The Illusion of Scale in Segregated Witness

 The bitcoin community is actively debating how to scale the bitcoin network to achieve faster transactions and greater usage. Bitcoin Core’s development team has proposed Segregated Witness, which would separate signature data (witnesses) from transaction data in order to fit more transactions into the current 1MB block size. (Witness data is estimated to account or 60% of the transaction data size, so SegWit would presumably allow 60% more transactions to fit into a 1MB block.) In May 2017, a group of companies supported an agreement for SegWit 2x – would which both implement SegWit and then supposedly later lift the block size to 2MB.However, SegWit will not deliver what it promises. As Dr. Craig Wright, Chief Scientist at nChain, writes in a recent research paper SegWit only creates an illusion of scaling the bitcoin network. Fundamentally, SegWit fails to appreciate that the true value of bitcoin lies in the relationship between use and demand. As proposed, SegWit distributes value and reduces bitcoin to a pure settlement system; it fails to solve the issue of scalability, and introduces security and scarcity issues through its inclusion of sidechains.This blog summarizes key points of Dr. Wright’s paper by looking at the true value of bitcoin, exploring the shortcomings of SegWit (both legal and practical), and explaining why sidechains are an unrealistic answer to bitcoin’s scaling problem. 

Value of bitcoin

Money gains value through use, and the same holds true for bitcoin.  There is a direct relationship between the market price of bitcoin, the velocity of use, and the overall sum of bitcoin available.To put it simply: the overall value of bitcoin comes from both velocity and uptake. Just like in any system, supply and demand set price; when the supply and demand are consistent, there remains a linear relationship between price and velocity that cannot be ignored.Every increase in the usability of bitcoin increases the overall value of the currency. To increase velocity, we need to increase use of bitcoin – and as we increase use, we increase demand.  The total number of bitcoin will reach a fixed maximum quantity (never more than 21 million), which further compounds this effect.  As adoption increases, demand and value increase for bitcoin.In order to grow, bitcoin needs to maintain a transaction capability greater than the number of users. However, due to its 1MB block size limit, the network has currently hit an arbitrary cap that maxes out the number of transactions that can be efficiently performed and prevents the system from accepting more users.Think of bitcoin like an eight-lane highway with a single broken tollbooth; it is not the highway that is broken. Likewise, the bitcoin system itself is not technically incapable. Rather, its system needs to open up to as many users as possible.Increasing the block size is the single most viable solution to scale the network, but SegWit does not do that (and SegWit 2x would only modestly increase the block size to 2MB). SegWit is at most a short term supposed solution which will not create the velocity of use needed to drive up the market price of bitcoin to its highest potential. 

Problems with SegWit

In addition, SegWit presents key problems. First, removing witness data creates complications.  While pruning signature information may appear fine for the everyday user, it can create significant legal vulnerabilities for exchanges, merchants, and businesses. Digital signatures have probative value, which is why laws and regulations often require full transaction data to be maintained. If SegWit were implemented, such legal issues can inhibit bitcoin from being more commonly used, which as explained above, is key to driving up the currency’s value.Beyond legal implications, SegWit requires more transactional overhead to achieve a more limited increase in throughput. Hiding parts of the data does not reduce the transactional cost; it just renames the cost and increases the overhead.SegWit with a standard weight provides from 1.2x to 1.6x (at most) the transactional throughput, based upon a 1MB partial block (after signature data is pruned) and a 4MB full block (before signature data is pruned).  That means SegWit increases the amount of data storage and network traffic by 400% (from 1MB to essentially 4MB worth of data), to only gain transactional throughput of 150%.  It’s 150% increase at a 400% cost.  What’s the point?In contrast, if the block size were raised to 4MB or 8MB (without implementing SegWit), throughput would increase 400% or 800% automatically. 

Security issues with sidechains

SegWit offers the opportunity to introduce sidechains, but sidechains also present problems.First, sidechains reduce scarcity (which creates inflation).  History has shown that creating more money (without more demand) will lower value. Introducing sidechains that cap the number of transactions will limit the growth of bitcoin. Those factors will cause a price decrease, and more importantly, will limit the functionality of the bitcoin system.Second, sidechains introduce risk. Sidechain promoters promise that a 1:1 peg will enable settlement on the blockchain without losing any functionality; they argue that 1:1 peg can allow payments with financial integrity, without bitcoin.However, the ability to peg multiple payments within sidechains will inevitably lead to issues. Think multiple pegs to a single transaction: there’s nothing stopping the introduction of a peg that is associated with a sidechain being mapped in a way that isn’t analogous to 1:1 mapping. There are not any set rules for fixed mappings.That means it’s possible to map a sidechain at one rate, then alter it later.  This could be used to undermine the blockchain’s immutable and absolute nature.  Creating a chain of pseudonymous records that can be analyzed–but not altered – after the fact is key to encouraging greater adoption of the bitcoin network.  Instead, sidechains add layers of data and information to obscure the process.Third, sidechains encourage unnecessary complexity. Sidechains effectively produce multiple monies within one system. Increasing the number of financial channels doesn’t provide more choice: it conceals a simple solution.Bitcoin was designed to remove intermediaries, but sidechains create the need for middlemen to navigate risk and simplify use. To make matters worse, sidechains provide no additional scalability over increasing the block size. Sidechains add overhead (via settling sidechain transactions within bitcoin), but fail to reduce transactional cost.For these and other reasons, SegWit presents only the illusion of scale.  The true solution to scale the bitcoin network is simple: increase the block size.Dr. Wright’s full paper about the illusion of SegWit as a scaling solution is available