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First, let me start by saying that I love Bitcoin and that I am bullish on the long-term prospects of cryptocurrency as a whole. It has changed my life for the better, and I’ve met a lot of people along the way that can say the same about it.
But I wanted to take a moment to “get real” about Bitcoin, especially after experiencing, first hand, it’s dramatic rise in value this year, and the accompanying surge of interest from the general public, many of whom are rushing to purchase the coin despite not knowing what it really is.
What is Bitcoin?
According to Satoshi himself, Bitcoin was designed to be a peer-to-peer electronic cash that would allow online payments to be sent between parties without a financial institution.
It accomplishes this by broadcasting transactions in an append-only public ledger. Records of these transactions are stored on blocks which are cryptographically linked to each block before it, in a chain-like sequence. This work is done by miners which require computing power to find the variable nonce that will yield the correct hash – called proof-of-work, which is an integral part of the consensus protocol.
Transactions take a long time
Even if none of the above really makes any sense to you, the important part to get out of it is, that the integrity of Bitcoin’s trustless system relies on a difficulty adjustment setting that pegs the cryptographic function solve time to 10 minutes, regardless of the total computing power on the network. This dynamically adjusting difficulty setting was designed into the protocol to intentionally slow the transaction time down, so that it would be difficult for an attacker to gain an advantage by attempting to solve a consecutive chain of blocks and therefore own the keys to history. This does not take into account the wait time in the mempool before a transaction gets added into the next block – figure that in and you’re looking at up to seven hours for a confirmation.
The takeaway is that transactions are not instantaneous. They take time.
Transactions are expensive
Bitcoin fees are measured in Satoshi’s per byte of data transmitted. Since a Satoshi is a fraction of a Bitcoin, as the price of the coin continues upward, so too does the relative price of the transaction itself. To compound the problem, the wave of new interest has congested the network, causing transaction delays. To overcome this, senders can prioritize inclusion of their transaction into the next block by increasing the fee tied to their transaction. The increased competition further raises the market price per transaction. As of this writing, each transaction costs about $24.23 or nearly the same price as a wire transfer.
Now imagine a scenario where you’re trying to buy a stick of gum at a gas station – will you wait 10 minutes or more and pay nearly $25 for the processing fee? Probably not. In fact, for the majority of your daily or even occasional purchases, Bitcoin doesn’t seem like a viable option against the methods you already use.
Competing systems are still better
Bitcoin’s network of miners can handle about 3.5 transactions per second (tps) on a 1MB block. Compare that with PayPal which easily processes 150 tps during peak periods or Visa, which does 2,000 tps without breaking a sweat and has a theoretical peak maximum of 56,000 tps, and you can see that competing systems can scale with transaction load a lot better. In order for Bitcoin to be an everyday payment system, it must at least compete on the same level as existing systems and have a hope to scale to greater heights.
Centralized systems like Visa and PayPal can continuously make infrastructure improvements to increase the transaction processing speed and throughput. However, Bitcoin’s decentralized structure means that it does not benefit from uniform decision making motivated by a business objective. Despite its rapid growth and adoption, improvements to the protocol have been few and far between, failing to keep up with demand, and therefore exacerbating the problems I’ve mentioned in earlier sections of this article.
Many have noticed other cryptocurrencies addressing the problems I’ve mentioned with Bitcoin. In the early days, Bitcoin relied on market dominance of its brand and was less encumbered by transaction time and costs. Today, it has brought awareness to the cryptocurrency community and allowed other “altcoins” exposure to interested buyers. Those that spend time researching the tech behind the currency are well aware of the problems I’ve mentioned and might see stronger merit in a competing currency. In fact, Bitcoin is losing market share rapidly to all other coins, representing just 36 percent of the cryptocurrency market, just half of it was a year earlier.
What about the coming improvements?
There has been a lot of discussion around off-chain tech that is supposed to address these issues. Many still seem a long way from being implemented, have their own issues, and still have to contend with consensus agreement and user education in order to work.
Then there’s the argument of improvements to Bitcoin’s protocol itself. The community has been highly fragmented after the breakup of the New York Agreement, which was supposed to help address Bitcoin’s lack of centralization, by allowing different, but important, factions of the community a vote. In its current state, it’s hard to imagine the implementation of any near-term scalability improvements to the protocol, to address these issues.
Bitcoin as digital gold
There’s another side of the virtual coin in this discussion – that Bitcoin doesn’t need to be an everyday currency, but rather serve as the store of value in the representative form of digital gold. If that is the case, then higher transaction fees and long confirmation times reduce the incentive for participants to move money, leading to more ‘hodling,’ theoretically reducing the supply and increasing the price. Other currencies can then serve as the decentralized payment method to allow for fast and low-cost transactions. The concern with this is that by removing the utility value of Bitcoin, larger capital flows of fiat into more useful currencies might also encourage a reduction in Bitcoin’s relevancy and thereby cause the opposite effect. It seems that with its dwindling market share, this might already be happening.
In the end, Mr. Nakamoto’s goal was to make Bitcoin a payment system, not a wealth accumulation medium. Only time will tell which argument wins out, but in its current form, Bitcoin is a long way from an everyday currency.