This guide takes a look at blockchain scalability, with a focal point of understanding its importance through highlighting Bitcoin scalability ptoblem and its effects.
Bitcoin is often seen as ‘too slow’ and ‘too expensive’. When the network is congested, a bitcoin transaction might need an average of more than one hour for it to be processed. As the founding father of cryptocurrencies, the long processing time was considered unacceptable by many in the cryptocurrency community. Not only that, transaction fees were getting more expensive. Five years ago, an average Bitcoin transaction requires less than $0.05 of transaction fees but at the network’s peak back in December 2017, the average fees reached an average of $40! Microtransactions – which represented the basis of Bitcoin’s purpose – were simply not possible due to the extremely high fees and long waiting times.
The core issue that Bitcoin is facing is called scalability.
(Read more: Will A Crash in Bitcoin’s Price Lead to Its Demise?)
What is Scalability?
Scalability is defined as the capacity for a system or network to grow in size and manage increased demand. With greater usage and activity, any system or network will need to be enlarged to accommodate that growth. The core problem surrounding blockchain technology is scalability; there are limits on the amount of transactions that the Bitcoin network – or any other cryptocurrency network – can process.
Why is Bitcoin Unable to Cope with More Transactions?
The processing capacity of Bitcoin’s network is limited by 2 main factors:
- Average Block Creation Time: It takes approximately 10 minutes to create and secure a block containing around 2,000+ Bitcoin transactions. This means that only a certain amount of transactions can be processed at a given time.
- Block Size Limits: Every block has a limit of 1MB (1,000 KB). This means that there is a limit to the amount of transactions that can be added into the block. The initial reason behind this limit was to prevent Denial-of-Service (DOS) attacks by hackers seeking to create huge (or infinite) blocks that will harm and paralyze Bitcoin’s network.
Since it’s creation, Bitcoin’s open-source code base has seen very few changes and its fundamental properties – like its block creation times and block size limits – are still the same. The number of participants in the Bitcoin network has grown from a handful of Bitcoin enthusiasts to over 10 million daily users currently. You can imagine the tremendous stress that the network is facing due to greater usage and activity.
(See also: Bitcoin’s Civil War: How and Why?)
Comparison Bitcoin Vs Conventional Payment Networks
In order for us to get a better understanding of Bitcoin’s processing capabilities, we have to use a common metric of measuring the number of transactions the any network can process, called Transactions Per Seconds (TPS). Let’s take a look at the processing speeds of Bitcoin compared to other centralized systems.
It is obvious that Bitcoin’s transaction speed is nowhere close to traditional payment processors such as Paypal (193 TPS) or Visa (24,000 TPS!). There is still a long way to go before Bitcoin can compete with its traditional counterparts and be a real, viable alternative to them.
(Read also: How Will Bitcoin Futures Affect Bitcoin Prices? Here’s What History Says)
Why is Blockchain Slow?
A decentralized and distributed network is much slower than a centralized system such as Visa or Paypal. In order to understand why, we need to understand how Blockchain works.
(Source: BloombergNEF)
It is important to recognize that Blockchain is the underlying technology of many Cryptocurrencies, not just Bitcoin. Bitcoin is the first and most well-known application of blockchain technology and is therefore, a suitable example for our explanation.
The Blockchain is literally a chain of blocks connected sequentially to one another, with each block containing verified transactions that are immutable, secure and public. Blockchain ledgers are slower compared to centralized systems since they are required to perform additional work that include:
- Signature Verification: Every single transaction within the network requires digital signatures signed cryptographically by the owner of the private keys (who are technically the owners of the coins). This is mandatory in a peer-to-peer network to prove the authenticity of the coins, and therefore the transaction itself. Generating and verifying these signatures is computationally intensive and complex. On the other hand, a centralized system doesn’t require verification of every single request since the central server dictates the rules governing access.
- Redundant Computations: A distributed system is naturally redundant due to the replication of the same ledger over many access points. Due to the open source nature of Bitcoin, anyone can become a node and operate their own server. An advantage of this architecture is that the network is extremely secure (fault tolerant). However, this means that transactions must be processed individually and separately for each node in the network, therefore requiring more work and taking more time. Alternatively, the client-server relationship in a centralized system requires processing of the transaction in just a single instance.
- Achieving Consensus: Reaching consensus in a decentralized system is a vital requirement for any blockchain. Bitcoin employs a Proof-of-Work (POW) consensus mechanism to achieve consensus, requiring miners to solve complex mathematical problems using huge amounts of computational and electrical resources. Once proven correct, the winning miner is rewarded in Bitcoins (BTC) and the network will agree to the new block being included in the blockchain. This involves significant amount of communication between nodes in ensuring the current state of the blockchain. The consensus mechanism directly affects the average block creation times; for the Bitcoin network, it takes 10 minutes for this entire process to materialize. In a centralized database, the chances of conflicting transactions are minimal and therefore, requires much lesser processing time.
(Read also: Guide on Identifying Scam Coins)
Effects of Bitcoin’s Scalability Problem
The scalability problem of Blockchains can result in negative side effects for the community.
- Expensive Fees: In the early days of Bitcoin, you can send a transaction by paying an average fee of just $0.05. Compare that to now, where fees have exceeded $40 when the network is congested. Imagine paying USD $40 of fees just to send USD $5 worth of Bitcoins. You’d be better off using bank transfers than Bitcoin. Transaction fees are an important part of the network to incentivize miners in processing and validating your transactions into the network. Since there is a block limit where only a limited number of transactions can fit into a block at a given time, miners will be financially incentivized to pick those transactions that pays the highest fees. If you want your transaction to be processed fast, then you have to pay higher fees. This leads to a bidding war where transaction fees are pushed higher when the network is congested.
- Increase in Waiting Time: A congested network would also lead to an increase in waiting times, since there is only so much space in a block for transactions and miners will prioritize those who pay the highest fees. Some have reportedly waited in excess of hours and even days just for confirmation of their transactions! This creates a major inconvenience for users, especially those who are paying minimal fees.
- Low Mainstream Adoption: Expensive transaction fees and long waiting times would directly affect mainstream adoption for both users and merchants. On the user end, increasing friction in using Bitcoin as a medium-of-exchange would ultimately compromise the purpose of Bitcoin being ‘digital cash’ in the first place. More importantly, merchants would not accept Bitcoin – or cryptocurrencies in general – as a viable means for payments; why would merchants wait 10 minutes to an hour just to confirm a transaction when they can stick with VISAor MasterCard which will process transactions instantaneously? Lower merchant adoption means there is less avenues for cryptocurrency holders to use their coins as a means of payment. In fact, several reports indicated that Bitcoin’s acceptance by merchants have been falling since 2017.
(See also: Guide to Cryptocurrency Liquidity: Understanding Liquidity & Its Importance)
Where Do We Go From Here?
As we speak, there are already exciting plans and interesting innovations to address this major issue and significantly enhance the scalability of blockchains. Our next article features an extensive overview of the different scalability solutions currently being developed in the cryptocurrency market. Here it is:
Overview of Crypto Scaling Solutions
Here at Master The Crypto, we’re dedicated to simplifying the complexities of cryptocurrencies and blockchain technology, and we’re excited to publish a series of guides on the different scalability solutions in the blockchain arena. Do subscribe to our mailing list for more updates!
(You might also be interested in: Beginner’s Guide to ICO Investing: How to Participate in ICOs)
Beneficial Resources To Get You Started
If you're starting your journey into the complex world of cryptocurrencies, here's a list of useful resources and guides that will get you on your way:
Trading& Exchange
- Crypto Guide 101: Choosing The Best Cryptocurrency Exchange
- Guide to Bittrex Exchange: How to Trade on Bittrex
- Guide to Binance Exchange: How to Open Binance Account and What You Should Know
- Guide to Etherdelta Exchange: How to Trade on Etherdelta
- Guide To Cryptocurrency Trading Basics: Introduction to Crypto Technical Analysis
- Cryptocurrency Trading: Understanding Cryptocurrency Trading Pairs & How it Works
- Crypto Trading Guide: 4 Common Pitfalls Every Crypto Trader Will Experience
Wallets
- Guide to Cryptocurrency Wallets: Why Do You Need Wallets?
- Guide to Cryptocurrency Wallets: Opening a Bitcoin Wallet
- Guide to Cryptocurrency Wallets: Opening a MyEtherWallet (MEW)
Read also: Crypto Trading Guide: 4 Common Pitfalls Every Crypto Trader Will Experience and Guide To Cryptocurrency Trading Basics: Introduction to Crypto Technical Analysis.
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I'm Aziz, a seasoned cryptocurrency trader who's really passionate about 2 things; #1) the awesome-revolutionary blockchain technology underlying crypto and #2) helping make bitcoin great ‘again'!
