As the first digital currency to scale, Bitcoin ushered in a new era where investors, technologists and corporations have taken an interest in cryptocurrency's potential.
Since the first units of Bitcoin were mined in 2009, the digital currency has generated widespread visibility. However, this innovative technological innovation is not without its limitations. This article will touch on Bitcoin's biggest shortcomings.
One major challenge faced by the Bitcoin network is the difficulty it has faced when making crucial decisions. Because of its decentralised nature, this network needs to obtain the support of miners in order to make key changes.
To bring about a significant change, such as increasing the size of the blocks in Bitcoin's blockchain, the network would need to execute a hard fork, which is a permanent change in the digital currency's protocol. When a hard fork takes place, blocks mined using the old rules are rejected by the new blockchain.
For the Bitcoin network to execute one of these forks, miners commanding a supermajority of hashing (also known as processing) power must signal in favour of the proposed change. At the time of this report (13 June 2018), the network would need 75% of all hashing power to signal support for such an alteration to take place.
Bitcoin Transaction Processing Limitations
Bitcoin was originally created to process seven transactions per second. As the digital currency's network grew in size, this limitation proved increasingly troublesome and created steadily rising transaction times and fees.
These fees hit an all-time high in December 2017, when they reached an average of roughly US$160 apiece near the end of the month. This took place shortly after Bitcoin prices climbed to a record high of more than US$20,000 (£14,946.50) on CoinMarketCap.
Developers recognised the threat that this situation posed to the Bitcoin network's continued usability and proposed varying solutions to address the situation. Unfortunately, many of these proposed solutions failed to achieve the consensus needed for them to be approved and implemented.
Bitcoin was originally created to have 1MB blocks, and at the time of this writing, that specification had not changed. Increasing this block size is one solution that developers have proposed, but these efforts have not been successful.
While the Bitcoin protocol was hard wired to process seven transactions per second, developers were able to bolster the network's transaction capacity by implementing an upgrade called Segregated Witness (SegWit). This update allowed the blocks in Bitcoin's blockchain to hold a higher number of transactions without increasing the actual block size.
In addition, implementing SegWit has cleared the way for developers to roll out the Lightning Network, which has been designed to allow Bitcoin transactions to take place off-chain. Basically, the lightning network helps set up transactions between two parties that don't need to be confirmed by the entire network.
As quoted in the Lightning Network whitepaper, "If only two parties care about a transaction, it is not necessary for all other nodes in the Bitcoin network to know about the transaction."
Privacy In Transactions
One of the original intentions of Bitcoin, as outlined in its whitepaper, was to provide privacy. While the creator (or creators) of Bitcoin wanted the digital currency's transactions to remain private, its design failed to produce this result.
A Bitcoin transaction is basically money being sent between Bitcoin addresses, which are randomly generated strings of letters and numbers. Over time, many transactions can get attached to an address.
Bitcoin's Basic Design
Bitcoin has been praised by many as a great technological innovation. In addition to being the first digital currency to scale, it coincided with the implementation of the first blockchain, a distributed ledger system that has since generated great visibility.
While Bitcoin has made some contributions to technology as we know it, other digital currencies have leveraged these innovations to make further progress. For example, while Bitcoin has provided users with a certain degree of privacy, digital currencies such as Monero and Zcash have done far more to provide this benefit.
In addition, several projects have worked to create next-generation blockchains. Ethereum, for example, is a blockchain that allows developers to create decentralised applications that leverage smart contracts. For building upon Bitcoin's technology, Ethereum has been referred to as a second-generation blockchain.
In 2018, a project named Seele held a digital token sale in an effort to raise funds for a fourth-generation blockchain. The project aimed to create a "heterogenous forest network," which would essentially consist of a "meta chain" (parent chain) and sub chains. In other words, this project wanted to create a network that would include several separate blockchains that could be used by different organisations.
While Bitcoin coincided with several technological innovations, the digital currency is not without its shortcomings. One major challenge faced by the Bitcoin network is its process for implementing changes to the digital currency's protocol. For a hard fork to take place, miners representing a supermajority of hashing power must signal their support of a proposed change.
Bitcoin has also encountered significant difficulties processing transactions as network demand has grown, and some argue that it has fallen short in terms of offering its users privacy. And while Bitcoin provided some rather impressive innovations when it first came out, several other digital currencies have built upon its technology to create new and improved platforms.
As a result of these limitations, Bitcoin can appear a bit more basic compared to newer digital currencies.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.