cash system controlled by governments and corporate banks.

Bitcoin Foundation chief scientist Gavin Andresen and Bitcoin core developer Mike Hearn have created a Bitcoin fork called XT. Miners on the XT network can process Bitcoin blocks in larger 8 MB chunks. Blocks don’t need to be full to be processed, but this gives miners the option in the event of a transaction deluge. The XT network is programmed to grow the size of blocks on a set schedule, doubling the block size every two years. Currently XT-enabled blocks are compatible with both the original Bitcoin network and the XT network. Once 75 percent of mined blocks are compatible with XT, the XT network will hard fork, creating a new network and currency. The network also won’t be run by consensus like the current Bitcoin network is. Rather, decisions concerning XT’s future will be decided by Hearn and Andresen (a move welcomed by Bitcoin businesses facing regulatory pressures from financial authorities).

There’s also Bitcoin core developer Jeff Garzik’s proposal to slightly raise the block limit to 2 MB.

Yet another Bitcoin core developer, Peter Todd, is promoting a solution called Lightning (authored by Thaddeus Dryja and Joseph Poon), allowing Bitcoin members to conduct transactions off the blockchain in payment channels. In practice that means people would rely on untrusted entities to facilitate transactions within a centralized network. An example of that is Changetip, a digital wallet that allows people to tip others in Bitcoin. When a person tips another person through Changetip, that transaction doesn’t show up on the blockchain, because it’s happening on Changetip’s internal network.

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A group of payment channels could allow the Bitcoin network to handle more transactions. Transactions that happen within a payment channel could be consolidated before they’re verified on the blockchain, turning them into a smaller data file that requires less processing power. This solution would redistribute some of the power that miners (who are largely responsible for verifying Bitcoin transactions) currently hold.

The cons

There are, of course, counter-arguments for every option.

Those who object to XT say it will slow down the network, because larger blocks will take more time to confirm. There are also claims that the XT network is already the target of a cyberattack, which may stem miners from migrating. Furthermore, XT puts much of the decision-making power in the hands of miners, who some feel already have too much control over the blockchain. Still, miners may not be enticed by XT for financial reasons. When there’s a little bit of a backlog of transactions, it encourages Bitcoin users to pay a fee to have their transaction prioritized in a particular block. XT is designed to avoid these sorts of system overloads that create competitive fees.

“I want my block size bigger because that means my competitor isn’t getting that information. Meanwhile the people on the other side — are they going to sit around not earning money on their hashing power? No, they’ll join someone else,” said Todd.

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Ideologically, XT also poses problems for some in the community because it’s not run by consensus.

Meanwhile, Hearn argued the Lightning solution is problematic because it’s unnecessarily complicated. For instance, Lightning employs smart contracts to prevent Bitcoin theft. Here’s an example, from the Lightning white paper: “If Bob can produce to Alice an unknown 20-byte random input data R from a known H, within three days, then Alice will settle the contract by paying Bob 0.1 BTC.” If those terms are violated in any way, the contract is null, and Bob can’t collect those Bitcoin.

There are also potential security pitfalls that allow Bitcoin to be stolen under certain circumstances, requiring those using the payment channel to take a complex set of precautions.

The middle-ground solution, where the Bitcoin block size is adjusted temporarily, has been criticized for being too little, too late. The only point the community can agree on is that robust action needs to be taken.

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Silicon Valley

This disagreement may make those invested in Bitcoin companies a little nervous. Over the past few years, an increasing amount of venture capital has flowed into Bitcoin. Since 2012, VCs have invested more than $800 million into Bitcoin companies, according to Coindesk.

This week’s “network test,” a symptom of the overall disagreement within the community, demonstrates that a decentralized financial system may be too volatile for banks, VCs, and startups to continue investing in it. Financial institutions are going to have a problem with a network that’s so easily disrupted by the community that runs it.

And the value proposition for investing in Bitcoin may be shrinking. Banks and other small startups are experimenting with developing their own blockchain technologies that are proprietary. For example, Chain, which just landed $30 million in funding, creates personalized blockchain networks for enterprises. Entities that are operating within the confines of financial regulation may find it safer to work with these technologies rather than Bitcoin itself — though some believe Bitcoin has intrinsic value outside of the blockchain.

“The deflationary design of the currency itself — it’s completely opposite to the way fiat is managed. Also the management, the fact that Bitcoin itself manages the growth rate of the currency,” said Marshall Swatt, CTO and cofounder of Bitcoin exchange Coinsetter, about the benefits of using the Bitcoin network.

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“I think there’s still advantages to adding blockchain technology to existing systems. But I think it would be sad if the Bitcoin blockchain dies because of the community’s inability to come to a consensus,” he added.

Bitcoin isn’t dying

That said, the Bitcoin community isn’t facing certain death. But Bitcoin startups that have taken large investment rounds might be. Without widespread adoption of Bitcoin, it will be hard for these companies to make money. There’s also pressure for the government to start regulating these companies. For instance, New York requires Bitcoin startups to be licensed, but the requirements have been difficult for some companies to meet, forcing them to leave the state. Still others are considering shutting down because of the obscure regulatory environment.

This culling of the herd may be OK with some.

“I would much rather Bitcoin remain small if the alternative is to make it look like PayPal,” said Todd. Though keeping the community small and centered on a core ideology may be ideal for some, it also has the potential to backfire. Right now there is a lot of choice in the Bitcoin market because of the amount of VC funding that’s fostering various exchanges and digital wallets. But, if there’s too much competition and not enough users, companies will subsequently shutter, and that could concentrate powers in the hands of a few exchanges and digital wallets.

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The decision surrounding Bitcoin is undoubtedly difficult, but in order for the network to grow, certain members of the community must make concessions. Or else Bitcoin is doomed to be a “failed project.”

Update: The name of Lightning promoter and Bitcoin core developer Peter Todd has been changed to reflect its appropriate spelling. An earlier version of this story listed him as Todd Park. The Lightning network idea was developed by Joseph Poon and Thaddeus Dryja.