Technological future of cryptocurrencies

Technological future of cryptocurrencies

Bitcoin ledger was initially released in 2009. Back then only a few forward thinkers knew about it. Not it seems that everyone is discussion and mentioning Bitcoin and other cryptocurrencies (also known as altcoins). Does this mean that in the near future these digital assets will crowd out traditional fiat currencies?

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The keys to success

If we study the nature of cryptocurrencies, we will find out that there are a couple of preconditions for the cryptocurrencies to rule the world. Firstly, blockchain should become widely used. The logic is simple: if the underlying technology itself becomes a vital element of global infrastructure, so will the cryptocurrencies. In essence, blockchain allows to record and transfer data in a way that is transparent, safe, auditable, and resistant to outages. This feature has an immense potential in industries like banking and payments, cybersecurity, supply chain management, forecasting, the Internet of Things, insurance, voting and many more. From what we can judge now, blockchain offers breakthrough solutions in many fields. The possibility that it will rebuild these areas seems high.  

The second thing which is needed for cryptocurrency’s leap forwards is the solution to scalability problem.

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A mining farm

Blockchain systems are extremely complex and require much of computing power because they have excluded trusted intermediaries like central banks. Nowadays each node (i.e. miner’s computer) in all blockchain protocols stores all states (account balances, contract code, etc.) and processes all transactions. Although this makes the system very secure, a blockchain can’t process more transactions than a single node can. As a result, Bitcoin is limited to 7 transactions per second, and Ethereum – to 15. To make a comparison: Visa processes 45,000 per second.

Unless the cryptocurrencies solve this problem (while remaining decentralized), we’ll still need our central banks. Will they solve it? It seems that here we need to speak about each cryptocurrency separately. Let’s study how Bitcoin and Ethereum are dealing with the scalability issue.

Bitcoin

Segregated Witness protocol (SegWit) was launched on August 24, 2017, in order to increase Bitcoin’s scalability. SegWit is a soft fork. In other words, it represents a change to the protocol that doesn’t conflict with the existing software, isn’t mandatory and allows the network to adjust to the new features implemented on the go. If nodes don’t accept new rules of the system, they will still be able to interact with nodes that use new rules. As a result, a soft fork is backward-compatible with previous transactions on the blockchain.

SegWit fixes a lot of Bitcoin bugs and changes the storage structure inside Bitcoin’s every block: a part of the information is stored not in the blockchain, but in separate files outside of it. The aim is to speed up transactions and lower their fees. There are two types of data which are contained in a transaction: the actual data (non-witness data), such as address, outputs, etc., and signatures (witness data), which represent all the information required to confirm a transaction. These data are then never used again. Segwit thus allows reducing the transaction size by removing signature data from Bitcoin transactions and replacing Bitcoin’s block size limit with a block weight limit.

SegWit constitutes now about 10% of all Bitcoin transactions. In 2018, the degree of SegWit’s adoption is expected to increase. Bitcoin’s core development team plans to launch a new wallet interface featuring SegWit in May 2018. Coinbase, the largest US-based exchange, will make its wallets compliant with SegWit this year as well. Yet, SegWit is not enough to help Bitcoin transactions become faster. SegWit paves the way for the Lightning Network, which should provide a fundamental solution to Bitcoin’s scalability problem. It involves a number of separate payment channels between two parties to conduct transactions off Bitcoin’s blockchain. That makes transactions much faster and cheaper, while theoretically keeping most of the security advantages of a blockchain. The launch of the Lightning Network is decentralized. Now only the brave few test the protocol.

Apart from SegWit, there was also a project called Bitcoin Unlimited. Its advocates proposed to cancel 1-MB limit of Bitcoin’s block size. However, Bitcoin developers were against this solution, because it would increase the power requirements for nodes. Small miners wouldn’t be able to survive. With their departure, the system would become more centralized. Yet the even gradual move to Lightning-based payments will lift significant pressure from Bitcoin’s blockchain.

Then a kind of compromise was designed in the form of SegWit2x protocol. SegWit2x envisages that part of the information will be stored outside of blockchain, while the block size will be increased up to 2 MB. Once again, the solution didn’t satisfy everyone. A group of developers headed by the former Facebook employee Amaury Sechét refused SegWit2x. They decided to keep blockchain’s structure the same (not to store information outside of it) but increased the block size to 8 MB. They called the new cryptocurrency Bitcoin Cash. On August 1, 2017, a forced division took place – the hard fork – and Bitcoin Cash came to life. In the following months, the cryptocurrency has managed to gain plenty of demand.

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The important conclusion here is that, as blockchain systems are decentralized, a lot of people work on solving the scalability problem. In doing so, they are actually able to implement their solutions by making hard forks. As a result, these multiple solutions which lead to the constant increases in the number of cryptocurrencies. Anyway, a progress is happening.

Ethereum

Ethereum processes more transactions than all other cryptocurrencies altogether. It is the main platform for the development of new Blockchain products and ICOs (Initial Coin Offerings). Although there are similar projects like NEO, EOS, Stellar or Cardano, Ethereum is not giving up its leadership.

Ethereum research and development is going pretty fast. The developers announced and already officially launched the switch to Proof-of-Stake algorithm. This will allow getting rid of traditional miners and will make processing several times cheaper. The main goal of Ethereum developers is to make a system of sharding blockchains (to allow the system to process many transactions in parallel), which should improve its scalability and put Ethereum in one row with payment systems like Visa.

According to Ethereum’s co-founder Vitalik Buterin, in time ETH will be able to process hundreds of thousands of transactions in a second. He plans to achieve this goal by introducing validator manager contract on the main blockchain and enfold 100 and more blockchain networks on the base of ETH. These blockchains will work autonomously, but and validator manager will check that they are in consensus and defend them from hacking. This surely sounds very promising, so we will follow the news and will monitor Ethereum’s progress.

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