The Bitcoin Scaling Debate for Beginners part 1

Blockchain Blockchain Blockchain.

If you have even a casual interest in finance, then you've heard lots in the last few months about Blockchain, which is the underlying technology behind Bitcoin. There are tremendous potential applications with it including in financial services, healthcare and even identity.

It also means 2 things for Bitcoin.

  1. Bitcoin has taken a backseat in the public eye to Blockchain
  2. Bitcoin has gained in importance as it is the longest standing and most successful Blockchain project to date...

Bitcoin and Blockchain are linked together and what happens to Bitcoin affects how others view Blockchain as a viable technology. And right now there's a big question going on in the Bitcoin community that needs to be addressed: Scaling.

Disclaimer: I'm not a technologist and just explaining this to the best of my ability.

Blockchain 101

Blockchain is distributed ledger technology. Some of the shorthand you see might even call it DLT for this reason. Each computer, called a node, is hooked up to a network. The network is decentralized and widely distributed all over the world, thus why it's a distributed technology. The ledger part, like with a financial ledger or balance of transactions, is distributed as well, allowing any computer on the network to access ALL of the transactions on the network.

If it sounds like it's a database to you, you're right it is. A distributed and decentralized database. Bits on Blocks has a great intro but it is technical.

What is a Block?

All of the information on a set of transactions is combined into a block. A block is created every 10 minutes. At the moment, each block contains 1 MB of data. Remember this for later.

Each block is formed and is connected to the other blocks forming a chain. A group of computers called miners help to form the block and give it the security of its cryptography (thus making it a cryptocurrency) by solving some complex math problems to create the cryptography for the block. The miners earn Bitcoin for doing this important job.

 

When the block is created, it is announced to the entire network and EVERY computer on the network updates with it, creating numerous confirmations for the transactions in that block. Blockchain is considered a 'trustless' network because the 2 parties to the transaction the sender and the receiver of the funds are not confirming the transaction, these independent 3rd parties in the network are doing the confirmation meaning trust between the 2 transacting people is not required.

Does this sound inefficient to you for running a network? It is. It's a tradeoff of decentralization for efficiency. This is one of the reasons why many of the companies that research using DLT in their fields will end up not doing so. Many won't but others will. It is an important technology.

The Bitcoin Scaling Issue

Remember how I mentioned that each block holds 1 MB of data? That's not much data by today's standards. Add to that lots of new transactions daily.

From Blockchain.info, you can see that the number of transactions keeps increasing on the Bitcoin network and this chart isn't even fully updated yet.....

Let's see an example to explain the problem.

Scaling Using a Long Line We ALL Know

Now imagine yourself in one of those long DMV lines waiting to renew your driver's license. And let's further imagine that there are 25 people ahead of you. You've pulled your number and you are waiting patiently in line.

The DMV then announces they are taking 6 people at a time at 10 minute intervals. What they have told you is that 24 of the people ahead of you will be taken in 4 groups of 6 and you will have to wait 40 minutes (4x10) to get to the front of the line.

But you are ready now. Why wait?

This is the Bitcoin scaling issue not for people in line but for transactions in line waiting to be confirmed so they can be completed.

Too Many Transactions for 1MB of Data

Transactions performed now are having to wait multiple 10 min intervals for new blocks to be created. Why? Because 1MB of data is not very much data.

Bitcoin as a payment system needs a faster way to move and confirm these transactions, especially for those of us in the West used to Mastercard and Visa with their very fast confirmations.

How do we solve this problem?

There are a couple potential solutions floating around out there and in the next post I will go over the ones with the greatest chance of succeeding.

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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