Continuing the series of articles on thinking about the basics of Bitcoin and how cryptocurrencies compete or are able to complement the existingfinancial system. Today we will try to present the prospects of Bitcoin in contrast to the current payment systems. Do not forget to look at the first and second parts, and also stay tuned so as not to miss subsequent articles from the series.
Table of contents
Suddenly - Part 1: Bitcoin, not Blockchain
Suddenly - Part 2: Here's What Bitcoin Decides
To be continued…
In the book "From zero to one" Peter Thiel Describes How New Technologies Affectto build a future where everyone will benefit. Although the book focuses on individuals and companies, Bitcoin as a monetary system is a genuine technological leap from zero to one. Til, among other things, highlights the emergence of a steam engine as well as the transition from typewriters to computers as historical examples. He also suggested that since the early 1970s, innovation has stagnated to a large extent, noting that technological progress has since moved rather than from 0 to 1, but from 1 to n. Bitcoin solves this problem. Bitcoin's innovation is not only a leap from zero to one, but also something fundamentally different from the class of innovation that Thiel's book focuses on. Bitcoin is a digitally-built monetary protocol whose influence will far exceed that of steam engines and computer processors.
Bitcoin solves it
A new meme goes on the Internet: whatever the problem, Bitcoin solves it. Negative Return Debt? Bitcoin decides. Inequality of wealth? Bitcoin decides. Endless world war? Bitcoin decides. Financial crises? Bitcoin decides. A culture of anger? Bitcoin decides. We are not yet sure how exactly, but this is an articulation of the balancing effect that a solid and stable monetary system will have on all aspects of society. Money performs a coordinating function in society. They allow hundreds of millions of people to work together who otherwise would not have any basis for this. And Bitcoin is a tool that will enable more peaceful coordination, as it is not subject to manipulation and free from moral hazard. Its globalization is a problem of the movement “from 1 to n” (although not quite in the sense that Thiel speaks of), and Bitcoin scaling solutions will appearin a natural way. The resulting universal benefit may not literally cure all the diseases of the world, but the invention of a qualitatively new money network is fundamentally different from any single product, because money is an economic good that coordinates all other economic activity.
“The problem is just how to expand the scopeusing resources beyond the control of any one mind and, therefore, how to get rid of the need for conscious control and provide motives that will encourage individuals to perform the desired actions in the absence of someone who tells them what to do. ” - F. A. Hayek, “The Use of Knowledge in Society”
Hayek writes about the invention of money and the price mechanism as a tool that allows society to get rid of the need for "Conscious control". Bitcoin is an Advanced Successorof this mechanism, and its radical innovation, is a digital rarity, not payments or transaction speed. Although Bitcoin’s rarity is still in need of additional stress testing, it’s a solid achievement that makes Bitcoin unique. Not a single asset before Bitcoin — much less a digital asset — had limited emissions and scarce character. The end result of this innovation is the hardest kind of money that has ever existed. This is a fundamentally new achievement and a phenomenon that is unlikely to be repeated.
All other problems that you will need.to overcome Bitcoin are more commonplace compared to rarity. Digital payments? The idea that human ingenuity can create digital rarity but cannot build payment technology over it is illogical. Payment technology is just one of many “1 to n” innovations that will be built on to Bitcoin to globalize its adoption. Payments are not only easier to solve, but it is also not a critical task requiring solution. Today. The main application of Bitcoin today is notpayments, and a savings mechanism. Over time, when adoption grows and infrastructure is expanded, Bitcoin will turn into a transactional currency, but it will happen gradually, and not suddenly. And after the transition to Bitcoin, many will continue to use the old money systems and payment platforms.
Not a payment platform
Bitcoin blockchain will never become a platformfor mass payments, although there are active discussions on this subject. Many are of the opinion that for “success” Bitcoin should become a universal mechanism combining the role of a currency issuer, a clearing platform and a payment mechanism. And although Bitcoin does a great job with the first two functions (currency issuer + clearing platform), it categorically not a payment mechanism. Bitcoin fails the payment test for speed and scale. Good news? We do not need the Bitcoin network to act as a payment platform.
Confusion in philosophical (not technical)The debate largely stems from the Bitcoin whiterpaper subtitle: “Peer-to-peer electronic cash system.” Some interpreted this as if Bitcoin should be able to process absolutely all transactions in the world between two end parties. Others consider the structural weakness of Bitcoin to be the inability to process transactions on a scale or at the speed of Visa or MasterCard. In essence, according to skeptics, if Bitcoin does not meet these two standards, then it does not fulfill its promises. Fortunately, this is not so.
For reference: Bitcoin blocks are calculated on average every 10 minutes, but there is no fixed schedule. The next block can be calculated in 1 minute or 20 minutes, in 30 seconds or 36 minutes. The network is adjusted so that the blocks are calculated on average every 10 minutes. How can merchants or transaction processors live in such a slow and unpredictable world? Bitcoin blocks also have limited space for transactions. Although there is no fixed number of transactions per block, each Bitcoin transaction occupies a limited place in the block. As a result of limited bandwidth, blocks average approximately 2700 transactions. With an average interval between blocks of 10 minutes, 6blocks per hour, 24 hours a day and 365 days a year, this is equal to the network throughput of about 145 million transactions per year or 4.6 transactions per second. Visa, on the other hand, processes 124 billion transactions per year at a speed of ~ 4000 transactions per second (see here).
How Bitcoin Can Be Entirely Peer-to-Peera mechanism supporting the global financial system, if its scale and speed is almost a thousand times less than that of Visa alone? The reality has always been such that if Bitcoin should have a non-zero value, the result will be such a valuable system that its basic level will not be able to process all transactions without sacrificing decentralization or censorship resistance. Without these qualities, Bitcoin would not be a breakthrough innovation, and its value function would be disrupted. Ultimately, the Bitcoin protocol level provides the function of issuing currency and final settlements, but is unable to process all small transactions, such as your purchase of a cup of coffee.
Otherwise, all transactions of all peopleno matter how big or small they should be, they should be checked and stored by every inhabitant of the Earth. Without a mechanism for matching the interests of network participants, there would be a problem of shared resources, and the result would be a less secure currency system that is subject to centralization. Instead, we adopt a mechanism that limits transaction throughput at a basic level, delegating aspects of Bitcoin's peer-to-peer transactional architecture to individual layers integrating with Bitcoin. These concessions are made in order to provide the foundation of the Bitcoin monetary system. (decentralization → censorship → fixed offer).
“Fully peer-to-peer version of electronic cash” - many point to this text in whitepaperBitcoin, published by its pseudonymous creator, as evidence that Bitcoin was originally conceived to process all payments of all possible network participants. In the end, it really says "completely peer to peer." However, more important to Bitcoin than anything written in the annotation to whitewater (or whatever interpretation)is its consensus mechanism. Everything that is critical for Bitcoin is ensured by consensus among network participants, including a fixed offer and the throughput of each Bitcoin block, limiting the number of transactions that can be processed. This is the fundamental difference between Bitcoin and the old financial system: monetary policy based not on trust, but on consensus. The creator of Bitcoin built a system that took critical decisions from any central authority and instead relied on the wisdom of market consensus. This system is flexible enough to adapt, but at the same time quite resistant to significant changes. As a result, network participants, on a decentralized basis, decide how best to scale Bitcoin. It is thanks to this consensus mechanism that Bitcoin is free from the need for “conscious control”.
Nothing happens without some concessions. In the case of Bitcoin, there are two holy grails: a fixed offer of 21 million BTC and prevention of multiple spending of the currency (the problem of double spending). Bitcoin’s value is based on its ability to provide both of these functions on a decentralized, trust-free basis, and both are inextricably linked to the fixed network bandwidth. The bandwidth of each Bitcoin block can be considered as a valuable digital asset. All market participants wishing to receive confirmation of their transactions have to compete for a place in the block. The rarity of network bandwidth is a feature that optimizes the overall resource of Bitcoin. Competition for this rare resource ensures that it is used efficiently and its cost is maximized. Ultimately, rarity forces market participants to compete with each other, increasing the cost of network bandwidth, rather than transferring negative external factors to the rest of the network.
In the free Bitcoin market, priority is givenTransactions with the highest value and profit. Without the rarity of bandwidth, this cost function would not work. The existence of rarities is critically important than optimizing transaction throughput. No one really knows the optimal transaction throughput at any given time, partly because demand is constantly changing, but also because it is generally growing over time. It is critical that bandwidth is known and rare, which allows market participants to plan and, ultimately, compete. Shared resources are not depleted. Instead, participants compete and develop innovations in search of the best use of a rare asset. Rarity ensures that shared resources are not misused, and creates a predictable growth rate for the overall size of the Bitcoin blockchain, which ultimately protects and improves decentralization.
Miners ensure Bitcoin network security,allocating real energy resources to perform cryptographic hash functions to calculate Bitcoin blocks. By calculating the blocks, the miners check the history and complete the current transactions, which is then checked and confirmed by the rest of the network. In exchange, miners receive compensation in bitcoins. Allocate resources for network security - and get paid with the network’s internal currency (bitcoins). The compensation received by miners has two types: new bitcoins and transaction fees. To allocate resources to network security, miners must rely on the fact that aggregate compensation will retain its value in the future.
About every four years, the amount of newBitcoins paid to miners are halved (“halved”). Now with each block 12.5 new bitcoins are issued. After about 7 months, when the next halving occurs (see here), this amount will be reduced to 6.25 new bitcoins per block. After 4 years, 3.125 new bitcoins per block will be issued. This process will continue until the smallest bitcoin unit (1 / 100,000,000th) is reached, after which new bitcoins will no longer be emitted. This emission function manages a fixed bitcoin offer (21 million), and as a result, it also provides a transition from compensation for network security (mainly) in new bitcoins today to a system that completely relies on transaction fees.
But how does this relate to Visa and bandwidthtransaction ability? If it were not for the rarity of the throughput of each Bitcoin block, there would be no mechanism for creating a market for transactional commissions. The limited capacity of the block creates competition between market participants for the completion of transactions, which contributes to an increase in the cost of bandwidth and its efficient use. Without a commission market, the only way to pay miners for network security would be to change Bitcoin's fixed monetary policy and increase supply. But remember that the rarity of the fixed offer of bitcoin (21 million) is the basis of its fundamental property as a means of saving. By creating the rarity of network bandwidth, we also guarantee the flawlessness of Bitcoin's fixed offer, which is a function of the full cost cycle. In such a reality, rarity is a much more important property than the speed or ultimate transaction throughput.
Fixed network bandwidth → Limited number of transactions → Commission market → Bitcoin fixed offer
And since the real problem thatBitcoin intends to solve - this is a problem of money and global quantitative easing (rather than payments), those who store wealth in bitcoins will prefer to have a fixed money supply, instead of sacrificing long-term flawlessness and reliability of transaction throughput. In short, the future of Bitcoin is much more reliable in a world where all market participants can rely on a fixed and rare offer, accepting lower transaction throughput and speed as concessions. What is the use of high transaction throughput and speed if the fundamental value of a currency is at risk? The existing financial system has already chosen the opposite concession for us. High speed and throughput of transactions due to centralization, but due to the architecture, vulnerable to system monetary depreciation. Bitcoin is an alternative, and we should not repeat the old mistakes.
Bitcoin ≠ Visa
Ultimately, Bitcoin does not compete with Visafor excellence in global payments. Bitcoin competes with dollar, euro, yen and gold as money, and any comparison with Visa, its transaction volume or speed is fundamentally untenable. Bitcoin plays the role of currency issuance and final settlements. As a result, it would be appropriate to compare Bitcoin with the US Federal Reserve System (FRS) as the issuer of the currency and the clearing mechanism. No one mixes Visa and Fed functions, but for some reason Visa and Bitcoin are often compared.
Although this will take time andinvestment, the Visa payment network can work on top of the Bitcoin network to make payments, just like it works on top of the existing banking system. Instead of clearing currency through a central bank, the final settlement of transactions can be done through the Bitcoin network. In the existing architecture, the payment level (Visa) and the level of settlements (banking network / central banks) are separated. The main problem that Bitcoin is trying to solve has little to do with the first, but is associated with the mechanism of issuing and clearing currencies (Fed and quantitative easing). Visa helps to transfer dollars, but Visa is not a dollar. It is a technology service company with 17,000 employees. Bitcoin has no employees.
In essence, Visa is based on trust.credit system. Although consumers tend to associate the use of a Visa card (or its equivalent) in a cash register terminal as a payment, in reality this is not so. Instead, the balance is verified, transactions are authorized, and final settlements are made later. In fact, there is no clearing when processing each individual transaction at the point of sale or at central banks. Instead, transactions are combined, summarized and cleared later, and only then the appropriate balance is assigned to the accounts. So when someone tries to equate a Visa transaction with a final settlement, it actually doesn’t work that way. But such a comparison is implicitly done when trying to compare Visa and Bitcoin.
Bitcoin and the Fed
When compared with its real competitors (Fed,ECB, Bank of Japan) Bitcoin is starting to look like a Ferrari. Final global settlements every 10 minutes, 24 hours a day, 7 days a week, 365 days a year, uncensored. Compare this with the existing censored financial system with many levels of intermediaries in the form of commercial and central banks, open only during “business” hours. This is a big misconception related to Bitcoin. Those who think that Bitcoin is too slow or has insufficient bandwidth, compare it to the wrong application. You can add a network of banks over the Bitcoin network, and the payment system will be able to function as it is today.
The problem is the risk of centralization. If bitcoins were stored in central banks, this would increase the likelihood that the Bitcoin network could be appropriated and compromised by a network of commercial and central banks that would want to forcibly change the rules of network consensus or censor end users. Ultimately, there was a lack of gold as cash. It was vulnerable to centralization, which led to the emergence of fiat currencies that are easy to manipulate. Although this is an unlikely way to scale Bitcoin, money and payment technology are different problems. The fundamental reason is that in each transfer of value there are two sides: one side almost always includes money, and the other includes goods and services. The payment level creates a bridge between them.
Due to the nature of trade, two sides of the transfervalues, as a rule and quite naturally, refer to different processes and different points in time. You can take as an example the currency calculation on the one hand and the transfer of ownership of a house or car on the other. Or payment for goods on Amazon and its delivery two days later - two different processes occurring at different points in time. And it’s important to recognize that Bitcoin does not know anything about the outside world, including the parties to the transfer of value. Bitcoin only issues and verifies currency (is each specific bitcoin really bitcoin). This is the function and limitation of any basiccurrency system. The payment level provides a bridge between foreign exchange payments (Fed or Bitcoin) and the supply of goods or the provision of services. Gold solved the problem of mass payments through banking centralization, the dollar, the Fed and large payment processors such as Visa. Bitcoin is likely to solve the problem of payments using a technologically more advanced mechanism, but we still have time for this, since this task is different from the money problem.
Bitcoin scaling is a 1 to n path
If we first solve the problem of money through digital rarity (from zero to one)then technological improvements forscaling transactions and solving the payment problem is the path from 1 to n. It is unlikely that human ingenuity, capable of solving the first problem, then will not cope with derivatives. This is not a matter of hope and faith, but of reason and logic, given the progress already made in scaling solutions and the difficulties that Bitcoin has already overcome. Censored innovations and the inherent economic incentives of Bitcoin will coordinate and accelerate the resolution of any future challenges. Market participants are motivated to increase the value of the network and create innovations to scale it, but solutions must work within the framework of network consensus or obtain sufficient consensus to change the rules.
In view of the nature of Bitcoin's economic incentives,it is much more likely that scaling solutions will work within existing consensus rules. One such example of progress in scaling Bitcoin through network consensus is the Lightning network. The Lightning network is built on over Bitcoin as a level with minimized trust to scale transaction throughput, which is still fundamentally different from the payment solution. However, if successful, Lightning will be used to create Bitcoin payment channels, making possible a much larger transaction throughput with much lower costs, where the speed and scale will compete with Visa. Although this will not necessarily be the final decision, it is an example of the innovation that Bitcoin is driving. Lightning is just one of many actively developed solutions, and competition will lead to better scaling solutions.
Approaching the scaling of Bitcoin is a slow and conservative process. Bitcoin Too Important to Follow Silicon Valley Mantra “Move fast and break everything”. Instead, he should move slowly anddo not break anything. In order for a global financial system to be built on a decentralized monetary system, the foundation must be protected at all costs. First you need to ensure the security of the base money level (Bitcoin), and then allow network participants to develop censorship-resistant innovations on top of it. Do not forget that Bitcoin is only 10 years old. We are at the very beginning of its monetization, and the infrastructure that will allow this new technology to grow is still under construction.
Somewhat funny, considering already decidedBitcoin tasks, immediately switch to the question: but why not mass payments today? Especially when you consider that in its clearing function, Bitcoin is already faster and more reliable than comparable mechanisms for final settlements in dollars, euros, yen or gold. If you understand that the fundamental application of Bitcoin today is a long-term savings mechanism (not payments), it becomes clear that not only the problem is incorrectly diagnosed, but also that the desired solutions can wait. In the future we will need the ability to make payments, but there is still time for this. In due time, we can have one and the other.
Do not forget that this is only the beginning of our very large series of articles devoted to this topic. Follow the news on our website so as not to miss the sequel.