Bitcoin is broken?

“Send any amount of money, to anyone, anywhere in the world, and for free!”

That used to be my rally cry when preaching the bitcoin gospel to anyone willing to listen.  To be honest I told a fair amount of people that had no interest in listening too.  Bitcoin is intended to be an inexpensive platform for sending money, however the average cost of a transaction spiked this year to over $55.  Not ideal for someone like me who pays my barber in bitcoin.  My $25 haircut would now be $80 at that transaction fee rate.  No thank you.

chart from bitinfocharts.com/comparison/bitcoin-transactionfees.html

How did we get here?  Why are transaction fees so high?  To understand that you need to go under the hood and examine some Bitcoin fundamentals.

Alice wants to send 0.001 bitcoin to Bob.  Alice opens up her wallet, selects Bob as the recipient, and presses send.  When this happens the transaction is broadcast throughout the Bitcoin network.  A transaction is not finalized until it has been confirmed.  Best practice is to wait for a few confirmations before you consider yourself the owner of the bitcoins you have received.  Approximately every 10 minutes a confirmation takes place on the Bitcoin network.

Why are confirmations important?  Because confirmations are what secures Bitcoin!  Instead of trusting a third party such as Paypal, Venmo, or your bank to validate the account ledger Bitcoin uses mathematics.  Eureka!

Bitcoin is the first technology to solve the double-spend problem.  How can we be sure that Alice does not send the same bitcoin she sent Bob back to herself?  Confirmations!

Confirmations happen through a process called mining.  Mining serves a few purposes on the bitcoin network, but in this example we will focus only on confirmations.  The bitcoin mining process uses computer hardware and electricity to solve complex math problems.

Let’s jump back a few steps.  Transactions are broadcasts out to all nodes on the network.  When the nodes (also known as miners) receive the transaction they bundle those transactions into a block and begin working to solve the mathematical problem.  To drastically simplify let’s say I ask you to solve the below lock without knowing the combination?  How would you begin?

You would probably start with ‘00000’, then ‘00001’, followed by ‘00002’, and so on.  You get the idea.  Miners are competing against each other solve the lock and the first to solve the problem creates a block containing all of transactions they recently received.  The process takes approximately 10 minutes.  Once a block is created all the miners immediately begin working on solving the next “combination lock.”  As each block is created the new block is tied to the previous block using cryptography.  Do not worry.  I will not bore you today with cryptography, but this technology is used to secure Internet.  Block after block is created chaining the history of bitcoin transactions since it’s inception; hence the name blockchain and cryptocurrency.

If Alice tries to send the bitcoin she sent to Bob back to herself after it has been confirmed the network nodes (miners) will look at the blockchain history and see that the transaction is invalid.  What happens if Alice sends out two transactions to the network: 0.001 bitcoin to Bob and the same bitcoin to another wallet she controls?  This is where things get interesting.

Miners do not process transactions on a first come first serve basis.  Miners  keep the fees associated to a transaction so they process transactions with higher fees first.  If Alice sends Bob 0.001 bitcoin, but uses a transaction fee of $0.00 the transaction may take a while to be confirmed.  It might take months or never get confirmed at all.  Alice could then send the same bitcoin to herself using a transaction fee of $3 and it will confirm faster.  There are a few other attack vectors, but this is why a recipient must wait for a few confirmations.

Now you have a general understanding how bitcoin transactions are processed.  Let’s get back to why it is so expensive to send bitcoin: transaction fees.  Bitcoin has not scaled at the pace needed.  There are simply too many transactions currently happening on the network right now to keep up.  Supply and demand are at work here.  If you need a transaction to go through quickly a higher fee is required.  The transactions with highest fees get priority.

Does this mean Bitcoin is only destined for rich people moving massive amounts of money?  Not so fast.  Fortunately the fabulous bitcoin development community is hard at work on a fix.

Usher in the Lightning Network!

The lightning network is an extremely exciting bolt on to Bitcoin.  It improves upon the existing infrastructure by providing instant payments, low cost, and scales the network.  Waiting for confirmations will no longer be needed.  Transaction fees will shrink to an amount of less than 1%.  On December 25, 2017 release candidate one was delivered!

It will not happen overnight, but there is light(ning) at the end of the tunnel.

Thanks for reading.  Please leave a comment below.

 

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