At a Glance…

In May 2017, a group of Bitcoin (BTC) developers and industry leaders laid out a plan to increase Bitcoin’s block size from 1MB to 2MB with an update dubbed “SegWit2X.” The block size increase would have enabled Bitcoin’s network to cope with the cryptocurrency’s recent surge in activity. On its face, expanding Bitcoin’s capabilities seems beneficial for everyone involved, but SegWit2X was hotly contested. Proponents of a blocksize increase (known as “Big Blockers”) believe that enabling Bitcoin’s network to process more transactions is necessary for the cryptocurrency to function as a cash alternative and compete with traditional payment systems. On the other hand, SegWit2X’s opponents, known as “Decentralists,” worry that increasing Bitcoin’s block size will make the blockchain more cumbersome, centralizing mining power in a way that both compromises Bitcoin’s security and attracts unwanted regulation. Eventually, SegWit2X proved too controversial and its supporters postponed the update. Still, the block size debate is far from over, as evidenced by the recent hard fork resulting in the birth of Bitcoin Cash (BCH). This alert examines SegWit2X, the greater block size debate, and the important ramifications this debate has for Bitcoin’s future.

Although Bitcoin (BTC) has slowly gained mainstream attention over the past eight years, it has exploded into the spotlight over the past 12 months, together with the emergence of other blockchain-based cryptocurrencies. Accepted by retailers such as Expedia and Subway, Bitcoin as the leading cryptocurrency has drawn even more attention from private investors. At the time of this writing, Bitcoin’s current market capitalization exceeds more than $265 billion, while its value has appreciated by more than 1,439 percent in the last year alone.1 Behind this blistering success, a contentious debate among developers regarding whether to increase Bitcoin’s “block size” continues, carrying with it important ramifications for Bitcoin’s future.

SegWit2X as a proposed resolution to the block size debate

Bitcoin’s block size debate centers around a desire to enable the Bitcoin network to manage more transactions at a given time (for a detailed primer on how the Bitcoin algorithm works, read our comprehensive white paper on Bitcoin and Blockchain).2 The current Bitcoin blockchain, made up of 1MB blocks, can process up to seven transactions per second. Compare that with conventional payment systems, such as credit card processors, that can handle more than 24,000 transactions per second. As Bitcoin’s popularity continues to grow, the current 1MB block size struggles to keep up with the growing number of transactions.

The block size debate was set to end November 2017, when a group of developers and industry leaders in the Bitcoin community planned to roll out an update to the Bitcoin protocol known as SegWit2X.3 SegWit2X proposed two changes to the Bitcoin protocol: (1) segregating witness data from transaction data (“SegWit”); and (2) doubling the block size from 1MB to 2MB (“2X”).

With little opposition, SegWit went into effect and separated signature data from transaction data. Before SegWit, signature data occupied roughly 65 percent of the available storage capacity in a given block. By separating signature data from transaction data and placing it in an extended block, enacting SegWit alone increased the network’s capacity by freeing up more space in each block for additional transactions.

The second phase of SegWit2X, doubling the block size from 1MB to 2MB to further boost Bitcoin’s capacity, has proved more contentious. The 2X plan was so contentious that SegWit2X’s organizers eventually suspended the update because it threatened to “divide the community and be a setback to Bitcoin’s growth.”4

At first glance, one may think that increasing Bitcoin’s capacity to process transactions would be beneficial for everyone involved. The more transactions the network can handle, the quicker the currency will be more broadly adopted, and the more value it will generate, right? The truth is, SegWit2X and the greater block size debate has been a point of contention in the crypto-community since Bitcoin’s early days. For example, in July 2017, a group of developers felt so strongly that they went so far as to break away from the main Bitcoin blockchain. In what is known as a “hard fork,” the developers created BitcoinCash (BCH), a new digital asset on a blockchain made up of 8MB blocks.5 Looking at each side of the debate between those in favor of larger blocks, the “Big Blockers,” and those against, the “Decentralists,” demonstrates exactly why there is so much turmoil around such a seemingly innocuous plan.

Big Blockers and their big plans for Bitcoin

The argument in favor of larger blocks is relatively straightforward and mostly supported by a belief that Bitcoin should become a mass-adopted payment system similar to PayPal or credit cards. Big Blockers point to two main benefits: (1) more transactions per-minute; and (2) lower transaction fees.

First, larger blocks will be able to carry more transaction information per block, thus driving down the average time it takes for a transaction to be published to the blockchain. To survive as a competitive payment system, Bitcoin will need to process many more transactions-per-minute.

The second benefit, one associated with lower transaction times, is lower transaction fees. Right now, miners fill up space in a given block with the transactions that offer the highest fees. Transaction fees that hovered around $0.50 in early 2017 skyrocketed to an average of around $20.00 later that year. Larger blocks will open up more space in each block, decreasing demand for limited space and lowering transaction fees required to occupy that space. For consumers to swap out their fiat currency for Bitcoin when shopping at their favorite retailer, transaction fees will need to decrease significantly.

Enacting SegWit did please Big Blockers and advanced Bitcoin’s usefulness as a payment system by enabling full and effective use of the Lightning Network. The Lightning Network is an off-chain application that allows users to send and receive micropayments without waiting for their transaction to be mined before becoming effective. By segregating the signature data from the transaction data in each block, the Lightning Network can function safely without the fear of transaction malleability problems (a process by which a user alters signature data, which in turn alters the transaction identifier and potentially results in double spending).

Decentralist concerns about big blocks

The Decentralists fear that the Big Blockers’ push to make Bitcoin the next mass-payment system will spell its demise. Decentralists mainly fear that larger blocks would: (1) compromise security by centralizing hash power; and (2) subject Bitcoin to extensive regulations.

Chief among the Decentralists’ concerns is that increasing the block size makes Bitcoin less secure because it centralizes the power to confirm transactions in the hands of a few wealthy participants. To confirm a transaction and publish it to the blockchain, a majority of users operating nodes must reach consensus that the transaction is legitimate. Currently, this power is distributed among a large number of users, making Bitcoin secure and instilling confidence in the legitimacy of each transaction. Decentralists worry that a block size increase will prevent many users from participating in this confirmation process, because it takes far more computing power to process larger blocks. This effectively centralizes hash power in the hands of the few miners with the computing power needed to process the larger blocks. By reducing the total number of nodes needed to reach consensus, larger blocks increase the chance of a group of miners ganging up and preventing certain transactions, or even reversing already confirmed transactions (a threat known as a “51% attack”).6

Along with centralizing hash power, there is a worry that a centralized Bitcoin welcomes regulation, which would radically depart from Bitcoin’s roots as a decentralized, independent, and censor-free network. Although a 2MB block can carry more data, it might not be desirable for those who are attracted to Bitcoin’s appeal as an independent currency. In recent months, cryptocurrencies including Bitcoin have already drawn more scrutiny from regulatory agencies in the United States, including the SEC,7 CFTC,8 and IRS. Further centralizing hash power may fan that flame. Consumers and retailers fear that Bitcoin’s future might be similar to PayPal’s, which was subjected to extensive government regulations, leading to its transformation from a cash alternative to a more regulated system. For Bitcoin, the added legal and governmental oversight could limit its appeal as a generally lighter regulated and universally accessible cash-alternative.

The way forward

Though SegWit2X was suspended in November 2017, the debate on how to cope with Bitcoin’s boom persists. In a cooperative twist, at the time of this publication Jeff Garzik, SegWit2X’s lead developer, had recently announced a plan to try and revive some of the SegWit2X code with a new objective of “bringing multiple chains together in one software."9 While Big Blockers advocate for increasing the block size to realize Bitcoin’s potential as a cash-alternative, Decentralists fear that the increased block size will make the Bitcoin blockchain more cumbersome, centralizing mining power in a way that both compromises Bitcoin’s security and attracts unwanted regulation. The way forward depends on which functions of Bitcoin users want to preserve the most. If users want Bitcoin to function as a universally accessible and pseudonymous alternative to fiat currency, then a block size increase is inevitable. If, on the other hand, users prefer Bitcoin to continue its recent surge as an independent investment tool free from the norms of traditional markets, then the Decentralists should prevail. One thing is certain, in the cryptocurrency space where innovation and volatility rule – time flies, so we will not have to wait too long to find out.