Bitcoin as a Settlement System

This is the second of four articles outlining BitPay’s current throughts and plans regarding the block size issue. It follows yesterday’s article: Miners Control Bitcoin.

Some people believe that Bitcoin is best suited as a settlement system rather than a payment system. This notion is rooted in a view that it’s not possible to have a truly decentralized, trustless payment system that can handle the day to day payments needs for the population of people on this planet. They think that Satoshi’s vision of Bitcoin as a purely peer-to-peer version of electronic cash is unattainable.

That’s nonsense. It can be done.

A settlement system is a payment system. Settlement transactions are simply a particular type of payment. Those who propose that Bitcoin should be used primarily for settlement transactions argue that frequent payments should be assisted by third parties, with those third parties periodically committing transactions to the Bitcoin block chain. That will certainly work with centrally administered, off chain payment systems (it already does). It might even work with more advanced schemes like the lightning network (though it remains unproven). But even if all cryptocurrencies were only used for settlement transactions, Bitcoin still has to compete with them to provide the best transaction service at the lowest cost.

History suggests settlement systems must start out as widely accepted payment systems. Before gold was used for settlement, it was a widely accepted form of payment. US dollars had to be backed by gold to gain adoption as a payment system. Digital US dollars had to be fungible with physical currency. Today, despite the fact that it’s no longer backed by gold, the US dollar is used for settlement because it’s widely accepted for payments. It’s possible that Bitcoin might find adoption as a settlement system without first gaining widespread adoption as a payment system, but I think it’s unlikely.

The argument continues that if Bitcoin is only used for settlement transactions, it doesn’t need to scale. If it doesn’t need to scale, artificial limits can be imposed and a fee market will develop such that despite being more expensive, it is still usable for settlement. But we don’t need to create a fee market - it already exists. People routinely pay fees for transactions using Visa, MasterCard, PayPal, Litecoin, Dogecoin, and a host of other payment options. People don’t have to use Bitcoin, and they won’t if its fees are not competitive. A penny for an average on-chain transaction is probably too expensive to be competitive. Off-chain transactions using payment channels, the lightning network, or a sidechain will likely need to be free, if not very close to it. If Bitcoin comes up short on this front, it’s leaving the field wide open to competitors.

Bitcoin will make a fine settlement system if it first works well as a payment system. Bitcoin should only be limited by actual processing constraints and not arbitrarily chosen caps. Those that argue that Bitcoin should only be used for settlement are really saying that they don’t think it’s possible for a decentralized cryptocurrency to process a high volume of transactions. Talented developers and engineers will prove them wrong on that point.

Continue Reading: Scalability, Hard Forks and Markets.


Stephen Pair is CEO at BitPay, a service enabling merchants to accept bitcoin. BitPay also leads development of the Bitcore and Copay open source projects. You can get in touch with @spair and @BitPay on Twitter.