The Way that Bitcoin Scales

Wrapped Bitcoin, and Secondary Systems

Among the many critiques of Bitcoin, is the argument that it doesn’t scale. Proponents of this opinion typically cite Bitcoin’s six transactions per second, or its intensely high energy consumption as the reasons for it not scaling. As far as I can tell, these are shortsighted critiques that don’t take into account the multitude of ways that Bitcoin CAN scale. I agree that the Bitcoin Blockchain is unlikely to ever be able to consistently handle a global load of transactions. It doesn’t need to. This letter addresses more of the FUD that the Bitcoin community has been dealing with as of late.

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The Bitcoin Blockchain: “Layer 1”

Final settlement of Bitcoin transactions only occur on the Bitcoin Blockchain. That is, the ledger maintained by computers participating in the Bitcoin Network. Only transactions that are settled here are considered to be final, and irreversible. The blockchain is only capable of processing 6 transactions per second (tx/s). This is the standard metric when comparing the “speed” of a blockchain. This metric is known as the “transaction throughput”.

Why Does Transaction Throughput Matter?

In order to contextualize transaction throughput, let us look at global payment networks we are already well aware of, and make a comparison. The VISA network is capable of processing an estimated 1,800 transactions per second1. Other blockchain networks such as Cardano are said to be able to process multiple thousands of transactions per second.2

Transaction throughput matters in the blockchain world because if enough people are trying to transact at the same time, fees will go up, and your transactions may be delayed. This obviously reduces the utility of the network, as you expect your transactions to be processed in a timely manner. In periods of high network congestion, Bitcoin transactions have cost as much as $50. With Ethereum, network fees have reached $200 or more.

So we know we need a monetary network that can process lots of transactions, but the consensus in the Bitcoin world (and I agree with this) is that we cannot jeopardize the decentralization, or security of Bitcoin, in favour of high transaction throughput.

You Want 3 Things, But You Have to Pick 2

There is a saying in the Bitcoin world.

You can optimize your blockchain for 2 of 3 things.

  1. Decentralization

  2. Security

  3. Transaction Throughput

Upon analysis, you will likely find that blockchains with high transaction throughput have compromised by increasing centralization, and/or decreasing the security of the network. Bitcoin has opted to optimize for Decentralization, and Security. This inevitably means that high transaction throughput must take place on “secondary systems” also called “layer-2 solutions”.

All Other Systems that Use Bitcoin: “Layer-2”

The following is a non-exhaustive list of systems that increase the ability for users to transact with Bitcoin.

  1. Bitcoin Exchanges

  2. 3rd Party Payment Networks (PayPal, Venmo)

  3. Custodial Bitcoin Wallets or Accounts (Banks that adopt Bitcoin)

  4. The Lightning Network

  5. SideChains (Liquid, RSK)

  6. Pegged Bitcoin (wBTC, BTCB)

  7. Synthetic Bitcoin (τBTC)

The reality we see emerging is that Bitcoin is much bigger than just the blockchain that it sits upon. These systems that speed up the velocity of Bitcoin are made up of companies and other blockchains.

Bitcoin is a Money Protocol

The reason companies and other networks find ways for people to use Bitcoin within their system, is because Bitcoin is money. One important thing to know about Bitcoin, is that it is a money protocol. It is a set of rules that everyone using Bitcoin agrees to. The modern internet is built upon an information protocol called TCP/IP. All of the websites and apps that you spend dozens of hours on (Facebook, YouTube, Google, Wikipedia) are all built on top of TCP/IP. Similarly, companies and blockchains are building their own apps and services on top of Bitcoin.

On of my favourite pieces of evidence of this fact, is that other blockchains build “tokenized” Bitcoin into their own network. Ethereum has innovated a way to transact with Bitcoin through “wrapped Bitcoin”. Similarly, Binance has its own tokenized Bitcoin called BTCB. To me, this is an indication that these “competing” cryptocurrencies wouldn’t be able to effectively compete with each other unless they built a way to use Bitcoin.

Part 2 - Tokenized Bitcoin on Other Blockchains

This is quite the technical topic, so to make it digestable, I will be releasing another letter tomorrow. In part two, I will be breaking down how Bitcoin becomes usable on other blockchains, and the tradeoffs users are making when they decide to “wrap” their Bitcoin on other chains.

If any questions have risen given this topic - feel free to hit respond and ask me to clarify!

Stay tuned for tomorrow’s letter.

Cheers,

Keegan Francis