If you’ve been around bitcoin long enough, you may know that transaction fees can go through extreme periods of congestion. But why might that be? Isn’t that a problem for a global, decentralized currency?
Well, not necessarily. Let’s explore the mechanics behind Bitcoin transaction fees, and see what solutions developers are working on to achieve massive scalability for bitcoin.
Bitcoin’s Scaling “Problem”
In order for bitcoin to become a global payment network, it needs to be able to process transactions for people all around the world at a reasonable speed and price. Bitcoin’s base layer (L1) processes an average of seven transactions per second (TPS), compared to today’s legacy payment processors like Visa or Mastercard, which can process thousands. Naturally, there has been a lot of discussion about scaling bitcoin to enable everyone in the world to use bitcoin for everyday payments of any size. But these arguments are missing the the forest for the trees.
The Bitcoin L1 doesn’t need a higher TPS; It needs layers built atop of it to support scalability.
While some may view high on-chain fees and 1 MB blocks as bitcoin’s scaling problem, it is actually an incredibly important market dynamic that helps us to better understand the need for the Bitcoin scaling technologies listed below.
High Fees Are Not Inherently Bad
As recent market dynamics have shown, bitcoin’s transaction fees can spike quite high under highly-congested periods. High enough, in fact, to price out everyday people’s smaller transactions.
How can that be a good thing?
Because on-chain transaction fees aren’t designed with the user in mind — they’re for the miners. Of course, bitcoin’s fee model contributes to the sovereignty and power that bitcoin provides the average person, but the market is revealing that the Layer 1 isn’t where everyday transactions belong. They need to move to the various layer 2s being built on top of bitcoin.
Different Bitcoin layers have different purposes:
- Layer 1 prioritizes security and decentralization. In this case, high transaction fees are very beneficial. Beyond supporting miners, higher transaction fees make attacking the base layer of bitcoin very expensive, thus incurring an unsustainable prohibitive cost on attackers over time.
- Layer 2 prioritizes scalability and speed. Spearheading this is the Lightning network, but other scaling solutions like statechains provide different tradeoffs that may attract certain user bases within bitcoin.
- Layer 3 prioritizes the user experience. Tools like Fedimint, eCash, and RGB are working to build on top of L2 solutions like lightning with more being developed.
And the good news about higher transaction fees on the base chain: it creates new demand for innovative scaling solutions. Let’s see how bitcoin is scaling.
How Is Bitcoin Scaling?
In order for hyperbitcoinization to become a reality, bitcoin needs to work for people while scaling to handle many more transactions per second than legacy payment networks do. That means bitcoiners need to use every tool available to mitigate high on-chain fees while developers all around the world work to scale up the number of transactions that bitcoin can handle.
While some claim that there is a simple solution, the reality is that there is no single “silver bullet” to scale bitcoin. In fact, scaling bitcoin to compete with existing payment networks is going to require as many different tools as we can possibly get our hands on. Here are just some of the ways bitcoin is scaling to handle more transactions per second, keep Mempool congestion to an absolute minimum, and discover the most efficient fee rate.
1. HODL
HODL. It’s our favorite word and for good reason. It’s not just something that we say. It’s a part of who we are. We understand that bitcoin is the greatest money in all of history and we want to hold onto as much as we can for as long as we can.
HODLing is all about delayed gratification. When we HODL, it means that we aren’t spending any bitcoin today so that we can enjoy increased purchasing power in the future. It means that we are not taking up valuable block space required to send sats from one address to another. While it may not be obvious, HODLing actually helps bitcoin to scale by reducing Mempool congestion, curbing on-chain fees, and is supporting the price of bitcoin.
2. Coin Control
In the event that you ever need to send bitcoin to another address or consolidate some of your address balances (UTXOs), it makes the most sense to use coin control to minimize the size of your transactions.
Coin control is a privacy enhancing wallet feature that gives you the option of selecting exactly which address balances you send from. Ideally, you want to send from the smallest number of addresses so that your transaction is as small as possible. The fewer sending addresses (inputs) and receiving addresses (outputs) usually translates to less data in your transaction and more efficient use of limited block space.
3. Custom Miner Fees
For those learning how to use bitcoin effectively, understanding custom miner fees is one of the most important parts of sending transactions. Whenever someone sends a transaction, the fee signals to miners and the rest of the network what that sender is willing to pay to have their transaction added to the blockchain.
Throughout bitcoin’s history, the cost of sending on-chain transactions has spiked and caused some intense debate about how to best scale bitcoin. In late 2017, fees were as high as $60 and not many wallets had the ability to set a custom miner fee. Even if your wallet did give you the option to set your own fee, it was probably some sort of arbitrary wallet preset like “low, medium, and high”.
Fast forward to today and we have all sorts of Bitcoin wallets that enable their users to send transactions with custom miner fee rate as low as 1 sat/vbyte (vB). Keep in mind this doesn’t mean fees are getting cheaper. We still see 2017-like spikes in transaction fees due to Ordinals and other high-demand activity taking place on the blockchain. It just enables more flexibility for the user to mitigate those fees. The tradeoff is that by selecting a low sat/vB rate, you have to wait a longer amount of time for the transaction to confirm. If network congestion remains high for a long time, however, then you may have to wait longer than you’d like for that transaction to confirm.
Sparrow Wallet, for example, implements a custom fee slider that you can adjust to your preference based on what’s currently happening in the Mempool.
As more users send transactions with custom miner fees, more users are likely to send with a below-average fee to see if it will confirm in a reasonable amount of time. If transactions are taking too long to confirm, you can “bump” the fee to get it confirmed sooner.
4. Fee Bumping
Fee bumping is yet another important part of how bitcoin is scaling. Instead of using a large initial miner fee to send a transaction, (which ultimately bids up the price of on-chain fees) you can pay an abnormally low fee rate and let it sit in the Mempool for a while to see if it will get added to the blockchain.
While a transaction is pending in the Mempool, either the sender or the receiver can adjust the miner fee after the transaction has been broadcast (if their wallet supports fee bumping) in an attempt to get confirmed on the blockchain sooner. The sender can send a second transaction using Replace By Fee (RBF) or any of the recipients can create a second “child” transaction with a larger miner fee that would pay for the parent transaction using Child Pays For Parent (CPFP).
While RBF and CPFP may not seem like they have a direct effect on scaling, the use of either of these fee bumping methods is helping bitcoin to scale by creating a more precise miner fee market.
5. Batched Transactions
If you have ever sent bitcoin to more than a single Bitcoin address, chances are that you had to make more than a single on-chain transaction. Sending multiple outputs in a single transaction is helping to reduce Mempool congestion by pooling multiple transactions into one. A number of Bitcoin exchanges and custodial services have been using batched transactions for years but with more wallets supporting this feature, batched sends are now possible for the average user.
In fact, batched output transactions are being experimented with as a means to open and close payment channels on the lightning network.
6. Lightning Network
As mentioned, one of the most exciting parts of scaling bitcoin is the Lightning network. Instead of scaling directly on-chain with the methods that I have already talked about, the Lightning network is a second layer that is built on top of bitcoin that allows for a much higher volume of transactions. Instead of sending small payments directly on the blockchain, the Lightning network hopes to absorb smaller transactions, enable higher transactional throughput, and increase “transaction density” per on-chain transaction.
Rather than sending small payments on the blockchain itself, on-chain transactions are used to open payment channels. People use those payment channels to transact a larger number of smaller payments. Not only do these smaller payments reduce Mempool congestion, but they also settle in seconds so that bitcoin, making bitcoin practical for over-the-counter purchases.
7. SatsCard & OpenDime
Another great way to keep bitcoin off of exchange order books while also really adding to the “Bitcoin days destroyed” metric is to use a specialized hardware wallet, SatsCard or OpenDime. One of these devices requires a single on-chain transaction to load the device and then another single on-chain transaction to unload the device. In between those 2 transactions, a SatsCard and OpenDime can change ownership an unlimited number of times without making any additional on-chain transactions. That helps to reduce on-chain fees while also increasing privacy for anyone who ever owned the device before its balance is swept. The higher the number of owners of each device, the greater the anonymity set for each and every owner along the way.
While these devices tend to be more niche at the moment, they are a fun way to spend bitcoin amongst friends with as much privacy and anonymity as cash.
8. Bitcoin Improvement Proposals
Bitcoin Improvement Proposals (BIPs for short) are also one of the most important ways that bitcoin is scaling. Part of what makes bitcoin such a beautiful system is that it is open source and a lot of the surrounding infrastructure is too. Some BIPs are suggestions to change the Bitcoin protocol itself while others are proposals are for improving how wallets work. New BIPs are proposed all the time so it’s only a matter of time until another groundbreaking BIP becomes the hot topic of discussion amongst the Bitcoin community.
One of the most prominent BIPs to help to scale bitcoin is commonly known as SegWit (BIP 141), which allows for more transactions in each 1MB block.
9. Liquid
Liquid is a BTC-pegged sidechain that Blockstream launched in October of 2018. It is primarily designed for sending and receiving larger amounts of bitcoin between exchanges with incredibly low fees. The more transactions that take place between exchanges using Liquid, the fewer transactions that bloat the Mempool.
10. Statechains
Statechains are a layer-2 scaling mechanism that enable anyone to pass Bitcoin ownership onto another without the need for an on-chain transaction every time. Instead of a traditoinal transaction, statechains transfer the private key linked to a specific amount of Bitcoin between users. A key player in the statechain space is Mercury Wallet.
Statechains use “statecoins” representing a specific amount of bitcoin that you deposit to an address. From here, the associated private key is split between the depositor and the Mercury server (the statechain entity), while the depositor holds a time-locked ‘backup transaction’ that grants them full control of the statecoin after a given amount of time. No one ever knows the full private key, and each party must cooperate to sign a transaction.
11. CoinPools
CoinPools essentially let multiple users share ownership over a single Bitcoin UTXO, but the CoinPool ledger and the base Bitcoin ledger are entirely independent. This framework lets users instantly spend their own partial ownership of the UTXO, thus reducing the number of individual UTXOs clogging the main chain. Assuming proper implementation, CoinPools would allow anyone to claim their own slice of a UTXO and spend it, which would massively distribute Bitcoin ownership at the base layer over time.
Imagine Alice, Bob, and Jon all share 1 UTXO worth 30 BTC, but each of them hold just 10 BTC within the UTXO.
Within the off-chain CoinPool, the three are free to transact with one another, and withdraw unilaterally.
12. Custodial Services
Finally, custodial services are a surprising but relevant part of the scaling equation.
Since not everyone is able to instantly start stacking sats without first using a third party, custodial services still play a big part in how bitcoin is scaling. Some of the most common services in the space are already using a number of the methods I have mentioned.
Familiar traditional financial services like CashApp allow their users to withdraw to their own Bitcoin address as part of a batched transaction. Some Lightning wallets enable their users to transact on the Lightning network without needing to run their own node or manage payment channels.
Other custodial services are more unique and closer to bitcoin’s decentralization: Fedimint and eCash.
Essentially like a community custody system, Fedimints are like Bitcoin wallets that distribute trust among Fedimint members rather than a single, centralized entity. Not only does Fedimint offload some of the congestion from the main chain, but it also enables private payments despite having custodial involvement.
With eCash, you can use a compatible wallet like Cashu to fund with bitcoin. An eCash system has a mint and an eCash wallet, like Cashu. Wallets use the mint’s Lightning node for sending and receiving bitcoin, but receive “eCash” in its place, worth a certain number of sats. A mint has zero personal information on you, and allows you to trade with eCash without anyone identifying either party.
All of these custodial services are working to onboard new users in one way or another. As soon as those new users become HODLers and take control of their own private keys, they’re likely to realize the benefits of scaling bitcoin with not just one, but many of the methods I’ve just highlighted.
Note: It’s important to understand that keeping your bitcoin on an exchange is ultimately bad for Bitcoin adoption because they have custody of your bitcoin. As bitcoiners like to say, “Not your keys, not your coins.” I always recommend that you take custody of your own Bitcoin private keys using a cold storage device, or even third-party service with some sort of multisig or collaborative custody plan.
How Are You Scaling Bitcoin?
Whether you’re a newcoiner who’s learning how to take custody of your own keys or a seasoned Bitcoin HODLer, we can all do our part to help bitcoin scale. What starts off as a simple journey, may end up as an obsession (like it has for me) that drives you to run your own Lightning node and help others send fast, cheap, micropayments.
No matter your motivation, as the tools that we use continue to be improved, scaling bitcoin will continue to get more and more efficient as the world needs it to to achieve hyperbitcoinization.
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