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Introduction to SegWit – Part 2. Capacity, Scalability and Coin Cap

In addition to protecting the Bitcoin network from the malleability issue with transaction identifiers, Segregated Witness protocol also increases the capacity of the blocks. This article will explain why block capacity is so important and how it impacts the fees on the Bitcoin network.

 

Capacity and scalability of the Bitcoin network

Block capacity and scalability have become a very important issue for the Bitcoin network in the 2016 and 2017 as the popularity of the network kept going up. Miners on the Bitcoin network compile transactions into blocks of the bitcoin blockchain. For a transaction to occur, it needs to become a part of the blockchain, which means that it needs to have miners add it to a block.

These blocks have a size limit of 1 megabyte and the network aims to create a block every ten minutes, which means that the network has a limit as to how many transactions it can process, no matter how many miners it has. This limit is between 3 and 7 transactions per second. Compare this number to 24,000 transactions per second, which is how many transactions Visa financial network can process and the problem with Bitcoin becomes obvious.

The original whitepaper of Satoshi Nakamoto had “peer-to-peer electronic cash system” in the title. The whitepaper also mentioned micro transactions. The original vision was that a person can buy someone a coffee or send money for some other small insignificant purchase using Bitcoin, without a need for a centralized bank or a third party. However, this can’t happen on a massive scale if Bitcoin can only process 3 to 7 transactions per second versus Visa’s 24,000.

This problem is also the reason why the fees on the Bitcoin network have grown very significantly. For example, on January 7, 2017, the average transaction fee on the Bitcoin network was just USD$0.326. Transaction fees on the network are voluntary. However, this number grew 10x by October of 2017 and reached its peak at the end of December of 2017. Average transaction fee on the Bitcoin network as of December 21, 2017 was USD$54.9 It went down a bit from its all-time high, but as of the writing of this article it still remains very high. On January 7, 2018, the fee was USD$31.195, almost exactly ten time more compared to the number from the same day the year before that. You can see the real time fee as you are reading this article by visiting https://bitinfocharts.com/comparison/bitcoin-transactionfees.html

 

Bitcoins in circulation

To understand why the Bitcoin network has fees, you need to understand that the number of Bitcoins in circulation is limited. The original idea by Satoshi Nakamoto was that the Bitcoin network will only have 21 million bitcoins in circulation by 2140.

The bitcoin network went live in 2009, shortly after the peak of the world financial crisis of 2008/2009. The crisis has occurred in part because of the subprime mortgage meltdown in the United States. After the meltdown, the US Government bailed out the biggest players in the financial markets. In simple terms, the bailout meant that the responsibility for the actions of the big banks such as Goldman Sacks, Bank of America and others and insurance companies such as AIG was transferred to the regular taxpayers. The government printed more money and gave this money to banks and corporations. By doing so, it increased the national debt of the United States, meaning that future generations of Americans would have to pay this debt by paying taxes.

Something like this can’t happen with the Bitcoin network because the network is decentralized. There is no central authority that makes decisions about the network. No one can decide to add more bitcoins to circulation or to regulate the currency in any way, shape or form. These benefits come at a cost and this cost is that transactions on the bitcoin network are irreversible. Once the network confirms a transaction, the money is gone. This means that you need to be very careful when spending bitcoins or any other cryptocurrency because if you send money to scammers or make a mistake, you won’t be able to do anything about it.