Why the altcoin takeover scenario has become a possibility

[Steve Sokolowski]

While I haven't posted for some time, I thought that it would be worthwhile to write today because the bitcoin blocksize limitation has started to affect customers' payout choices. The choices being made by customers are worth examining not only because they indicate that the blocksize limitation is nearing a tipping point, but also because I believe the possible outcomes of the debate are become clearer. In particular, the scenario where an altcoin surpasses bitcoin is more likely than many believe, and the timeframe in which an upgrade can occur is clearer than ever before.

First, it's necessary to review some background of the past week's activities. During the rally that peaked a few days ago, transaction volume on the bitcoin network increased significantly. However, unlike previous spikes in volume, which were largely due to low-fee "test" transactions, this time the minimum fee to be included in a block rose significantly. While the fees have declined since, much of the decline can be attributed to the value of bitcoins declining rather than a vast reduction of network utilization.

Fees to execute payouts rose to around 40 cents - and such payouts require 6-10 hours for confirmation. Customers understandably complain about these long delays, but we can neither pass on the extra fees to them (as most would rather wait than pay more), nor take them ourselves (because mining is a low-margin business). To be confirmed within a few blocks, we would have had to pay over two dollars. To complicate matters, the exchanges themselves were delayed by this congestion, so we did not even receive the payout money for 20 hours after requesting it from Cryptsy. All in all, while we have always promised "next day payouts," it took 27 hours for payouts to confirm at 3:00am the following day.

Posts on Internet forums repeat the notion that even two dollars is a small price to pay when issuing $1600 in bitcoin payouts. That's true when comparing a person-to-person payment between the legacy system and bitcoin. These posts fail to understand a key issue: the most interesting uses of bitcoin don't involve this simple case of a person-to-person payment. They involve transactions with hundreds of outputs, and multisignature transactions, and escrow accounts. Most of the bitcoin economy actually resolves around these types of transactions, not the transaction where a single customer pays a single merchant at a store. Our payout transactions, where we charge people who want frequent payouts the transaction fees, are one of those cases.

Something interesting started to happen this week. Last week, 82% of our payouts were being taken in bitcoin. Currently, 72% of payouts are being paid in bitcoin. In the interim, an additional 10% of the total payouts are now going to altcoins. The big winner is litecoin, which saw a significant increase. Surprising increases also occurred for the "second generation" altcoins, especially NXT, which is a coin that is technically superior to bitcoin in most ways, but which suffers from proof-of-stake.

Why would payouts be taken in altcoins? Some users undoubtedly believe that altcoins will appreciate in the wake of the bitcoin rally. But others have mentioned that their fees are significantly lower in these altcoins. It's not difficult to see why: a small miner who has a ZEUS 20MH/s ASIC and requests payouts in bitcoin every day is currently paying more than 1% of his profit in transaction fees. They can obtain "paper bitcoins" in a roundabout way: get paid in litecoins, with a transaction fee of close to zero, and then sell the litecoins for "paper bitcoins."

The way this actually works is that we use our "paper bitcoins" at some exchange to buy those litecoins, which are then paid to a miner as real litecoins across the network, and then those litecoins go back to a different exchange and are traded for "paper bitcoins" there. Though the customer now has our money, there are never any bitcoins actually used in this transaction because it is too expensive to transfer them. For these customers, "bitcoins" are just numbers on an exchange, whereas litecoins are what are actually being used to transfer value. This isn't an isolated incident; whereas most litecoin blocks were previously mined with only the coinbase transaction, many blocks now look like this one: http://explorer.litecoin.net/block/a2b4 ... c60bdd602f. Keep in mind that there are four times as many litecoin blocks as bitcoin blocks, making a block with many transactions more significant than it would seem at first. These blocks are nowhere close to the size of bitcoin blocks, of course, but are larger than bitcoin's blocks during half of its history.

The reason this started happening is simple economics. Since most people only care about being paid (whatever that payment is for), they care little about the form of that payment. It's cheaper to go through this roundabout method using litecoins than it is to deal with real bitcoins at all. For this reason, the "small blocks forever" argument is untenable. When transaction fees rise, people don't pay more. They simply go to the next altcoin down the line. Eventually, someone else you want to pay will also be doing this, and what reason would you have to turn back to bitcoins at all?

Those in favor of small blocks believe that they can create a "fee market" and limit bitcoin to certain types of transactions while still making it a widely used currency. But it's becoming obvious that that won't happen. Like in any other market, bitcoin has to compete against other technologies, and people will use the cheapest one. And in this case, the cheapest technologies also happen to be nearly 100% API compatible with bitcoin, something that has never happened in an alternative to any other major system.

The January 11, 2016 start date for the implementation of BIP 101 is approaching. While I previously would have said that the date might pass without incident, some news that was overlooked this week was the announcement by OpenBazaar that they are on track for a full launch within 7 weeks. OpenBazaar, which Chris and I have long held to be the killer app, will explode transaction volumes. A bubble in anticipation of OpenBazaar's launch might be even closer. I see three ways that the blocksize debate plays out, ordered from least likely to most likely. In all cases, I make the safe assumption that bitcoin transaction growth is not going to cease.

------------

The least likely scenario is that the Core developers could come up with their own solution within a very short time, perhaps a week or two. They don't have long, because they haven't even discussed the topic in many weeks of their weekly meetings, and any solution needs a huge amount of testing that needs to be finished by January 11. If there is a solution that is working by that time, there is a chance that the exchanges, which have already committed to BIP 101, might be convinced to discard their existing work. Given that there is so little time, no working code, and people who have already committed to an alternate solution, I think this scenario is unlikely.

-------------

A moderately likely scenario is that no agreement is reached on the blocksize solution for an extended period, long past January 11. Most people may just simply not care enough and believe the problem isn't that big a deal, failing to see the trends described above. Or, SHA-256 miners may naively believe that it is in their best interest to do nothing, because they think their mining fees will become more valuable. In this case, I think that transaction volume spills over to litecoin, and then to dogecoin, and whichever of these coins first resolves the blocksize issue will supplant bitcoin because the resolution of the blocksize issue in a coin that is gaining traction will result in a massive bubble in that coin's value. While it is possible that bitcoin would retain some value, I don't see why even large organizations would continue to use bitcoin when the majority of transactions have moved onto the other chain.

If I had to guess which coin would become the world reserve currency in this scenario, I would go with dogecoin. It's something that sounds as far fetched as Trump becoming the Republican nominee, and we should know that even things that seem absurd sometimes turn out to be more likely than originally believed. The reason is that dogecoin is the third currency down from bitcoin, and Charles Lee, leader of the second currency, has previously stated that he does not believe that litecoin's block size should be increased. Furthermore, unlike many altcoins, dogecoin uses proof of work, and its scrypt algorithm has ASICs which protect it against attacks from cloud computing instances being rented all at once. Dogecoin is more likely than NXT or Monero because it is a fork of bitcoin and its API is almost exactly the same, allowing easy conversion of services.

-------------

The most likely scenario of the three is that as January approaches, transactions are starting to move off onto the litecoin and dogecoin networks. That will catalyze people who, right now, have no reason to take any action (since even if they upgraded to bitcoin XT, no upgrade would occur at the moment). There will be a crisis and a large number of people will commit to the only solution that is available. A major unknown here is whether the Core developers would be willing to patch the Core with BIP 101, or whether they would decide to go down with the ship on principle, leaving Mike Hearn as a "benevolent dictator for life." My opinion is that even though some have shown bad faith, they would apply the patch and attempt to regain control of the process after the fork.

The worst part about the BIP 101 upgrade process is that there is a built in delay where after the network commits, there will be sufficient time for theymos and whoever else opposes the upgrade to make a last-ditch effort to destroy bitcoin by taking 33% of XT pools offline so that 50% would be running the old code. I wouldn't be surprised to see the largest DDoS attacks in the history of the Internet when the network commits to the upgrade two weeks later. The attacks would probably affect normal users of other services like Netflix streaming and attract global media attention.

------------

Three events are creating a perfect storm. The recent rally has renewed interest in bitcoin and dramatically increased transaction fees, forcing some transactions to other chains for the first time. OpenBazaar has announced that it plans to release within the next two months, bringing the killer app for bitcoin online at last. Finally, Mike Hearn's January 11 date of earliest BIP 101 adoption is approaching quickly, and represents the first time when the network can actually fork. Whichever of these scenarios happens, it is going to happen soon - and it is unlikely that the bitcoin landscape is going to remain as it is for very much longer.

[adlai]

Have you tried measuring how many of your altcoin payout customers hold rather than exchanging for bitcoins?

Obviously this is impossible to measure for one of your altcoins, but it should be doable for the ones that have blockchains.

[Steve Sokolowski]

Have you tried measuring how many of your altcoin payout customers hold rather than exchanging for bitcoins?

Obviously this is impossible to measure for one of your altcoins, but it should be doable for the ones that have blockchains.

Great suggestion, and I'm sure it would be technically feasible to do, but I don't want to do this study because it's not a good idea for a business to invade the privacy of its customers. I'm sure if we did perform an analysis on this data, however, it would reveal some interesting results.