– April 21, 2017

The current problems are an impressive illustration of both Bitcoin’s strengths and weaknesses. Bitcoin’s blockchain – the ledger of official records of Bitcoin creation and transactions –  is continually updated by computers running Bitcoin software. A new block is added every ten minutes, and “miners” that add these blocks are rewarded with newly created Bitcoins and transaction fees. The problem that has been brewing for some time is that the network is designed to add a new block every ten minutes no matter what the traffic, and each block only contains 1 MB of information. If there are more desired transactions than can be fit onto a new block, users have to pay higher transaction fees or wait. This is in contrast to credit card transactions, for instance, in which Visa or MasterCard can process huge numbers of transactions almost instantaneously. As Bitcoin increases in popularity, demand for transactions continually increases and this problem only becomes more acute. This is a serious bottleneck to any desire for Bitcoin to be used by a wide consumer base.

Two Competing Update Options
Bitcoin users and software developers are in almost unanimous agreement they should update the software to increase the number of transactions that can be processed by the network. They are in sharp disagreement as to how. At present, there are two primary competing proposals. One protocol streamlines the information recorded for each transaction, making it easier to fit more transactions on one block. The other would instead make blocks bigger, allowing Bitcoin users to increase block size indefinitely as they see fit.

Each side has its merits. The latter proposal, known as Bitcoin Unlimited, is clearly the more flexible solution to the problem of increasing transactions. The former, known as Segregated Witness or SegWit, would double capacity, but both factions of Bitcoin’s user base are united in hoping there will someday soon be more than twice as much demand for transactions as there is now. This would only be a temporary solution. The argument for SegWit and its sponsoring group Bitcoin Core is not whether Bitcoin Unlimited would make transactions easier. It’s an argument about whether it should.

I wrote in a previous piece about the increasing influence of Bitcoin “mining pools,” large operations with many computers running specialized Bitcoin code. These pools create a majority of new blocks (and thus collect most of the associated newly created Bitcoins as and transaction fees). This concentrates a lot of the power in shaping Bitcoin’s future into a few hands, belonging to the leaders of the mining pools. Bitcoin Unlimited allows nodes running Bitcoin software to vote on when and by how much the block size would be increased. In practice, this concentrates mining pools’ power further by allowing mining pools – a large percentage of the nodes – more control over the nature of the code itself. This arguably strikes at the decentralized nature of Bitcoin that is one of the tenets of its appeal.

However, others argue Bitcoin Core has itself acted as an unofficial legislative body throughout Bitcoin’s development and are not representing the preferences of the user base. Many of the developers of Bitcoin Core have been involved in the code since the early days of Bitcoin and have wielded significant influence through their experience and expertise.

What Happens Next?
There is nothing stopping any Bitcoin user from updating their software and implementing either of these solutions right now – except if they do, other nodes that do not change their software won’t accept their new blocks as valid. Essentially, any significant bloc of users can enact veto power on changes by refusing to change their software. Any new blocks that are not backwards-compatible create a crisis as to whether their additions to the blockchain are valid. The only ways to make a change are to get a critical mass of users to agree on updates so that the rest have to go along, or to divide into two camps and create mutually incompatible paths, like rival medieval popes excommunicating one another. For now, both sides – and investors – are wary of creating such a “hard fork.”

What will happen if they do? Well, one reason this debate, which has been ongoing for some time, has gained attention recently is because in March 2017 major Bitcoin exchanges released an official statement detailing their contingency plan. The causality of this release to the likelihood of a fork runs in both directions: the exchanges made a statement because of the increasing possibility of a fork, but the statement also inspired further consideration of the possibility. In the event of a fork, the exchanges announced their intent to list Bitcoin Core and Bitcoin Unlimited as separate assets.

Observers – surprise! – are divided about the effect that would have, as well as about the likelihood of a split. Some Bitcoin enthusiasts welcome a potential split. It would allow the two competing models to prove themselves in the marketplace. Others are unconvinced both would be simultaneously viable, and partly due to this predict a hard fork will be averted.

Potential Dangers Ahead
One potential concern is that users who hold Bitcoins in digital wallets, unless they take preventative action to ensure being on a particular side, would see these Bitcoins’ path determined by the practices of what service they hold their Bitcoin wallet with. To me, this seems like one of the greatest dangers of the hard fork: the possibility that it will confuse people with a casual interest in the subject and lead them to shy away. Whether Bitcoin intends to circulate as money or whether it is meant to be a financial asset, the Bitcoin community benefits from expanded demand from new users. A hard fork is going to scare some people off.

There is also speculation that each side could “attack” the other’s blockchain in case of a fork. Bitcoin miners could use some of their processing power to create empty blocks on the other blockchain to disrupt its operations and force a reunification. This could work or else cause the offended branch to drastically change their algorithm. Either case could cause serious reputational harm to one or both sides. A peaceful solution might result if miners choose to run both new protocols and assign relative processing power in a way that their expected return from each branch is equal. This could create an equilibrium in which ideological users could choose their own branch and miners would step into any arbitrage opportunities and balance an exchange rate.

My own opinion is that the Bitcoin Unlimited model is best for Bitcoin’s future. Its primary advantage is that it allows the blockchain to flexibly adapt to higher levels of demand not just now, but in the future. It does put a lot of decision-making power in the hands of mining pools, but since most of mining pools’ revenue comes from mining new Bitcoins, they seem well-positioned to act in a way that protects the value of Bitcoin. However, I believe it is imperative that both sides are gracious in victory or defeat. Bitcoin is backed by the integrity of the blockchain, much in the same way that dollars are backed by the Federal Reserve and were once backed by precious metals. Just as bimetallism was disruptive and divisive to the 19th Century dollar, I think a “bi-blockchain” Bitcoin running two protocols will create uncertainty and unease among investors and work against Bitcoin’s price and adoption in the global market.  



Patrick Coate, PhD

Get notified of new articles from Patrick Coate, PhD and AIER.

AIER - American Institute for Economic Research

250 Division Street | PO Box 1000
Great Barrington, MA 01230-1000

Contact AIER
Telephone: 1-888-528-1216 | Fax: 1-413-528-0103

Press and other media outlets contact
[email protected]

Editorial Policy

This work is licensed under a 
Creative Commons Attribution 4.0 International License,
except where copyright is otherwise reserved.

© 2021 American Institute for Economic Research
Privacy Policy

AIER is a 501(c)(3) Nonprofit
registered in the US under EIN: 04-2121305