Why Bitcoin will scale even without SegWit or big blocks

If you are like me, you are tired of the debate over Bitcoin expansion. In this debate, one side of the argument is that it hopes to increase the capacity of a single block to 2MB and implement it through network forks. The other side's point of view is that it still hopes to maintain the 1MB block size limit, but to expand Bitcoin through methods such as segregated verification (segwit) and the lightning network. This debate has been going on and may even continue for a few years without any substantial results. Segregated verification started in December last year, and the nodes covered so far have not even reached 30% (segregated verification requires 95% of nodes to upgrade support). Similarly, the block expansion that Bitcoin Unlimited hopes to carry out has currently supported less than 30% of nodes (BU requires 75% of nodes to upgrade).

The situation now is that neither side has achieved their goals. This division of the Bitcoin community has been going on for several years, and I think it will take a long time to reach a consensus. But what I am curious about is that neither side wants to really achieve anything, but they are all winners. The block expanders hope to expand the block size to 2MB, breaking the control of the Bitcoin Core team on Bitcoin development, and even expand the block size to a larger capacity through a hard fork in the future. The side that does not support block expansion is worried that the hard fork implemented by the Bitcoin Unlimited team will have a devastating risk to Bitcoin. They hope to expand Bitcoin through segregated verification technology and some technologies that rely on segregated verification, such as Schnorr signatures and lightning networks. Fundamentally, both sides seem to be implementing according to the plan, but what is most likely to happen is that this deadlock will continue for several years.

That’s why I’m writing this article. I’ve been wrestling with what will happen and which side will win (hint: this is the most likely outcome). It’s important to note that the opinions I’ve expressed are based on my experience, and these things may or may not happen.

Handling fees, handling fees, and more handling fees!

You may have heard that there are still many transactions in the mining pool that have not been recorded in the block. The main complaint of the miners who advocate block expansion is that when their transactions are not confirmed for 12 hours or more, it will make it more and more difficult to use Bitcoin. The subconscious reaction of the miners who do not advocate block expansion is "you should let miners implement isolated verification", which is also the focus of the dispute between the two parties.

Throughout Bitcoin's history, a 250-byte transaction cost about $0.50 in fees. Now, you might think that's too expensive or cheap, but you can't deny that transaction fees have been rising year-over-year. This is mainly because as the volume of Bitcoin transactions grows, the payment of fees can't keep up. These transactions that need to be recorded in the block and the fees they have to pay are called the fee market by Bitcoin exchanges.

Therefore, many people speculate that as more and more transactions stuck in the mining pool are blocked, the transaction fee will continue to rise linearly, and we will face transaction fees of more than $5 in the next few years. Although I don’t know what will happen in the future, please allow me to describe what I think is the most logical and reasonable outcome based on our current situation.

Some people believe that even if 1MB blocks are still used and Segwit is not implemented, transactions will be recorded dramatically off-chain. You may ask, how can transactions be recorded off-chain without Segwit and Lightning Network? First of all, it should be noted that many transactions already happen off-chain. Xapo claims that they have more offline transactions off-chain than on-chain transactions. Most Bitcoin exchanges and service providers such as Coinbase, Localbitcoins, Purse.io can already provide some offline off-chain transaction services.

A large number of on-chain transactions actually use these services. A typical example is that if someone wants to use a discount on Purse.io, they will go to Coinbase to exchange dollars for Bitcoin, transfer the Bitcoin to the Purse.io e-wallet, and then buy the item on Amazon. In this scenario, an on-chain Bitcoin transaction occurs, from Coinbase to Purse, and transactions like this happen many times every day.

Moderate improvement

If the transaction fees are very high and the transactions are very frequent, then companies like Coinbase and Purse can reach a bilateral cooperation agreement. For example, Purse.io can open a public account through Coinbase, and they can deposit or withdraw Bitcoin from the account. Whenever Bitcoin is sent from Coinbase to Purse, Coinbase will ask Purse, "Hey, is this address controlled by you?" If so, Purse will respond with his key signature, so that there is no need for this transaction to occur on the chain. Coinbase can fully trust Purse.io's account information and will also notify Purse.io at the same time so that they can trust the user at the same time. In this way, when users using Purse conduct Bitcoin transactions, the transaction does not need to be conducted on the chain, nor does it need to wait for transaction confirmation, and there is no handling fee.

It is worth noting that in this case, everyone can benefit from it. Coinbase can hold more Bitcoin in its system, Purse can immediately gain the trust of users, and users do not have to pay any fees for on-chain transactions, nor will they leak more privacy information through on-chain transactions. The same thing can also be applied in another scenario. When someone wants to send Bitcoin from Purse, Purse can ask Coinbase, is this an address you control? If Coinbase responds with its key signature, Purse will initiate a transfer request on Coinbase to the user account associated with the address. Similarly, this transaction does not need to be conducted on the chain, there is no fee, and there is no need to wait for user confirmation. In short, everyone will benefit from it.

Now, every once in a while, Purse will withdraw a large amount of its balance on Coinbase to earn profits from it, so that Purse will not succumb to Coinbase's terms because of the risk of losing Bitcoin. Similarly, Coinbase will also hope that Purse can deposit more Bitcoin balances to earn profits. In this way, Coinbase, Purse and users can all restrain each other and benefit from it.

It is also worth noting that if there are a large number of transactions between Coinbase and Purse, many offline transactions can be compressed into one on-chain transaction. Assuming that the two companies usually conduct 1,001 transactions and settlement transactions on the system every day, if they combine these transactions into one transaction per day that is only conducted on the chain, this will save the handling fees of 1,000 transactions per day, which is equivalent to saving about $500 in transaction fees per day. Such a design can also alleviate transaction congestion on the chain, so this is not only a victory for the three parties, but also a victory for the entire Bitcoin network!

This method should be easy to accept. It is basically a two-way payment channel for Bitcoin, and in addition to using a specially designated payment channel through our Coinbase account, Bitcoin payment is a more restricted, more complex, but more secure payment method. In addition, the bilateral cooperation agreement between the two companies can also be used to carry out business such as loans. Once the balance on the accounts of the two companies is less than 0, a legal contract will be used to protect the borrowing company, and insurance can also be used to guarantee it. In other words, this bilateral agreement is more practical than a two-way payment channel and can better meet the company's business needs.

So why is this happening? Probably because we don’t know which transactions can be conducted off-chain. However, I think it’s most likely because the transaction fees are already high enough for these companies to sign such a bilateral and mutually beneficial cooperation agreement, and the cost of upgrading the software required to achieve the cooperation is negligible. As the transaction fees increase, we can expect that the cooperation agreements between these mainstream Bitcoin service providers will lead to more transactions being conducted off-chain, which will also bring more downward pressure on the transaction fees of Bitcoin.

The emergence of new networks

Now more and more companies have signed bilateral cooperation agreements. Some observers have found that if A and B have reached a bilateral cooperation relationship, and B and C have also reached a bilateral cooperation relationship, then A can use the off-chain transaction service provided by B to send or receive Bitcoin to C, without the need for A and C to directly reach a bilateral cooperation agreement. At this time, B can choose whether to agree to the transaction between A and C. Usually, in order to facilitate B's agreement to the cooperation, A and C will pay B a certain handling fee, which will be much lower than the cost incurred by A and C directly conducting transactions on the chain.

In fact, such bilateral cooperation agreements can continue forever. If A and B reach a bilateral cooperation agreement, B and C, C and D, and D and E also reach a bilateral cooperation, then A can directly conduct off-chain transactions with E under the premise that B, C and D all agree. In this way, this bilateral cooperation relationship will form a new relational network. Any node in the network can conduct Bitcoin transactions with other nodes that can be connected to it.

This should sound familiar. Yes, the designated bilateral partnership I described is actually how the Lightning Network works. In fact, the path to a designated bilateral partnership is the next obvious step. Through such a partnership, any two parties can trade without signing a bilateral agreement.

The inevitable merger

As the network of bilateral relationships develops, it is natural for each new participant to want to cooperate bilaterally with those participants who have developed network nodes. In other words, they all want to establish cooperation with companies with more bilateral relationships. But generally speaking, these companies also want to minimize bilateral cooperation with other nodes (because each bilateral cooperation relationship has a cost), but hope to be connected to as many nodes as possible after reaching each bilateral cooperation relationship.

Then, through these incentives, the nodes naturally develop into a hub-and-spoke network topology. In this special network structure, a large number of spokes have direct relationships with a central node (hub). This minimizes the number of bilateral relationships (each spoke has 1 bilateral cooperation relationship) and maximizes the network coverage (at most only need to traverse 2 bilateral relationships to visit all nodes). You can think of the nodes of the hub-and-spoke network as two users who want to transfer money to each other between banks. The bank completes the transaction by transferring the amount from one of their accounts to the other. The transfer of funds from one customer's account to another can be charged a fee or it can be free. In fintech terms, this central node is actually the so-called clearing house. And such a clearing house replaces cash transactions by conducting Bitcoin transactions off-chain.

The benefit of this arrangement is proportional to the on-chain transaction fees. You can transfer money instantly between most Bitcoin service providers without recording the transaction on the chain, and most importantly, without incurring on-chain transaction fees. This is a win for Bitcoin service providers, users, and the Bitcoin network. This will further reduce network congestion because the only transactions that need to be carried out are those of Bitcoin service providers receiving and sending Bitcoin, which will not appear on the network or in user wallets.

The main disadvantage of the hub-and-spoke network is the existence of a central node/single point of failure. The central node will become the rule maker, which is also driving us into the next revolution.

Final Step

There is a view that centralized network risks will become a hidden danger, even before the emergence of hub-and-spoke networks. But how can we remove centralization from the network? How can we make the ledger information not controlled by a single company? In order to mitigate the risks of central institutions, Bitcoin service providers will need a distributed ledger that can track who owns how much assets and can quickly transfer assets without the control of a single node. In essence, Bitcoin service providers need such a multilateral cooperation agreement to provide users with a distributed ledger without a central institution.

This should sound familiar, because it is the private blockchain that is ridiculously ridiculed as unfair. The private blockchain itself is a big topic, but its main feature is that there is no central authority, and it is still a ledger based on key signatures.

The main difference between private chains and Bitcoin is whether the ledger is changeable. In Bitcoin, mining is done using a proof-of-work mechanism. In private chains, we use signatures from the vast majority of members for verification. If the members participating in the signature are recognized and protected by legal contracts or insurance guarantees, then it is feasible to verify the immutability of the ledger by using signatures. Each member of the alliance can increase the funds in their own account by sending Bitcoin to a multi-signature (multisig) address. Members can also revoke or roll back transactions on the chain through the signature guarantee of the vast majority of nodes.

The main advantages of this second-layer network are high frequency, availability, and scalability. Since the network is controlled by the members of the network, the scalability of the network depends on the hardware resource limitations and bandwidth capacity of the network members. After the proof of work is no longer required, problems such as selfish mining and uncertain waiting time will also disappear. And considering that the cost of running this network is much lower than the cost of paying the handling fee, each node can carry out a large number of block-consuming businesses on the chain.

This wouldn’t be a bad thing. Most credit card or bank transactions happen on systems that consumers don’t understand. But the important thing is that this ledger has many desirable properties (no central authority, allows for transfer of ownership) and has the characteristics of the Bitcoin network. In addition, this network would greatly reduce congestion on the Bitcoin network and allow for a larger number of transactions without requiring any scaling changes to the Bitcoin network.

future

What I have described is a commercial private blockchain for the Bitcoin network. If nothing unexpected happens, it will change the status quo. Because it will satisfy both block expanders and blockers. Although this is not in the form of Bitcoin expansion. Blockers want to avoid a hard fork. Supporters of block expansion want to enable the Bitcoin network to increase the capacity and speed of transactions. This is not what both parties want to see, but in the future, Bitcoin is more likely to exist as a larger underlying system.

It is interesting to see why the same type of distributed ledger cannot be used for trading other assets besides Bitcoin. Bitcoin users are frustrated by $0.50 per trade and 3 hours of settlement time, imagine how securities trading users would tolerate $10 per trade and 3 full days of settlement time! Many financial trading network evolutions have followed a very similar path, just like the evolution of Bitcoin that I predict will happen in this article.

in conclusion

So what does this mean for Bitcoin?

First, destruction and darkness come from the debate between the two sides. At this moment, how we can expand Bitcoin has become an empty talk. A large amount of demand often comes from the fertile soil for innovation. Similarly, the demand for block space will enable companies and individuals to create solutions.

Second, on-chain transaction fees will not grow linearly either. Because a large number of transactions will be conducted off-chain, transaction fees will decrease rather than increase. However, any predictions about future transaction fees are speculative, and we are better off not paying too much attention to them.

Third, all the ideas of on-chain payments are unrealistic. You won’t pay for your coffee every morning through on-chain transactions. Because there will be more convenient and fast payment services designed with better user experience, allowing you to use Bitcoin to trade outside the chain.

In conclusion, Bitcoin is maturing and the market will ultimately define what Bitcoin will become. I am sure that on either side of this debate, there will be people who don’t like what Bitcoin will become, but that is the decentralized currency you hold.