Why Bitcoin Transaction Capacity Doesn’t Really Matter

In my last article, I wrote about how the Bitcoin network will scale one way or the other. In this article, I will write about how network transaction capacity doesn’t matter nearly as much as people seem to believe. To get there, I’m going to start with a little bit of economics, specifically the role of money. In any classical definition of money, there are three main functions.

The first is as a Medium of Exchange. Generally, this means that money is used as an intermediary in the trade of goods. Money facilitates trade. Characteristics of something that’s useful as a medium of exchange are divisibility, recognizability, transportability, fungibility and accessibility. We’ll look at a few of these properties a little later in this article.

The second is as a Unit of Account. This means that money is used to determine value of other goods. Money makes comparing the relative value of very different goods much easier. Characteristics of something that’s useful as a unit of account are fungibility, stability and measurability.

The third is as a Store of Value. This means that money can be used to store wealth. Money basically allows people to save. Characteristics of something that’s useful as a store of value are rarity, durability, securability and low carrying charges.

Bitcoin is called a currency because it can do a lot of these three tasks. That doesn’t mean it does each one equally well, however. Let’s look at each one.

Bitcoin is a Unique Medium of Exchange

Before Bitcoin, you had two types of Medium of Exchange. You had cash, which is physical and requires no central authority. And you have a variety of other types of digital mediums like credit cards which are digital but require a central authority. The uniqueness of Bitcoin as a Medium of Exchange is that it’s an entirely new type: a Medium of Exchange that is digital and requires no central authority.

In other words, Bitcoin has better transportability than other digital Mediums of Exchange (like Paypal) due to a lack of a central authority and Bitcoin has a better transportability than cash due to the fact that it doesn’t require physical transport. Bitcoin is strictly superior in terms of transportability than other mediums of exchange that existed before. Ransomware and Darknet markets are two places where other Mediums of Exchange are not options and as a result, use Bitcoin almost exclusively.

Unfortunately, Bitcoin is also strictly worse than other digital Mediums of Exchange in accessibility. Though easier than in the past, it still takes a lot of work to get Bitcoin. On the other hand, a lot more people already have access to other Medium of Exchange mediums like a credit or debit card. The general tendency is that when both Bitcoin and another Medium of Exchange are available for use as payment, the more accessible Medium of Exchange is what most people choose. For example, most merchants that take credit cards and Bitcoin don’t get a lot of business in Bitcoin.

That said, Bitcoin is superior in accessibility to other altcoins because there are more places with better liquidity to buy and sell. As a result, Bitcoin gets used extensively as a Medium of Exchange in the purchase and sale of altcoins. If you wanted to buy a new altcoin, often, the only way to do so would be to buy Bitcoins at a fiat exchange like Bitfinex and then use those bitcoins to purchase the altcoin at an altcoin exchange like Shapeshift. Bitcoin’s superior accessibility compared to all altcoins has caused bitcoin to be used as the Medium of Exchange between fiat currency and altcoins.

While Bitcoin is superior in some ways as a Medium of Exchange, it’s also inferior in many ways to the traditional Mediums of Exchange like cash or credit cards.

Bitcoin is in its Infancy as a Unit of Account

Even in places where Bitcoin is used exclusively as a Medium of Exchange (Darknet markets or Ransomware as mentioned above), the pricing on these markets fluctuates in terms of bitcoin but stable in some other unit of account (say, USD). Cost for illegal drugs will typically stay stable in USD, but not in BTC.

And it’s easy to see why. The cost of production of most goods is accounted in another Unit of Account (like USD), so pricing the good strictly in bitcoin (that is, not adjusting the BTC price based on its price relative to fiat) would add too much risk of pricing too high or too low and thus risk profitability. In other words, Bitcoin is not stable enough with respect to the cost of production of most things to use as the Unit of Account.

An actual appropriate use of this image

The main places where Bitcoin is actually used as the Unit of Account are physical Bitcoins (like Casascius Coins) and interestingly, altcoins. The reason why physical Bitcoins use Bitcoin as the Unit of Account is because the coins have embedded in them some amount of Bitcoins. In order to be stable with respect to the cost of production, these coins are priced in Bitcoins.

Altcoins are priced largely in Bitcoins and this fact can be seen at most altcoin exchanges. Nearly all of them provide a BTC/altcoin pair to trade and these pairs have much higher volume than other altcoin pairings that are available. For many altcoins, there simply isn’t another option. Accessibility to altcoins is primarily through Bitcoin and this has caused altcoin prices to be accounted primarily in bitcoin. This is an interesting phenomenon in that because Bitcoin is used so extensively as the Medium of Exchange to altcoins, it’s become the Unit of Account.

Bitcoin isn’t used as the Unit of Account in too many places, though continued growth as a Medium of Exchange may change this in the future.

Bitcoin is an Amazing Store of Value

Store of value is where Bitcoin really shines.

You can add as many locks on this thing as you want

Bitcoin is securable. You can make backups, make m-of-n keys required for access, keep it exclusively in your brain, store it digitally, on paper, etc. You have a lot of options for securing Bitcoin that are strictly superior to every other store of value.

Bitcoin is rare. There will only be a maximum of 21 million coins, which is enforced by code. Furthermore, as keys get lost, there will be even less coins over time.

Bitcoin is durable. Bitcoin does not decay as it’s an entry on a distributed ledger. One Bitcoin stays one Bitcoin and cannot get destroyed by fire, a hacker attack on some centralized location or insolvency of a government or company.

Bitcoin has very little, if any carrying charges. Unless you’re using a third-party service to secure your Bitcoin, Bitcoin can be carried for free.

In these four ways, Bitcoin is superior to Stores of Value like gold, real estate, collectibles and stock. Real estate and stock can be seized by a central authority (basically whoever controls the registry of ownership), which makes those assets worse than Bitcoin in terms of securability. Gold can’t be backed up, which makes gold worse than Bitcoin in terms of securability. Collectibles and real estate typically require carrying charges in the form of storage fees, upkeep, taxes and insurance which makes Bitcoin superior in terms of carrying charges. Additional stock can be issued at will and thus Bitcoin is superior in terms of rarity.

So if Bitcoin’s so superior to other Stores of Value, why isn’t the price of Bitcoin higher? We’ll get to this a bit more later, but the main reason is due to the fact that Bitcoin is only 8 years old. Bitcoin simply hasn’t been proven over a long period of time and though small, there is a very real risk that the entire network can collapse.

Why Do You Have Bitcoin?

This question I pose to you, dear reader, in light of the three main properties. Notice that I’m not specifically asking about why you bought your first Bitcoin, but why you own Bitcoin today.

It’s possible that you’re an altcoin buyer and you own bitcoin because you are in the market to buy some altcoins. It’s also possible that you need to pay some Ransomware vendor and you happened to be in that short time window between when you bought bitcoin with fiat, but before you paid the Ransomware vendor. Most likely, though, if you’re reading this article, you own Bitcoin because it’s a great Store of Value.

If you doubt me, think about when you started buying Bitcoin. What argument convinced you? Would you have bought if Bitcoin didn’t have a 21 million limit? Would you have bought if there was a good possibility that your Bitcoins would be nullified by a network fork? How about if there was some decent chance of an exploit that would cheat you out of Bitcoin?

Altcoin buyers and Ransomware victims aside, Bitcoin’s property as a great Store of Value is probably why you have Bitcoin. And here’s where I think we can find some common ground. Medium of exchange is nice, but that’s not why the vast majority of people hold Bitcoin. The largest holders of Bitcoin actually haven’t spent very much of it (see: Winklevoss twins, Roger Ver, Trace Mayer). When they actually spend, they generally have spent to develop or promote Bitcoin and thus make their holdings of Bitcoin worth more (isn’t capitalism great?).

As Daniel Krawisz has pointed out in this classic essay, the value of Bitcoin comes from the hoarders. That is, the people who use Bitcoin as a Store of Value give Bitcoin value, not the ones who use Bitcoin as a Medium of Exchange. And that makes sense. If you only use Bitcoin as a Medium of Exchange, you would buy Bitcoin when you need it, spend it and be done. The vendor who accepts it most likely has to convert the Bitcoin back to fiat to pay the costs of production for that good. The net effect on Bitcoin is actually negligible compared to anyone that buys and holds.

The Great Scaling Debate

In the context of the above the current scaling debate seems a bit misguided. We’re essentially arguing about features that add to bitcoin’s utility as a Medium of Exchange rather than bitcoin’s utility as a Store of Value. Lightning Network, Large Blocks, even Sidechains to some degree are all about Medium of Exchange improvements, not Store of Value improvements. That’s not to say Medium of Exchange improvements like transaction capacity don’t matter at all. It’s just that Bitcoin’s usefulness as a Store of Value is much greater and hence much more important.

Now I understand that the Medium of Exchange stuff is sexy. Every person that I’ve introduced to bitcoin has their minds blown when I have them download a Bitcoin wallet and send them some amount of Bitcoins. This is much easier to explain and much easier for people to grasp than the improbability of SHA256, RIPEMD160 and secp256k1 being compromised at the same time. But understand that the reason Bitcoin is so valuable is because Bitcoin is a great Store of Value.

As a community, we’re bikeshedding, arguing over points that aren’t as important.

So How Do We Improve Bitcoin as a Store of Value?

Here are some features contributed to Bitcoin’s usability as a Store of Value:

  • 21 million limit — This gives Bitcoin rarity.
  • p2pkh — This was added early in Bitcoin’s history as a way to secure against possible secp256k1 curve compromises (this is also why you shouldn’t reuse addresses). This made Bitcoin more secure.
  • p2sh — This gave more options for securing Bitcoin.

That said, the perceived security and durability of Bitcoin increases as it lives longer. Incidentally, this and the network effect are why Bitcoin is priced so much higher than altcoins with essentially the same features. The market’s trust in the security, durability and even rarity of Bitcoin can only be built with time. The market’s perception of these qualities in Bitcoin, in other words, doesn’t simply increase due to better features, but only as such features are proved over time.

Just Don’t Screw Up

The main way, then, to increase the market’s trust in Bitcoin’s usefulness as a Store of Value is to avoid catastrophe. There are many possible catastrophes, but here are two that I want to point out.

Artistic Rendition of a Hard Fork

First, don’t split the network in a contentious hard fork. That would be catastrophic in so many ways, not the least of which is that there would be confusion about what Bitcoin is.

Second, don’t introduce vulnerabilities to Bitcoin by making the code too complex. Perhaps the worst thing that can be done to Bitcoin is an exploit in the code where someone manages to cheat. Adding complexity creates a more vulnerable and possibly larger attack surface. Reducing the risk of bugs is a way that we can improve bitcoin’s utility as a store of value. Even bugs that aren’t necessarily in the most critical part of the code (libconsensus) contribute to a perception of vulnerability, so reducing those improves Bitcoin’s utility as a Store of Value.

In other words, resistance to change is a good quality for Bitcoin’s utility as a Store of Value. The community, in its deadlock for the last 2 years over this issue, whether it has intended or not, has actually increased perceived durability and security. By avoiding a contentious hard fork we’ve avoided catastrophe. By not implementing a complex change like Segwit, we’re keeping the code clean and reducing risk of cheating. These, in turn have increased the perceived durability and security and hence, Bitcoin’s utility as a Store of Value.

Conclusion

So what can we do as a community?

The horse should be labeled Segwit or Big Blocks, depending on your point of view

First, we should just drop this whole debate. Stop talking about it and move on. Stop beating it like the dead horse that it is. Segwit isn’t happening, larger blocks aren’t happening. The sooner we stop talking about these issues and all the emotional rhetoric that comes along with it, the better it will be. Wars destroy, cause uncertainty and reduce security and durability. Ending the Bitcoin Civil War ends the prospect of two changes the market doesn’t want and removes uncertainty and avoids catastrophe. A united community that gets past this issue increases the perceived security and durability of Bitcoin and thus Bitcoin’s utility as a Store of Value.

Second, as part of practicing Realpolitik, we should delete the code corresponding to Segwit and (Bitcoin Unlimited/Bitcoin Classic/etc). Much like the production of war machines in a peacetime economy, neither of these efforts are going to be that useful in a peaceful world where neither of these features activate. Reducing complexity only makes sense and this is a clear signal to the market that we’ve moved on from this issue as a community. The resources (developers, money, mindshare, etc) devoted to these two efforts can now be freed up for innovation elsewhere in Bitcoin.

Third, focus efforts on building solutions on top of Bitcoin instead of in Bitcoin itself. Obvious improvements that can get community consensus (particularly, unit testing and fixing bugs) should still be developed in Bitcoin, but anything even a little controversial should be done in another layer on top. Let the market sort out what it wants instead of trying to centrally plan it.

The whole scaling debate has been an attempt by each side to force central planning on the other. Those are paths that end with violence and destruction of value. That way lies catastrophe. Let’s stop the civil war, avoid collapse and move on with what Bitcoin is already good at, being an excellent Store of Value.