Bitcoin is the world’s first decentralised digital currency and it was designed to work without a central bank. It was created as a means of exchange that could be transferred electronically in a secure, verifiable and immutable way.
Bitcoin was created by an unknown person, Satoshi Nakamoto, and was released as an open-source software in 2009. Until now, the identity of Nakamoto remains unknown.
Bitcoins are sent from user to user on the Bitcoin network directly, without passing through a central authority, though most transactions are made through cryptocurrency exchanges and wallets. The Bitcoin network runs on the Proof-of-Work (PoW) algorithm and transactions are verified by nodes (computers) through cryptography and recorded in a public distributed ledger called a blockchain. Blockchain is a decentralised digital ledger in which transactions made in cryptocurrencies are recorded chronologically and publicly in the network.
Fervent supporters of Bitcoin argue that Bitcoin can, in the future, revolutionise payment systems; its number of users has grown from a small group of passionate enthusiasts to over 13 million users. This increase in usage is coupled with an increase in number of transactions.
However, the current Bitcoin network is unable to process all these transactions fast and cheap enough. In December 2017 when the price of Bitcoin peaked, the average block time (transaction time) was 78 minutes — the longest block time was as high as 1,188 minutes. Furthermore, according to BitInfoCharts, people were paying $28 on average to make transactions using Bitcoin.
“I just sent $100 worth of bitcoin from my @Coinbase wallet to a hardware wallet (Ledger Nano S) as part of a video demo, and the Coinbase fee was $15!”
Daniel Roberts, Journalist
Why is Bitcoin unable to cope with the high number of transactions?
In order to explain this, we first have to explore the concept of blockchain. Blockchain is a sequence of blocks. Each block is a collection of all transactions over the past ten minutes, sealed by cryptography. All blocks added to the blockchain are immutable and every user can always check the transaction history of a specific transaction.
In 2010, after the creation of Bitcoin, Nakamoto introduced a block size limit of 1 megabyte (MB). This means that blocks over the size of 1MB would be automatically rejected by the network. This move was designed to prevent potential denial-of-service (DoS) attacks by hackers that create large blocks in attempt to slow down and paralyze the Bitcoin network. A DoS attack is a cyber-attack in which the hacker seeks to make a network resource unavailable to its intended users by temporarily or indefinitely disrupting services.
However, this move has posed some serious limitations to the Bitcoin network: the current Bitcoin network can only process three to seven Bitcoin transactions per second (tps) which is pale in comparison to Visa’s network that can process over 2,000 tps.
In order to solve this issue, Bitcoin plans to scale its network with the implementation of Segregated Witness and the Lightning Network.
Segregated Witness (SegWit)
SegWit is a modification to the original Bitcoin protocol. SegWit increases Bitcoin’s transaction speed by re-weighting the signatures of transaction data. Re-weighting involves splitting a transaction into two segments, moving the unlocking signature from the original segment to a “witness” segment. This means that more transactions can be added to each block thereby increasing the transaction speed of Bitcoin. In theory, the implementation of SegWit can double the transaction speed of the Bitcoin Network.
Bitcoin SegWit transactions now accounts for more than 40% of all Bitcoin network activity as it moves closer towards mainstream adoption amidst scalability concerns. Transactionfee.info shows that SegWit adoption has maintained robust growth as large exchanges continue to support the scalability solution. Since the implementation of SegWit, the Bitcoin network has cleared a backlog of pending transactions and this has led to a low average confirmation time of approximately 15 minutes.
The Creation of Bitcoin Cash
In July 2017, a small group of China-based Bitcoin miners were unhappy with the proposed implementation of SegWit — pushing forward for a split (hard fork) which created Bitcoin Cash. The hard fork increased the block size limit of Bitcoin Cash to 8MB with the aim of increasing user adoption by providing faster transactions and cheaper transaction fees.
In May 2018, Bitcoin Cash went through a soft fork which increased its block size from 8MB to 32MB. This move also enables developers to build smart contracts on top of the Bitcoin Cash network. You can find a comparison of Bitcoin vs Bitcoin Cash vs Litecoin here.
The implementation of SegWit also allowed the Bitcoin network to provide malleability in its transactions — allowing Lightning Network and atomic swaps to be implemented on the Bitcoin network. Malleability is a property of some cryptographic algorithms. An encryption algorithm is malleable if it is possible to transform a ciphertext into another ciphertext which decrypts to a related plaintext.
Lightning Network
Lightning Network was proposed by Thaddeus Dryja and Joseph Poon in 2015. The idea is based on an additional layer of network that is built on top of the Bitcoin blockchain; the transactions on the this network will eventually settle on the Bitcoin mainnet. Lightning Network is made up of user-generated channels that send payments back and forth in a secure and trust-less fashion. Ethereum has also adopted a similar technology called Plasma.
The diagram below shows how the Lightning Network is used:
Although Lightning Network was originally designed for Bitcoin, its technology is currently developed by a range of cryptocurrencies, such as Ethereum, Litecoin and Ripple.
“Lightning Network will be the ultimate decentralized exchange. Users that are running LN on both BTC and LTC can advertise an exchange price and act as a maker earning a spread. Other users can act as a taker and atomically swap LTC/BTC with the maker node via lightning.”
Charlie Lee, Creator of Litecoin, Chairman and Managing Director of Litecoin Foundation
In March 2018, Lightning Labs released the first Bitcoin mainnet-ready Lightning Network (LN) implementation. Lightning Network could help Bitcoin gain mainstream adoption by providing instantaneous payments and low transaction fees; since fees are proportional to the payment amount, users can make tiny payments which further enhances Bitcoin’s use case as an alternative to fiat currency.
This article first appeared on bytepapers.com.
