The Bitcoin network is getting really congested and this time, it is a serious worry

DISCLAIMER: None of this is financial advice specific to you. I could be wrong so you have to do your own research to find out what's best for you. 

TOPIC: Bitcoin | Bitcoin Cash | Bitcoin Death Spiral

Bitcoin is around its highest valuation but there is a worrying trend. Bitcoin's Network is getting really congested. There are currently 85900 Unconfirmed Transactions. The following shows the aggregate size of transactions waiting to be confirmed. 

BTC Mempool as at 2017-Aug-25
BTC Mempool as at 2017-Aug-25 (Source: Blockchain.info)

People are now having to wait for days to get a transaction confirmed. They are paying even higher fees on top of already high fees, hoping that this will get their transactions processed faster. But it is not always guaranteed that higher fees means faster processing. 

It happened before between May and June. At the time, we had no option so we all just had to put up with it. Now, however, it is a different story: we have Bitcoin Cash. We have an alternative. Miners are now switching to mine Bitcoin Cash. This trend might change temporarily in a couple of days when the mining difficulty level for Bitcoin Cash increases but will later again, decrease, as a consequence of how Bitcoin Cash is programmed. It is programmed to adjust its difficulty levels based on recent activity. 

From what I understand, this difficulty-adjusting algorithm was encoded into Bitcoin Cash to enable it to survive its early days after the fork. It turns out to be serendipity because its effect is now having an impact that potentially determines the fate of BTC and BCH. 

The net result is that, every time Bitcoin Cash difficulty levels reduce and assuming its current price is high enough, more and more miners mine Bitcoin Cash. As more miners leave the Bitcoin network, there are less left to process Bitcoin (BTC) transactions. This is why we are seeing this build up of unconfirmed transactions. 

Bitcoin has its own difficulty adjustment algorithm but it works a lot slower than Bitcoin Cash's. It cannot be changed unless a hard-fork is done. Changing it is not something that's easy and quick to organize before November. 

"A hash is the output of a hash function and, as it relates to Bitcoin, the Hash Rate is the speed at which a compute is completing an operation in the Bitcoin code. A higher hash rate is better when mining as it increases your opportunity of finding the next block and receiving the reward." [Source]. The following shows the hashrates between Bitcoin (BTC) and Bitcoin Cash (BCH).

Current hashrates for BTC and BCH
Current hashrates for BTC and BCH (Source: fork.lol)

As we can see the incentive for miners to divert their resources to Bitcoin Cash is close to matching Bitcoin's.

For all Bitcoin users, merchants, investors and traders and anyone else working with Bitcoin, all this should concern us. When you have to pay high fees and wait so long for transactions to complete, you would want to start looking for alternative cryptocurrencies. 

Ethereum, Litecoin, Dash, Monero, Ripple are alternatives. However, if you are used to Bitcoin, Bitcoin Cash is the closest substitute for Bitcoin. Bitcoin Cash is a fork/clone of Bitcoin. It is exactly the same as Bitcoin in most respects except that it has a higher 8MB block limit instead of 1MB like what Bitcoin has.

Short historical background: The people who started Bitcoin Cash believed that increasing the block limit t0 8MB is the simplest and quickest way to handle more transactions easily and quickly. Others in the Bitcoin community argued to use technologies named Segwit, Segwit2x and Lightning Network instead. The discussions went on for at least two years with no resolution. Eventually those who supported the 8MB solution, forked Bitcoin [1] so that it can make Bitcoin have 8MB blocks. With the low transaction costs and zero unconfirmed transactions currently on the Bitcoin Cash network, they are proving correct. 

The reason why I think this current situation is dangerous for Bitcoin is this:

  • When fees are high and waiting times are long, people will use alternative cryptocurrencies like Bitcoin Cash.
  • This reduces the demand for Bitcoin.
  • This reduces the price.
  • The reduction in price reduces mining profitability.
  • This reduces the miners mining Bitcoin.
  • This would further lead to even higher fees and even longer wait times.
  • The cycle repeats as Bitcoin's value and price spirals downwards. 

Graphically, it is like this: 

The Danger for Bitcoin's high fees and clogged up network

The danger for Bitcoin as it remains expensive and slow to use is that it can result in an ongoing cycle leading to its value and price eroding. Others refer to this event as the Bitcoin Death Spiral, which I find dramatic but I think alarming enough to catch the attention it deserves. 

As fees go higher, all wallets that have balances under those fees cannot be withdrawn. Even if another wallet pays for the fee, there is no sense paying $15 on fees just to take out $10 worth of BTCs for example. 

As wait times go longer and longer, everyone will begin to worry that their BTC transactions will get stuck for a really long time. Miners too, will worry trying to mine Bitcoins because by the time they claim their rewards, their BTCs may already have gone down in value. 

Eventually, using Bitcoin (BTC) becomes too risky. You don't want to be the one who gets stuck with Bitcoins in a Bitcoin wallet because there are little or no miners left to process your transaction for you even if you can afford the high fees by then to finally cash out. 

I am trying to think of how this can be prevented. Unless people do not care about high fees or long waits, there does not seem to be a way for Bitcoin to solve this problem in the short term (even say 3 months). Segwit got turned on and Lightning Network might help but their effect is not likely to be felt soon enough. The details of whether and how they should be implemented are subjects that are still heavily debated between different factions in the Bitcoin community. As yet, they do not have a convincing consensus. Even after the Bitcoin Cash fork, there's still people within the remaining Bitcoin group threatening to fork/clone Bitcoin yet again because they have a different vision how Bitcoin should move forward.

It might be too late by the time they have figured out a solution that solves their issues. High fees and slow confirmation times will remain for months if Bitcoin lasts that long. But as the Bitcoin Death Spiral process sets in, then it is likely that people will begin rushing to sell their devaluing Bitcoins. Bitcoin's price will eventually go down to zero. That's a sad ending for Bitcoin but it is a good chance that people will re-invest their funds back in other cryptocurrencies like Bitcoin Cash. If all the funds get reinvested back to Bitcoin Cash, then we can expect Bitcoin Cash to go just as high as where Bitcoin is now and take its place, maybe even the name. So instead of it being called Bitcoin Cash, it might just be called Bitcoin. It is also more likely that people will diversify their investments between Ethereum, Monero, Dash, Ripple and others. We can therefore expect the prices of those cryptocurrencies to climb up. 

 

UPDATE: Sunday, 3rd of September

After observing Bitcoin's network the last week, the probability of the Bitcoin Death Spiral taking place is now very low in my reassessment of the situation. I haven't seen it done before and I still do not know how it was done but the back log of transactions were processed almost instantaneously. 

 

FOOTNOTES:

[1] Making a fork of a project like Bitcoin is common in programming. It is not illegal or controversial in open source projects. All it means is that a group of developers copy the source code of a program so that they can make changes to it without affecting the other program. In this case, developers of Bitcoin Cash copied all the code of Bitcoin so that it can change the setting that says 1MB to 8MB. This way the people who want to try out Segwit, Segwit2x and Lightning Network can continue under the brand name Bitcoin, and they named their project Bitcoin Cash so that we can all distinguish between the two.