Bitcoin’s Scaling Problem and Segregated Witness

Before we talk about Bitcoin Cash (BCH), it’s important to understand where it came from and what problem it aims to solve. To do that, we need to spend a few minutes talking about Bitcoin (BTC).

Bitcoin broke new ground in a variety of important ways: philosophically, technologically, and economically. However, as the first of its kind, it soon became clear that Bitcoin had some deficiencies. Bitcoin is relatively slow, generating a new block for the blockchain only once every 10 minutes with a block size limited to 1MB. Further, it handles only seven transactions per second. As a store of value that is minimally transacted this is mostly manageable but for everyday use, speed is critical. Keep in mind that Visa processes 24,000 transactions per second as of late 2020.

As more users adopted Bitcoin, the network essentially bottlenecked. Bitcoin started to encounter its scaling problem around 2015 and two camps emerged to address it: those who favored small-block solutions, and those who favored large-block solutions.

Simply put: Big blocks are faster, but sacrifice decentralization because fewer nodes are able to process large blocks. Small blocks are slower, but maintain the key advantages of decentralization and security because more nodes can join and maintain the network. Speed and decentralization essentially exist on a spectrum, so the more you have of one, the less you have of the other.

With increased network traffic, even proponents of small block solutions recognized the need for at least some increase in processing speed. The solution small block proponents put forward is a process known as Segregated Witness (SegWit). It functions by removing signature data from Bitcoin transactions.

A new block added to the Bitcoin network contains transaction data and digital signature data about the origin and destination of bitcoin (BTC) in each transaction. SegWit does exactly what the name implies — it segregates the witness (the digital signature) from the transaction data. Essentially, it rearranges the data in any given block more efficiently. SegWit basically allows for double the block size (approximately 2MB per block).

SegWit is what is known as a soft fork, rather than a hard fork, and thus each node on the network could choose whether or not to adopt the new set of rules. Rejection of SegWit does not result in a new blockchain and cryptocurrency (unlike the hard fork that created Bitcoin Cash, which we’ll touch on in a bit). Adoption of the SegWit process is marginal, with an estimated 36% of all BTC transactions using it. Thus it only minimally increases the overall transaction speed of the Bitcoin ecosystem.

The Structure of Bitcoin Cash and the Importance of Block Size

Bitcoin Cash has its origin as a hard fork from Bitcoin. It is technically and structurally very similar to Bitcoin, but with one major difference: block size.

In the eyes of Bitcoin Cash supporters, Segregated Witness wasn’t an adequate solution to Bitcoin’s scalability problem. As a response to the deficiency they saw in SegWit, Bitcoin Cash was created and designed to pack 8MB of data into each block and to process 116 transactions per second on average. While transaction speed is greatly increased with BCH, the larger block size also requires more processing power for nodes to support the blockchain network.

So why not just make the blocks much bigger — say 100MB? That would make the network much faster, but extremely restrictive in terms of who could run a node, verify new blocks on the blockchain, and support the network. The debate about block size essentially boils down to speed versus decentralization and which of the two is more desirable.

Large institutions, organizations, or BCH-businesses are able to consolidate the type of processing power required for large block sizes. In contrast, it would be much more difficult for individuals to amass sufficient processing power to handle large blocks. This discrepancy threatens to create an oligopoly (where processing power is consolidated in the hands of a few key players), which ultimately endangers the decentralized nature of the blockchain. A healthy mix of decentralized, distributed, independent verification is what makes the blockchain secure and reliable so, in a nutshell, more nodes equals greater network security.

How Does Bitcoin Cash Work?

Bitcoin Cash is settled using a larger block size (which is 4-8 times larger than BTC, depending on the use of Segregated Witness) to process transactions more quickly.

These transactions are quick enough that you could make a grab-and-go retail purchase with BCH (like a cup of coffee), but if you were making a large purchase such as a car or a house, you could opt for a slower, more secure cryptocurrency like BTC.

BCH and BTC, therefore, fulfill different roles. Not every cryptocurrency is a store of value, and not every cryptocurrency needs to process data quickly to function like a credit card transaction. It makes sense to use different tools for different tasks — much like using a credit card for restaurant dining and a bank transfer to buy a house.

Ultimately, BCH is faster and features lower processing fees than BTC, but is still used less frequently as everyday cryptocurrency payments have yet to be widely adopted. Over time, many believe that greater awareness and complementary technological improvements and innovations will pave the way for BCH to serve as a leader in cryptocurrency payments.