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5 Burdens Of Bitcoin

With all the volatility and noise around Bitcoin – we’ve written a few pieces about it here and here. Whilst it may have a first mover advantage – that doesn’t make it the only cryptocurrency worth understanding. Today I want to discuss some of the technical limitations of bitcoin.

In part 2 I will explore some alternative cryptocurrencies, both those that are promising and some more tongue-in-cheek.

Burdens of Bitcoin

Judging by the price of Bitcoin and the press we’ve been seeing – I’m sure you’ve heard many pro-blockchain arguments – indeed in many ways it is revolutionary. For a 101 on the technology you can read my very first blog post here. Today I want to discuss five of the limitations that the Bitoin blockchain implementation has:

1. Storage practicalities: The basic premise of bitcoin is that it records and stores all historical records. As it gets bigger – this becomes rather a lot of data – currently over 150GB[1] to be precise. That’s a painful download! Also unlikely to fit in your spare computer capacity. This explains why many Bitcoin users opt not to store the blockchain on their computer and rather use an online wallet. This requires trusting a third party server to do this for you – the third party crypto is supposed to avoid. This problem is so large (pun intended) that “Bitcoin, as it currently exists, will never be able to support anywhere near the world’s total transaction volume.”[2] That’s not to say this will be the death of bitcoin – more likely it will change its current form.

Screen Shot 2018-01-17 at 11.25.48 am

2. Transaction speeds: Transactions on Bitcoin are slow. Firstly, the Bitcoin network is only able to process a maximum of seven transactions per second[3] (Visa does thousands). Further, transactions are only recorded to the blockchain once every 10 minutes. The reality is even worse as records regularly roll back, this has led to standard practice being to wait for 50 minutes – not exactly a tap and go payment.

3. Transaction costs: Bitcoin relies on the computing power provided by miners. This is fine when mining is an attractive profitable business – but what happens when we approach the upper limit of 21 million units? There will be less miners, providing less processing power. For more mining incentives, transactions costs must increase or bitcoin will need to be reformed to permit more supply (this would be deflationary). Another thematic driving up cost more recently (up to $0.32 for a transaction), is paying for priority in transactions. Whilst this can be compared to bank fees, we note banks are already taking steps to combat this (e.g. no more ATM fees).

4. Pseudo-anonymity: Whilst you are anonymous as a user, your transactions are public. This has actually led to some very interesting work studying chains of crime transactions (here is a good article on it). If you can identify one user – you can see everyone they have ever transacted with, but also watch all future transactions. Clearly not a favourable characteristic for the black market, but also egregiously intrusive for personal transactions (would you want to make your credit history public? Or if you’re a corporate, say Woolworths, would you want your competitors seeing all your supplier contracts?)

5. The 50% rule: Controlling the majority of the computing power being used for mining permits you to write alternative financial histories i.e. you can spend the same coin twice. Whilst this may seem far-fetched, consider that this only requires control of four mining pools.

Screen Shot 2018-01-17 at 11.30.16 am

Furthermore, 81 per cent of the computing power is in just one country, China:

Screen Shot 2018-01-17 at 11.32.20 am

Although Bitcoin is today’s mainstream cryptocurrency, this doesn’t guarantee it will be the top choice in 10 years. In part 2 I will discuss some alternative cryptocurrencies, some of these actively address the limitations of the Bitcoin implementation, others appear made in good humour. 

[1] Source: https://blockchain.info/charts/blocks-size

[2] Source: https://trends.ufm.edu/en/article/beyond-bitcoin/

[3] Source: https://www.kaspersky.com/blog/bitcoin-blockchain-issues/18019/

[4] Source: https://www.buybitcoinworldwide.com/mining/pools/

[4] Source: https://www.buybitcoinworldwide.com/mining/pools/

View More Articles By The Montgomery Team

Roger Montgomery is the Chief Investment Officer of Montgomery Investment Management, montinvest.com, and author of blog.rogermontgomery.com.

Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.



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