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Battle for `True' Bitcoin Is Just Getting Started: QuickTake Q&A

Battle for `True' Bitcoin Is Just Getting Started: QuickTake Q&A

(Bloomberg) -- In August, the bitcoin world split in two when bitcoin cash broke away from bitcoin. It was the culmination of years of growing tension about how to improve the world’s most popular cryptocurrency. The divide has set up a battle over which is the “true” bitcoin, pitting rivals whose combined market value has eclipsed that of Citigroup Inc. and Coca-Cola Co. Now, investors are bracing for volatility and a fight that could define what a cryptocurrency can or should be.

1. Why the tension?

Bitcoin was created in 2009 with an early focus on thwarting hackers rather than becoming widely used. To enhance security, developers kept the technology at the heart of bitcoin on a relatively small scale. But as its popularity mushroomed, problems emerged.

2. What are the problems?

Bitcoin transactions are bunched into blocks and verified on the ultra-powerful computers of so-called miners. Those blocks, strung together, form the open ledger known as the blockchain -- one of bitcoin’s major selling points. The early worries over security led designers to cap each block at 1 megabyte. As bitcoin’s popularity surged, processing times and fees soared mostly because of the smaller size of the blocks, making it uneconomical for some small transactions.

3. What are the fixes?

Two competing solutions emerged. One is simply to increase the size of blocks, speeding up transaction times. This is called the "on-chain" approach. The other approach, "off-chain," foresees shifting some of the work away from the over-strained blockchain to so-called sidechains -- essentially, mini-blockchains that handle specific tasks, then sync with the main network. Off-chain also involves opening the way for software improvements such as Lightning Network, which promises to handle transactions at high volumes.

4. Why are the two approaches at odds?

On-chain advocates, including bitcoin cash supporters, say their approach hews most closely to the original vision of bitcoin as an "electronic cash system" capable of making and receiving payments, like a regular currency. Off-chain backers see that as limiting and outdated. They propose that bitcoin be the foundation upon which other services are built. They say Lightning Network, for instance, can deliver faster and cheaper payment-handling than bitcoin -- or Visa and PayPal, for that matter -- and sidechains could be developed to expand use of bitcoin into smart contracts (as bitcoin rival ethereum does) or processing transactions more secretly (as rival monero does).

5. Why couldn’t the two sides reach a compromise?

Besides the philosophical differences, there are clashing economic interests. On-chain is backed mainly by miners, whose influence and profit could be at risk if transactions were processed outside the main blockchain. Off-chain supporters include companies like Blockstream, Lightning Labs and ACINQ, which plan to sell sidechain solutions or Lightning Network technology. Each camp accuses the other of putting profit ahead of bitcoin’s interests.

6. Why did bitcoin cash split from bitcoin?

Fed up with the bickering, a group of on-chain supporters in August tweaked bitcoin’s underlying code and launched their own currency: bitcoin cash. (Such offshoots in the software field are known as "forks.") Bitcoin cash blocks are 8 megabytes instead of 1 megabyte. The extra size has attracted businesses and speculators: Bitcoin cash’s price has rocketed from around $300 at the time of the split to above $1,500 in early December. But that hasn’t stopped bitcoin, which rose from around $2,000 to $11,000 in the same period.

Battle for `True' Bitcoin Is Just Getting Started: QuickTake Q&A

7. Why are miners a wildcard?

While most miners are philosophically aligned with bitcoin cash, they continue to mine bitcoin because it is profitable for them to do so. However, should ideology prevail, miners could flee bitcoin -- potentially slowing processing times to a crawl. That happened twice in recent months, sending bitcoin transaction times surging from below 20 minutes to several hours. Bitcoin’s price reacted violently, including a fleeting 29 percent plunge on Nov. 13.

8. Which signals should investors watch?

These three indicators help show how the battle is going:

  • Number of transactions. About 320,000 per day for bitcoin and 20,000 for bitcoin cash in November. If more businesses adopt bitcoin cash for payments, it could gain legitimacy as a rival. But if off-chain solutions such as Lightning Network are successfully rolled out, bitcoin cash could become less relevant.
  • Hash rate. Measured in exahashes per second, this indicates mining activity on each blockchain. Bitcoin averages about 11 exahashes per second versus fewer than 2 for bitcoin cash. Large shifts away from a currency could significantly slow processing times and make it harder to use.
  • Market capitalization of bitcoin cash versus bitcoin. In early December, the ratio was 0.14 ($26 billion for bitcoin cash to $192 billion for bitcoin). A higher ratio signals investors see a greater chance bitcoin cash could usurp bitcoin, and vice versa. The figure reached a low of 0.05 in October and peaked at 0.48 in November.

9. How could the winner influence cryptocurrencies?

Decentralized blockchains offer trust and privacy but are generally less convenient and slower than centralized processing. Off-chain technology is an attempt to address the issue and make cryptocurrencies more efficient and useful. Businesses that support bitcoin cash say they are open to off-chain solutions if technologies such as Lightning Network are shown to work. But if those technologies struggle during implementation, the more traditional designs of bitcoin cash could be the way forward.

10. Is it just bitcoin vs bitcoin cash?

Bitcoin cash’s successful fork triggered a slew of copycats. Bitcoin gold has already been created, and bitcoin diamond and super bitcoin are coming. However, these off-shoots mostly regurgitate existing ideas under new names and haven’t attracted as much support in the cryptocurrency community. For now, the main fight is between bitcoin and bitcoin cash.

11. Can bitcoin and bitcoin cash co-exist?

For sure, but the rewards are high for the version that can claim to be No. 1 to the public, and the financial world: Nasdaq Inc., CME Group Inc. and Cboe Global Markets Inc. all plan to offer cryptocurrency futures on just bitcoin, and not other variations.

The Reference Shelf

--With assistance from Lulu Yilun Chen

To contact the reporters on this story: Yuji Nakamura in Tokyo at ynakamura56@bloomberg.net, Olga Kharif in Portland at okharif@bloomberg.net.

To contact the editors responsible for this story: Robert Fenner at rfenner@bloomberg.net, Grant Clark

©2017 Bloomberg L.P.