Before and After — the Great Bitcoin Fork

Today, at 12:20pm UT, or 8:20am ET, Bitcoin split into two. One Bitcoin will be known as “Bitcoin” and enable Segwit2x, supported by most businesses in the community. Another Bitcoin will be “Bitcoin Cash”, which has lesser support, but is currently trading on futures markets at around 20% of Bitcoin’s value.

If you control the private keys to an address with 1 Bitcoin on July 31st, after this fork event, you will control 1 Bitcoin (BTC) and also 1 Bitcoin Cash (BCC) on two, previously identical but from that point onward divergent cryptocurrency networks. You will own two separate versions of Bitcoin with their own futures and supporters after the fork event.

PSA: bridge21 does not anticipate any interruption of service

Quickly, we do not anticipate any interruption of bridge21’s services from Bitcoin’s hard fork on August 1, 2017. All of our Bitcoin will be stored on addresses where we control the private keys during the fork event, thereby ensuring no loss of funds on either chain. We’re also keeping enough Mexican Pesos in reserve so that even if there are significant disruptions to the Bitcoin network, we will still be able to satisfy customer transactions for some time after the fork. Finally, our service doesn’t need a specific type of digital currency to “win” or “lose” in order to be successful, so we have no horse in the race.

Boredom Warning: Heavy Reading Ahead

Today’s blog post is the first half of a “before and after” piece on the specifics of the Bitcoin hard fork, including an objective look at both “sides” of the scaling debate. A warning, this post will require some knowledge of Bitcoin to understand, and is unlikely to be enjoyable or even comprehensible to the casual reader.

As no one really knows what will happen with the split tomorrow writing anything today is arguably a risky move. Then again so is building a money transfer company that uses Bitcoin to settle transactions, so here we go!

To scale or not to scale: the origins of the Bitcoin scaling debate

In 2010, Satoshi Nakamoto added a limit of 1MB to the Bitcoin blocksize. Bitcoin transactions were effectively free at that time, so there was a legitimate concern that attackers could “spam” the network and arbitrarily create huge blocks with phony transactions, permanently bloating the blockchain that everyone else would have to store in perpetuity. The 1MB limit was meant to prevent this attack until such a time that a better solution could be put in place. Satoshi suggested that the solution could be a set increase in the blocksize at certain block heights, effectively growing the limit at a predetermined rate, similar to how new Bitcoin are issued.

Bitcoin scaling, an extremely brief history

Since the 1MB limit was introduced in 2010, how to scale Bitcoin has been a constant source of debate in the Bitcoin community. This 1MB limit was originally thought to limit the number of transactions per second to 7, but in practice the real number was closer to 2.3 transactions per second. In 2010, this was far more volume than was required, leaving years to grow before a solution was required.

The need to solve the scaling issue became a priority in 2014, as we saw the trend in transaction growth threaten to hit the 1MB limit in 2016. Gavin Andresen first proposed 20MB blocks, which was too aggressive for many. This idea was replaced by BIP101, which was meant to increase block size at 40% per year starting at 8MB, conservatively under Moore’s Law and the average speed of broadband speed increases. From here we saw various proposals, including XT which originally implemented BIP101, BIP100 which let miners “vote” on the blocksize limit, Bitcoin Classic, which was a compromise to a simple 2MB blocksize, and finally Bitcoin Unlimited, a more aggressive approach of “emerging consensus” to let users “vote” on what the blocksize should be at a given time. Others favored no blocksize increase at all, but changing the Bitcoin protocol to support “layer two solutions”, which are effectively variations of the “high frequency payment channels” Satoshi implemented in version 0.1 of the Bitcoin software.

This 2+ years of debate occurred while Bitcoin users, investors, and other members of the community watched Bitcoin’s transaction volume slowly creep higher and higher, and in 2016, that volume started to push against the 1MB blocksize.

Bitcoin Transactions per Block over Time

This graphic of Bitcoin’s transactions per block clearly shows a change in the transaction growth trend of Bitcoin. In early 2016 the trend started to break down, and by mid 2016, the number of transactions per second stopped growing. Not because of a lack of user demand, but because of a hard-coded limit in the Bitcoin protocol itself limiting it to around 2.3 transactions per second, the 1MB blocksize limit. This also caused transaction fees to go from pennies to as high as $5.00 per transaction, and settlement times to go from 10 minutes to hours or days. This made Bitcoin non-competitive with existing services like Western Union or Paypal, strictly on the basis of speed and cost.

What impacts did the limit have on Bitcoin from 2014 through today?

As someone that’s followed Bitcoin since late 2010, it’s my opinion that the precipitous drop-off in investor interest in “pure” Bitcoin plays as well as the dramatic loss of Bitcoin market dominance are directly attributable to the lack of scaling and “redlining” of Bitcoin’s transactions per second. Bitcoin will not grow as originally designed without new users and startups using it, and building technologies and services over it.

It’s difficult to prove causation, but there are two trends that are correlated to the 2016 rate limiting of Bitcoin’s to 1MB blocks, or around 2.3 transactions per second.

Trend 1: Follow the Money — Blockchain vs. Bitcoin specific investment over time

First, investment in Bitcoin specific startups grew from 2012 through 2015, but trends changed dramatically in 2016, as is evident from light analysis of data from Coindesk shows. While investment in “blockchain” has still rising steadily year-over-year, investment in firms that are focused on using Bitcoin as a subset of “blockchain” have dwindled.

Blockchain vs. Bitcoin specific investment (Millions USD)

Note, this change in investor preference for alternatives to Bitcoin coincides with full blocks in 2016, and a lack of clear resolution to the scaling debate.

Trend 2: Bitcoin’s sudden and dramatic loss of market capitalization

A second, complementary trend appears when we examine Bitcoin’s market capitalization compared to all other cryptocurrencies in this chart from Coinmarketcap.com.

Notice that the sharp drop in Bitcoin market dominance from 80% to as low as sub-40% coincides with the Bitcoin blocksize “filling up” in 2016? Bitcoin’s market dominance compared to other digital currencies dropped like a rock at exactly when Bitcoin’s transactions per second limit started to impact its growth. If you imagine this market capitalization chart over the transactions per second chart above, the timing is uncanny.

It is also interesting that Bitcoin’s market dominance rebounded around July 1st, almost precisely the time the Bitcoin Cash hard fork was announced. There is absolutely no way to “prove” it, but with a community so divided, I speculate that the market viewed the fork as a positive sign for Bitcoin’s long term health. More on this later…

The scaling debate’s recent, turbulent history

Recently, the “Bitcoin Unlimited” movement gained momentum quickly, largely due to widespread frustration with a lack of real scaling solutions, and was closing in on 50% of the Bitcoin miners “voting” for their approach. The pure “Segwit” approach, which did not increase the blocksize limit, but partitioned digital signatures to an “extension block”, effectively giving an increase to 1.7 MB, achieved around 35% approval with the support of the dominant Bitcoin development team, Bitcoin “Core”. Segwit was not going to achieve activation, and Bitcoin Unlimited was gaining ground quickly, which made many in the community uneasy, as their approach to scaling was very new, radical, and arguably not as well tested in the real world.

This changed rapidly over an industry conference in 2017, where a compromise quickly achieved 80% and then > 90% support. This compromise was proposed earlier in April by a separate group, but failed to gain traction at that time. The compromise is known as Segwit2x, which combines Segregated Witness with a 2MB blocksize increase three months later.

Around the same time, a group led by a LiteCoin developer started a movement known as the “User Activated Soft Fork” (UASF), which would fork the Bitcoin network in early August, creating a Bitcoin that uses SegWit with no blocksize increase, separately from Bitcoin’s main chain.