Op-Ed: The Centralization Problem — Bitcoin and Bitcoin Cash

 

Executive Brief

The last month saw much attention turning towards Bitcoin Cash’s meteoric rise from a relatively irrelevant Bitcoin sibling, trading at around 0.085 / BTC to rally by a factor of six to an all time high of 0.53 / BTC, before retracing back by 70% to 0.16 / BTC at press time. The megalithic bull run coincided with the announcement that the Bitcoin2x fork planned for November 16 would be suspended — with the Bitcoin2x developers citing disruption to community cohesion as the reason for the cancellation.

The value proposition debate between Bitcoin and Bitcoin Cash has centred around each network’s ability to scale the number of transactions they can simultaneously process, the speed at which transactions are verified, and the security risks from centralization that may result from their respective approaches in doing so. The security provided by the distributed nature of blockchains remains Bitcoin’s best differentiator and value proposition compared to mainstream payment vehicles, and any upgrades that might threaten Bitcoin’s decentralized nature — reducing the number of nodes, or moving payment information off the blockchain onto secondary layers - will be fraught with controversy.

Read the full story below. 

Bitcoin was created as a decentralized and incorruptible censorship-resistant money that did not need financial institutions to function. This allowed everyday people to make transactions directly to one another for the first time, enabled by a distributed network of nodes and miners that operate a current version of the blockchain on their home network to monitor the validity of network transactions.

The current network allows for 1 megabyte worth of transactions to be processed in each block (updates to the blockchain record), but Bitcoin’s rise in users has seen network congestion lead to payments taking longer to be accepted into a block (processed), and high transaction fees that make it unsuitable for small everyday transactions.

 

The scaling debate:

There have been multiple Bitcoin software upgrade proposals from some of the most brilliant minds in the industry that would improve Bitcoin’s transaction capacity and processing speed. The best known are: Segregated Witness, Lightning Network, and increasing the block size.

Segregated Witness (SegWit) was activated in August this year, and moves user signature data outside of the traditional block structure, creating room for seventy percent more transactions to fit into the new block structure. There were plans to further upgrade the network rules to double the block size from one to two megabytes in mid November called Segwit2x, but a lack of community consensus led to it being suspended. The suspension was largely due to the fact that the Bitcoin economic community had security concerns regarding the network splitting, protest over excessive influence from developers and businesses that were making decisions on behalf of their users, and the computational requirements for larger blocks risking Bitcoin’s widely distributed nature.

 

Enter Bitcoin Cash

After tiring from years of debate about raising the block size, a splinter group of the Bitcoin community broke away from the main network to create Bitcoin Cash. Their belief is that all transactions should be processed on the blockchain only, and at scale by making use of larger 8 megabyte blocks. Bitcoin Cash’s main value proposition derived from Bitcoin’s network congestion crisis making small transactions slow and uneconomical, and the announcement that the Segwit2x hard-fork would be suspended on November 8 made Bitcoin Cash look comparatively more efficient than Bitcoin in the near-term — which was (at least in part) reflected in rapid appreciation in its price.

 

Enter Lightning Network

While larger blocks on the Bitcoin network won’t be realized now, other solutions that don’t require block size increases would see Bitcoin be able to function like Paypal or VISA rather than just a digital-gold-like store of value. The Lightning Network proposes that some transactions be routed through a secondary layer of nodes off the main blockchain (including swapping into other currencies), before broadcasting the settled transaction differential on the main blockchain(s) at a later time. This means that many transactions can be made in a time window—like purchasing multiple beers at a bar—with only one aggregate transaction of the total being processed on the blockchain. This approach reduces the cost and number of transactions that are posted to the blockchain and offers an instant settlement system for Bitcoin.

The Lightning Network will require users to commit some of their Bitcoin to every channel they create before any of it can be sent to other users. If Alice wants to make payments to Bob, she may for example need to commit $50 worth of Bitcoin to the channel. She could then make multiple transactions from that $50 in the channel to Bob, and when the channel is closed, any unspent Bitcoin from the channel is made available again from her Bitcoin wallet. Alice would also be able to take advantage of payment channels that Bob has open with other people. So if Alice had an open channel with Bob, and Bob had an open payment channel with Erin, Alice would be able to pay Erin without making a new payment channel with her. With many thousands of open payment channels, the Lightning Network would automatically find the optimal route to pay any given user on the network, and it is likely payment hubs would form to provide the liquidity needed for thousands of open channels with businesses and users for the system to operate in exchange for a small economic incentive in transfer fees.

The Lightning Network has clear benefits that enable it to operate as an extremely fast payment protocol. It reduces the cost of transactions, allows for instant payment settlement, and gives rapid scalability (though you can read a criticism of this claim here). Bitcoin users could take advantage of instant payments when convenient for them by opening up a payment channel with the required collateral, or making a standard Bitcoin transaction on the blockchain—or primary layer—if the fee structure at the time from network congestion was tolerable and transaction speed was not a concern.

 

Centralization Risks

Both blockchain and off-chain scaling solutions like the Lightning Network have potential costs in centralization that could compromise the integrity of their network.

Bitcoin Cash’s larger block approach makes it much more expensive for node operators to operate and maintain a copy of the blockchain — requiring them to have more network bandwidth, hard drive space, processing power, and computer memory. This leads to a comparative reduction in the number of hobbyist nodes and miners securing the network, giving more power to larger and more centralized entities on the network.

Larger block times are also detrimental to the fairness of block propagation times, or the time it takes for every node on the network to find out that the last block has been solved, and they should move onto working on a new one. While the internet bandwidth requirement for an increase from one megabyte to eight is easily within the capabilities of modern internet connections, there would be a compounding rise in the time taken for the node that solves a block to inform other nodes that the block has been solved, and for each forwarding node to do the same. This is of distinct advantage to the largest centralized entities or mining pools who solve most of the blocks, and can begin working on solving the next block while other miners are still wasting time working on the previous one that has already been solved. Block propagation time with the current one megabyte size has been seen to be as high as two minutes for ten percent of network nodes. Unless a solution is found, larger blocks reduce the profitability of smaller miners and could risk the trustless and decentralized nature that cryptocurrency is lauded for.

 

Fears of excessive developer influence and corporate takeover

Fewer and larger nodes lead to disproportionate influence over the network. The current cryptocurrency infrastructure sees the bulk of digital money stored or transacted through the use of custodial accounts at a small number of exchanges, online bitcoin vaults, and payment processors — giving the nodes that these centralized entities operate unreasonable influence over Bitcoin’s upgrade direction and trajectory.

The New York Agreement saw 58 of the largest firms and mining companies (the largest nodes) claiming to represent the vast majority of network users and mining power agree to support changes to the Bitcoin software that would implement SegWit and double the block size to 2 megabytes. These changes proved unpopular with the Bitcoin community who these firms were claiming to represent, and public backlash resulted in the upgrade called SegWit2x being suspended. The invite-only agreement was widely criticised for its hasty implementation time, its closed-door nature, and circumvention of peer-review processes that saw agreement between a select group of industry executives seeking to enforce their vision of the network on the user base without their consent.

 

Bitcoin’s value is in its distributed power structure

Bitcoin’s distributed power structure is what makes it great, and any upgrade or attempt to centralize its power structure—to centralize that which was designed to be distributed— could be seen as an attack that dilutes the very core of its appeal. In such a scenario things can go south quickly, since there is nothing else inherently maintaining Bitcoin’s value proposition, unlike stocks where earnings at least loosely peg to the share price.

Turning away from the community that supported you to where you are is never wise. The NFL and ESPN are two recent examples of organizations that went beyond their core competencies and entered into political activism, running against the values of their customers and sparking a record-setting decline in viewership. The Bitcoin scaling debate is not over, and other potential solutions do exist. Bitcoin’s decentralized appeal should not be sacrificed to make way for a centralized pyramid power structure that allows immediate scaling, especially when there may soon be better solutions that do not risk Bitcoin’s primary value proposition of decentralization. If the various iterations of “Bitcoin” can’t find the appropriate solution, another crypto will.

Until then, may the best team win.

The views expressed by the authors on this site do not necessarily represent the views of DCEBrief or the management team.

Author: Timothy Goggin

Timothy Goggin is an economic analyst with an interest in the application of moral philosophy and decentralized systems. He studied economics at the Business School at Victoria University of Wellington, New Zealand. His area of research is the consequential and moral dimensions of implementing digital currencies and the resulting synergies for consumers in the trading environment.

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