Money has three principal functions: as a medium of exchange, as a store of value, and as a unit of account.
Secondary attributes that have aided the adoption of various forms of money include interestingness (“Ooh! Look how shiny that gold is!”), uniform divisibility, portability, resistance to counterfeit, and imposeability. That last one is important, because it is what makes state-backed fiat currency the dominant form of money in the world. The U.S. government is territorially and militarily powerful. That allows it to print green paper unbacked by any commodity and tell people both within and without its jurisdiction to accept it. For almost fifty years, that model of money has prevailed.
Bitcoin, in the last few weeks, has made me want to add another attribute to this list: low transaction costs. Miners on the Bitcoin network—which once made a feature out of its low transaction costs—now charge roughly the equivalent of $43 to upwards of a hundred dollars to add a single transaction to the Blockchain. The size of a block on the Bitcoin Blockchain is limited. Currently, it is 1MB. A user-defined transaction fee is broadcast with every Bitcoin transation, and miners add transactions to new blocks in exchange for these fees. Bitcoin mines new blocks every 10 minutes.
I first became broadly aware of Bitcoin in 2011. Back then, the price was $10 a coin, and back then the standard cost of adding a transaction to the blockchain was .0001 BTC, or a tenth of a cent. Whoop! Nowadays, Bitcoin sells for upwards of $14,000 a coin, putting the equivalent price of .0001 BTC up to $1.40. But fees have increased much more than this, because there is more congestion. More users than ever—drawn in by rising Bitcoin prices—are trying to use the network at once, and this is creating congestion. If more than 1MB of transactions are broadcast, then miners will only add the most expensive transactions. The cost of the transaction fees has been bid up and up and up to the point where yesterday it averaged $43 per transaction. That might not be so bad if you’re sending 10 BTC to pay for a Lamborghini, but if you’re not a Bitcoin millionaire and you want to buy a coffee or pizza, or want to send $20 to a friend, or even just want to buy into Bitcoin for a couple of hundred bucks, a $43 transaction fee is a real killer. It makes any use of Bitcoin as a medium of exchange impossible for anything much other than London or Hong Kong real estate, and Lamborghinis, etc. This congestion also means days and days of waiting for transactions to be added to the blockchain.
Ultimately, this problem is preventing Bitcoin from functioning as a medium of exchange.
The problem has gotten so bad that millions of dollars are trapped in small accounts where the network transaction fees are larger than the balance of the account, effectively rendering them worthless. So for a lot of users, Bitcoin has turned out to be a pretty shitty store of value.
Now, a problem is not a problem if you solve it. An obvious solution is to increase the block size, to ease congestion. But the community has failed to implement this. But there has been a failure to find a solution to this problem of massive transaction fees, which is why they are still very high. Bitcoin’s community—which is controlled by the miners—has totally failed to reach a consensus on how to increase the block size, or indeed whether to increase the block size at all.
Some users allege that larger blocks will result in more centralization, as it will increase storage demands. Developers in the community such as Blockstream instead propose a Lightning Network to solve the problem of congestion. This Lightning Network is a space in the blockchain where multiple Bitcoin users create a contract to store their Bitcoin, and can transact in it among themselves without any fees for accessing the blockchain. But this is a theoretical future solution to a current and practical problem, so it’s not really offering any relief. If it was, we wouldn’t be having this conversation. Plus, even in the Lightning Network vision, users would still have to access the blockchain in order to put their funds into a Lightning Network channel, which would still require them to pay the fees to do so. Furthermore, Lightning Networks themselves might also demand high fees.
Anyway, the idea that larger blocks will cause centralization is extremely dubious. Data storage is very cheap, and getting much, much cheaper. Data transfer rates across the internet are also improving. And even the developers of the Lightning Network admit that in order to serve a global population, block size increases up above 100MB—far above even what Bitcoin Cash has today—will become necessary.
Massive fees, of course, benefit one specific group: miners. So, of course, it’s in their interest to keep the fees high, and to avoid increasing the block size. But by doing so, they are strangling the entire network.
Relief is coming in the form of hard forks. Some Bitcoin users have forked off Bitcoin’s history and started their own versions of the coin, Bitcoin Cash and Bitcoin Gold. These new implementations of Bitcoin are based around the principle of increasing the block size periodically to avoid congestion. Already, these coins already have much lower transaction fees—around 1-2c per transaction. As a result, they’re beginning to capture the market. Bitcoin Cash in particular has increased in price 37% over the past week, while Bitcoin Core’s price has fallen 25%. Other users are migrating away from Bitcoin Core toward other cryptocurrencies such as Ethereum, Monero, Zcash, Digibyte, Dogecoin, and Litecoin, as well as next-gen unmineable coins like IOTA and Rai Blocks. But as more and more users are drawn into the cryptocurrency space by rising crypto prices, other cryptocurrencies based on the basic Bitcoin model of small block size are also experiencing rising transaction fees. Monero and Ethereum in particular have seen their fees greatly spike.
Are transaction fees the thing that kills cryptocurrency? Almost certainly not. Decentralized ecash is a very popular concept that has attracted billions of dollars of investment. Meanwhile, central banking and state-backed fiat money have become increasingly unpopular in the wake of the 2008 financial sector bailouts that funnelled trillions of dollars away from taxpayers and into the pockets of bankers. And there are already many viable alternatives to Bitcoin Core, such as Bitcoin Cash which can function as a medium of exchange, and store of value.
But maybe this will be the thing that kills Bitcoin Core. And given that Bitcoin Core is by far the biggest and most widely known cryptocurrency, that may cause a severe but temporary depression for the wider crypto market that scares away many retail and institutional investors. Time is running out for a solution that drops transaction fees to a manageable level, and allows Bitcoin Core to function again as a medium of exchange and store of value. Bitcoin’s rate of adoption as a medium of exchange is already abysmal, with only 3 out of the top 500 ecommerce websites accepting it as payment for goods and services.
While transaction fees are currently enriching the miners, this rent-seeking is in danger of killing the golden goose. Bitcoin Core’s backers do not have the power of the U.S. government. They can’t force people to use Bitcoin Core to, for example, pay taxes. It’s a voluntary model. So if people can’t use Bitcoin Core as it was originally envisioned—as ecash—then the only people using it will be people HODLing it simply because the price has gone up. That is completely unsustainable. It’s the definition of a bubble, and at least in the tulip bubble the tulip growers didn’t charge their clients huge fees to move their tulips around! As more and more Bitcoin Core users switch to Bitcoin Cash and other alternatives, this bubble will burst.