Finding a balance between the network, miners, and users: What is the ideal block capacity?

Willy Woo is an entrepreneur, investor, trader and cryptocurrency enthusiast. In this article, Woo focuses on the issue of block capacity, analyzing the most controversial hot spot in the Bitcoin field from a new perspective through several charts. His analysis shows that there is currently insufficient evidence to prove that network congestion is Bitcoin's Achilles' heel.

Bitcoin has been in operation for eight years, and it has evolved from a single block with a few transactions in the early days to the present day where each block is filled with transactions and network congestion has become the norm.

One of the advantages of witnessing this kind of congestion in the early stages of Bitcoin’s development is that we are able to extract a lot of data while the network load is relatively light. In this post, we will start with Bitcoin’s transaction data and see if it can point to a reasonable block size (if one exists).

The chart above shows the Bitcoin network’s ability to process transactions (per second) in recent years.

This is a logarithmic graph. Clearly, this capacity increases linearly, with the blue circle representing the size of the Bitcoin mempool (think of the mempool as a kind of storage tank where transactions are temporarily stored before being processed by miners).

Although users have been complaining about blocks being nearly full and the network being overloaded, this chart unexpectedly reveals new information: before Q4 2016, the memory pool continued to increase its load, while the network kept following closely, trying to prevent the memory pool from breaking through the peak.

The network has been trying to catch up with the ever-increasing transaction demand.

Yes, we are facing network congestion, but we have not lost the ability to handle significant transaction volume. If this were true, we would see the blue circles in the above chart trending downwards instead of straight lines.

But this does not mean that we are still far from the network capacity limit, nor does it mean that this downward trend will appear in a few weeks or months.

Forecasting demand

We can use this table to predict future transaction demand.

Let’s assume that in 2020, when the next block reward halving occurs, the network will have 20 transactions per second. I will explain why this is unlikely to happen.

The Bitcoin network is primarily used as a store of value, but by 2020, Bitcoin's price volatility should have stabilized enough to be used as a currency, and I suspect that by then merchants will start using it for general commerce.

Solutions like the Lightning Network can open up new use cases like microtransactions for the Internet of Things (IoT).

The validity of the results we predict using this chart depends on whether Bitcoin's main use cases remain the same as they are today.

Currently, the main function of Bitcoin is still to preserve its value, but there are unlimited possibilities in the future.

Bitcoin and Coffee

Bitcoin network users and certain businesses have told us that rising transaction fees have caused Bitcoin to fail as a means of buying coffee and other small payments, such as advertising networks.

They believe that Bitcoin is no longer practical in general business activities, and therefore the Bitcoin network is at risk of decline. They believe that current payment activities are more suitable for low-priced cryptocurrencies that compete with Bitcoin.

Obviously, the increase in Bitcoin transaction volume has never stopped. This proves that although the idea of ​​"buying coffee with Bitcoin" is often mentioned, it is essentially just one of many online transactions and can be ignored.

Otherwise we would have seen a downward curve. Yet the network is still moving at the same pace. Bitcoin’s core use case remains to be the secure transfer and storage of large transactions.

As mentioned above, Bitcoin’s core use case will change as volatility decreases, and it may eventually become a currency that can be used in daily life.

Currently, Bitcoin is still used for storage of value, and it is still several years away from becoming a real currency, so we still have time to think carefully about how to solve the upcoming substantial increase in transaction demand.

Many businesses are suffering from high fees and slow confirmation times. This is not to ignore the fact that we will further analyze it below.

Miner income

Perhaps a year ago, miners would still be discussing whether large blocks or small blocks would lead to a decrease in their income.

Some even say that larger blocks can accommodate more transactions, thus generating more fees. However, before Q4 2016, we have seen temporary spikes in transaction congestion that hit the entire network.

It is clear that a demand-driven market has emerged, ultimately leading to higher revenues for miners.

Here is a picture that illustrates the connection between transaction fees and network congestion.

When the average block capacity reached 95% of the upper limit, the memory pool began to expand, and users began to increase the transaction fees, hoping to get miners to write their transactions into the next block as soon as possible without delays. Eventually, the transaction fees began to soar.

If you are a miner who values ​​short-term profits, you would definitely hope that the block capacity limit is as small as possible, preferably always staying at 95%.

You want to limit the transaction space so that the competition for transaction fees becomes more and more intense. For miners, the optimal block size is "keep the capacity small but still have congestion."

Question: How much is the fee for 8MB blocks?

Let’s use our imagination… Assuming Bitcoin XT is accepted by the community and the block capacity reaches 8 MB, how will miners earn income from transaction fees?

From a network perspective, supply will definitely outstrip demand, and the dynamic fee algorithm in the wallet will set lower fees.

We can use a chart to estimate the miners' income.

The current average transaction load per block is 0.95 MB, which can be seen on the far right of the picture above.

This translates to a 12% load in an 8 MB block. As can be seen in the above figure, miners can only receive 0.1 BTC per block. Currently, miners earn between 1 and 2 BTC per block in a 1 MB block. Therefore, an 8 MB block will reduce miners’ revenue by 10 to 20 times.

The block size most desired by users

The next step is to look at user needs - fast confirmation, reasonable fees and high security.

We have seen that at peak times, the network is at a snail’s pace. The following chart shows how long we have to wait for confirmation as blocks approach the maximum limit.

The size of the circle indicates that once the block capacity reaches 95% or more of the upper limit, the transaction volume in the memory pool will be almost crazy and the confirmation time will increase linearly.

Even when block capacity reached 80%, typical transaction confirmation times began to deviate from normal.

Importantly, the higher the transaction fee paid by users, the more secure the system will be, because miners can obtain higher computing power with their income. At important moments such as halving day, it is an important step for miners to upgrade their computing power.

Currently, handling fees are an important source of income for miners - 1.2 BTC handling fees + 12.5 BTC block rewards. After the next halving, the block reward will drop to 6.25 BTC, and handling fees will become an important part of ensuring network security.

Therefore, there is a "habitable zone" for transaction fees. For the sake of network security, transaction fees cannot be too low, but also cannot be too high.

My conclusion is that the ideal block capacity should be able to ensure a moderate confirmation time while balancing the relationship between transaction fees and network security, so 80% of the block cap should be the ideal block size.

Summary Analysis

We currently have three analysis results.

1. Although there will be delays in transaction processing time and periods of network congestion will lead to higher fees, the 1 MB block size is still able to adapt to current network needs.

2. The most reasonable block capacity for miners should be able to maximize their income - as long as it can be guaranteed to be above 95% of the network upper limit. Network congestion and users competing to raise transaction fees are the "games" that miners "want to play most".

3. Once the block capacity reaches more than 80% of the upper limit, the transaction confirmation time will be affected. At this stage, the handling fee is reasonable, but not too cheap. After all, as the block reward decreases, the handling fee is an important factor in ensuring the security of the Bitcoin network.

Analyzing the optimal network state should not rely solely on economic game theory, but also requires balancing the relationship between security, miner income, speed, and transaction costs ^[1] .

Given these constraints, I believe that the optimal block capacity should be dynamic, which can be adjusted according to network transaction needs and ultimately remain at around 80% of the upper limit capacity.

This way, typical confirmation times will not be affected, but the demand-driven fee market may charge higher fees to make miners pay for future network security, but this fee is still 4 times less than the current congestion period.

In this light, monero’s approach of adjusting its algorithm based on network load and achieving a dynamic block size seems reasonable.

The block capacity will be adjusted based on the premise of achieving a balance between miner income, security and reasonable costs for users.

Notes (↵ returns to text)

1. The assumptions here do not take into account technical issues, such as block propagation speed and the impact of the Chinese firewall. ↵