You may have heard about the bitcoin scaling issue that is currently playing out so I would like to offer the following as a simple yet comprehensive explanation of what is about to happen.
U.K.’s Brexit referendum on June 23rd, 2016 caused the British Pound to lose 10% of its value in a single night, which is a massive move for a regular currency. For cryptocurrencies, a move of 10% in a day has become a regular occurrence, so the price effects could be far more significant here.
Hope you enjoy and appreciate any questions, comments, and feedback.
eToro, Senior Market Analyst
Please note: All data, figures, and graphs are valid as of July 19th. All trading carries risk. Only risk capital you’re prepared to lose.
It’s great to see that the bitcoin network is growing rapidly. However, the rate of growth has become quite alarming lately as the network was not initially setup to handle this much traffic.
At the moment, each block in the bitcoin blockchain contains 1 Megabyte of data, which can hold approximately 1,000 to 2,000 transactions. Usually, it takes about 10 minutes to mine a block. So if there are more than a few thousand transactions in a short time it results in the network getting clogged and people can wait a long time for their transactions to be processed. Sometimes even a few days.
True, bitcoin is a decentralized currency so we don’t have any government or central bank deciding on monetary policy, but it’s clear here that the community needs to make a decision to improve the protocol.
Bitcoin is controlled by the miners. People who run the bitcoin software and confirm transactions. There are many different types of software that are used around the world. In the old days, you could mine bitcoins with a laptop. These days it requires a lot more computer power. So miners have begun to form groups called mining pools. They all link their computers together and when they mine a block, they divide the rewards among themselves.
There are about twenty major mining pools at the moment. These are the guys who are currently arguing about the best way to improve bitcoin.
So far there have been about 200 different proposals to improve bitcoin. Seeing that things were not moving, one of the proposals BIP148 put a hard deadline on this issue of August 1st. Less than two weeks from the time of this writing.
The goal of BIP148 is to force other miners to upgrade to the SegWit protocol. Without getting too technical, SegWit is a way of improving the bitcoin protocol in a way that each block can hold more transactions.
The idea is that anybody who does not upgrade their software to allow the implementation of SegWit will be rejected, causing a split (hard fork) in the network.
Wait… what’s a fork??
A hard fork is a major split that causes two different currencies to be created. This is what happened with Ethereum and Ethereum Classic about a year ago. Ether classic was the original form and Ethereum that we know today was the secondary currency that was created.
A soft fork is a simple change in protocol that does not split the network. For example, if everybody upgrades their software to BIP148 then it will upgrade the protocol to SegWit without causing a split. Of course, that’s a big IF.
However, some people were not happy with this solution. They quickly put together another proposal that would take effect before the August 1st deadline called SegWit2x.
The software that allows for SegWit2x should be available this Friday, July 21st and if it is adopted it will implement SegWit as a first step in the solution. Then, over the next six months will actually increase the block size from 1 MB to 2 MBs per block.
The setback is that this type of change to the bitcoin blocks would require the creation of a new currency. Yes, another possible hard fork.
For your convenience, we’ve put together a flow chart so that you can visualize the different possible paths that bitcoin faces at this time.
This image can also be found online at: http://imgur.com/a/0nWwn
Special thanks to everyone who helped put together this diagram. Our creative director Elior Abecsis, Moriah Waterland who is a leader in our efforts to put eToro on the blockchain, and Zach Chester our brand new Cryptocurrency Analyst.
Hoping that everything goes smoothly and wishing you a very pleasant day ahead.
This content is provided for information and educational purposes only and should not be considered to be a investment advice or recommendation.
The outlook presented is a personal opinion of the analyst and does not represent an official position of eToro.
Past performance is not an indication of future results. All trading involves risk; only risk capital you are prepared to lose.
Featured image from Shutterstock. Story image from eToro.