Bitcoin (COIN) remains among the hottest investing topics of the decade. In this column, we discuss one of the greatest challenges for bitcoin in that it is abhorrently slow. While this issue is known, Coinbase is now taking a step which will help bitcoin overcome this challenge, and you absolutely need to know about it because it is the most bullish development in the space to date in 2018.
Bitcoin speed problems
We won’t go into immense detail here as this issue has been discussed on the crypto space quite a bit, including by Quad 7 Capital when we documented the major problems for 2018. As it stands right now, bitcoin currently is not the best cryptocurrency for global applications, one of the major reasons is that bitcoin is immensely slow.
We have long held that as a means of actual currency/barter, bitcoin had zero chance of scaling up in its present form. While it had utility for larger transactions, it was next to useless for smaller transactions. This is particularly cumbersome for retail, and other micro transactions. Anyone who has used bitcoin for a transaction can attest to this.
While the time tends to vary, we know that the busier the network, the longer things take. After new transaction is put out on the Bitcoin blockchain ledger, transaction can become visible quickly, but the actual movement of the currency can take many minutes. When there is immense traffic, such as when there is a wild upswing or downswing in the price, it can take a number of minutes or even hours for the transaction to travel across the network and reach the recipient’s connection, causing an inconvenient wait for both the buyer and seller. While there has been a fix via the Segregated Witness, or SegWit, providers have yet to move in this direction with only 14% or so migrating (which also helps lower fees). Now, that is all about to change.
Coinbase makes a move
We were very pleased to learn that Coinbase, after months and months of delays, has said it will move all transactions to SegWit by the end of the month. Coinbase had long insisted that updating the software for a company of its scale simply takes time. As you may (or may not) be aware, The SegWit separates cryptographic signatures from the rest of the blockchain data. These signatures aren’t counted against that one-megabyte block-size limit, so it results in an effective block-size increase. Although it went into effect in the fall, adoption has been slow.
Why is it so difficult?
We at Quad7Capital obviously are not a cryptocurrency exchange so we do not have the inner workings of the coding required to facilitate such changes. What we do know is that the major problem centers on modifying their bitcoin software to use a new, more efficient transaction format. With these changes, there are concerns of downtime, delayed transaction completion, and more issues. As such it has taken significant time for software providers to roll out the necessary changes. When SegWit went into effect, about 10% of transactions were using the new format, and that number has not improved much at 14%. But Coinbase is among the most popular exchanges, and its move to SegWit, in our opinion, will be catalyst for others to follow suit, which we view as bullish for bitcoin.
Why is this bullish?
So at the end of the day, we as cryptocurrency investors believe this is bullish. Why? It alleviates some of the pressure facing bitcoin related to speed. You see, by effectively increasing the block size through the routine employed, transactions will move much faster, addressing the major problem of speed.
Coinbase is well followed. With it making the move to SegWit, we hypothesize the industry will follow suit in due time. The end result? Expect much faster transaction speed with bitcoin. However, this is not the end all, be all for bitcoin. If 100% of transactions are SegWit, we are looking at an effective doubling in the network’s size. That is a massive improvement, but transactions will not be lightning fast. That is why we believe the lightning network must be a priority longer-term.
Faster speed is welcomed, but near instant speed is needed longer-term
Speed continues to be the major issue for bitcoin. While the move to SegWit is a great start, and the move by Coinbase to move transactions to this protocol by the end of the month is extremely bullish, it only partially addresses the issue of speed.
The concept of the Lightning Network is the long term solution. A doubling of network capacity will drastically increase speed under SegWit, but we ware talking about INSTANT transactions with the Lightning Network. If adopted longer-term this network could allow for transactions and retail micro-transactions to take place nearly instantaneously, if not instantly. At the very least, the speed will be markedly faster than a fully adopted SegWit routine.
The concept is different, and the whole approach to processing a transaction changes. Unlike what we presently see, the Lightning Network actually employs so-called ‘smart contract’ approaches to enable near instant micro-payments using cryptocurrencies such as bitcoin. Basically, it exponentially improves upon the way bitcoin transactions are validated. We recommend reviewing the academic paper in detail. Under present conditions supercomputers on the network solve a complex mathematical algorithm to validate the transaction, which can take many minutes. The Lightning Network requires a ‘smart contract’ in which participants agree to transact on a separate, offline channel. Following this the blockchain would update to reflect the external transaction, vastly improving the speed of the transaction to near real time, which after all, is the greatest concern we have with bitcoin.
Bitcoin is extremely inefficient, and scaling up is hindered by very slow transaction speeds. The SegWit is a vast improvement and we view Coinbase’s adoption as a bullish catalyst for the price of bitcoin in the near-term. However, even at 100% adoption the network size would only double, which although drastically improving processing time, will still result in some delays. The longer-term solution is the Lightning Network, which will allow for instantaneous transactions, effectively eliminating the speed argument against bitcoin from the equation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are long Bitcoin, Litecoin, Ethereum, IOTA, Tron, Ripple, HTML 5.0 Coin,