Bitcoin’s Fatal Payment Flaw Leaves Room for a New King
You walk into your favorite coffee shop on Tuesday morning and order a vanilla latte.
The barista rings you up on a touch-screen register. She turns it to you and asks how you want to pay.
Your options are USD or bitcoin (BTC).
You choose bitcoin and hover your phone over the screen. It beeps and says: “Transaction processing, waiting for the network.”
The register sent your bitcoin transaction to the network. If there is no third-party middleman, such as Square Cash or Venmo, your bitcoin payment isn’t approved until the blockchain confirms your transaction.
Six minutes later, it’s still processing. Your latte is getting cold.
The line of irate coffee seekers behind you is now impatient. Patrons grumble because they need their caffeine fix.
Since the card reader is still tied up, the barista announces that they are “cash only.”
A scruffy gentleman near the door says: “You gotta be kiddin’ me!”
He storms out.
This nightmare is how things would have played out at my favorite coffee place in Brooklyn (and others), had the owners decided to start accepting bitcoin as payment.
Bitcoin Can’t Compete With Credit Cards
Bitcoin isn’t ready to be a medium of exchange. Its biggest limitation is that it can’t compete with credit and debit cards to process transactions.
Bitcoin transactions must be approved by the entire network. And this network can only handle a measly seven transactions per second.
It’s a different planet from Visa, which can handle 25,000 to 50,000 transactions per second.
That means you have to wait up to 10 minutes to pay for your latte with bitcoin. And when the network is crowded, the transaction might not make it into the first block.
At the peak of bitcoin-mania in 2017, it took as long as several hours to buy or sell the digital currency.
Without lightning-fast approval time, bitcoin is useless as a medium of exchange.
We could treat bitcoin as a digital store of value, the way gold is a physical store of value. After all, you would never bring a gold nugget into a coffee shop and clip some yellow metal off to pay for a muffin. (Well, some of the true gold bugs might!)
Without quick payments, there’s no advantage to bitcoin over credit cards.
While there are plenty of potential solutions, there’s no magic bullet yet:
Bitcoin spinoffs such as Bitcoin Cash and Litecoin share bitcoin’s core DNA. But they offer larger block sizes (more transactions) and/or faster confirmation times.Neither of these cryptocurrencies can compete with credit card transaction speed. Bitcoin Cash is faster than bitcoin but still only handles 61 transactions per second. And it doesn’t have bitcoin’s global network or universal acceptance.
Off-chain settlement. The lightning network is an off-chain network where groups of transactions between known parties can be combined as one payment. Hopes for this project were high, but development has slowed over concerns of network security and high fees.
Centralized custodians. The Bakkt exchange wants to be a depository for bitcoin to facilitate transactions. For instance, if your bitcoin is held at the NYSE-backed exchange, and the coffee shop also has an account at Bakkt, then the transaction only needs to be approved by Bakkt. This transaction is later added to the bitcoin network.The main problem is this doesn’t cut out the banking middleman. Bakkt replaces the role of the credit card processor while charging another fee.
The Crux of the Crypto’s Problem
This brings us to the crux of the problem: how Bitcoin functions. The network uses up computational “work” in the form of processing time. Right now, it’s the best way to secure a distributed network. But processing time hinders day-to-day bitcoin transactions.
And proof-of-work isn’t the only way to secure and run a blockchain. In the next few months, Ethereum (ETH) plans to upgrade its network to a long-awaited “proof of stake” consensus mechanism.
This allows holders of Ethereum to “stake” their coins in order to validate transactions. It attributes mining power to holders with the biggest “stake,” or skin in the game. It incentivizes distributed groups to come to an agreement on transactions. And it doesn’t require the same amount of computational power as proof-of-work.
The world’s second-largest cryptocurrency by market cap also allows programmable money in the form of smart contracts.
Ethereum developers have been planning this upgrade for a few years now. If it goes off without a hitch, it will be the biggest event in crypto this year (even bigger than the halving).
And you might be able to pay for coffee in an instant with ETH someday.
• Ian King, Editor of Automatic Fortunes at Banyan Hill Publishing, is a former hedge fund manager with over two decades of experience trading and analyzing financial markets. He has adapted his expertise to identify winning trends in cryptocurrencies.