“Bitcoin: A Peer-to-Peer Electronic Cash System.” By 2020 standards, this description of Bitcoin chosen by Satoshi Nakomoto as the title of the Bitcoin whitepaper is an odd one. The proliferation of blockchain technologies and their associated assets are for the most part neither peer-to-peer nor a cash system. This may seem strange to those who are not well versed in the subject, but it is true nonetheless. In particular, crypto-assets have lost their cash-like quality. This isn’t in reference to a change in usage, but rather a change in structure. Blockchain based assets have dismissed cash in favor of modern, account-based systems. This may seem natural, since transitioning the global economy from cash to electronic, account-based systems is a long-standing goal of many governments, banks, travelers, and retailers. Unfortunately for these blockchains and the traditional financial system they seek to replace, only cash scales.
Why does only cash scale? It has to do with the ordering of transactions. Here is an experiment you can run with a friend. Take any cash unit - a twenty, a dollar, a penny - and use two accounts on your preferred traditional financial application, perhaps Venmo, one with a zero balance, and the other with a balance equivalent to the cash unit. Let’s say you chose a dollar. In that case, measure the number of times you can pass that dollar back and forth in an hour. Then, compare that to the number of times you can send that dollar back and forth within that financial application.
UI concerns aside, you are likely to find yourself rate limited or facing periods of time where neither party has the dollar when using the traditional financial application. This isn’t due to some sort of bandwidth constraint. Rather, the issue is settlement - making sure that one account has the dollar they are trying to send to the other account. Settlement is not a challenge when passing the dollar back and forth. It is clear that the other party has the dollar to send you because they just handed you the dollar. The order is clear because only one person holds the dollar at once. In the account-based system, the order isn’t clear. If Venmo receives messages out of order, then there could be a failure because the party trying to send the dollar doesn’t have the dollar yet according to Venmo’s records.
The difference between these examples highlights the difference between Bitcoin and account-based systems. While Bitcoin isn’t something that one can hold in one’s hand, it is like cash in that each bitcoin token has one owner at a time. There is no ambiguity about the order of transactions for a single bitcoin token since that token is defined by a chain of signatures. Signing a bitcoin token from one holder to the next is akin to handing that dollar from one person to the next. Handing a dollar back and forth may seem like a silly example, but companies like Kronoverse are already putting similar systems into practice in their blockchain based game Crypto Fights where players can communicate via the blockchain by handing transactions back and forth to communicate game moves.
Account-based systems like Ethereum work differently from Bitcoin and much more like traditional systems. Bitcoin is a token system where each of the 2.1 quadrillion tokens (100 million sub-tokens for each of the 21 million bitcoin) is owned by a specific chain of signatures. Ethereum is owned by specific accounts, each with their own balance. Moving a bitcoin token involves signing that bitcoin from one holder to the next. Moving a unit of ether involves sending a message to debit the account of the current holder and credit the account of the next holder.
We can now see where the problems occur. Messages to credit and debit accounts don’t have an explicit order. If Alice sends bitcoin to Bob who sends that same bitcoin to Charlie, the order is explicit. In an account based system like Ethereum, if Alice sends ether to Bob who sends that ether to Charlie, the order is not explicit. If the Ethereum transaction processors process the transaction from Bob to Charlie before the transaction from Alice to Bob, the transaction from Bob to Charlie could fail. Herein lies the root of long-term scalability issues of account-based systems. Without an explicit ordering, there is a need for some period of time to settle transactions or else one risks having linked transactions fail. The lack of an explicit ordering also makes techniques like parallelization (using multiple computers at once) of transaction processing extremely cumbersome. Difficulties implementing Ethereum 2.0, a continuously delayed scaling solution that seeks to use sharding to increase parallelization, demonstrate the inadequacy of the account-based model.
Beyond a lack of scalability, account based blockchains necessitate other user experience issues. As stated above, transactions can fail due to ordering issues, but in an open system where traffic is regulated through transaction fees, these fees cannot be returned for an invalid transaction. On Ethereum, where transaction fees have recently been seen at $3 and above, this means that miner discretion in transaction ordering can cause users to burn serious cash without having made any errors. Further, account-based systems cannot accommodate “zero-confirmation” the way a cash-based system can. In Bitcoin SV, transactions settle instantly without having to wait for any blocks containing that transaction to be added to the blockchain. This is because the order is explicit and miners follow the first-seen rule, meaning that the first transaction to spend certain coins is the one that will be used. Account based systems like Ethereum cannot replicate this because there is no explicit ordering, so the 10-20 second block time serves as an effective speed limit. Finally, because Ethereum anticipates more disagreements among miners (orphaned blocks), their protocol rewards these orphaned blocks to keep miners motivated. This makes the network less competitive and also makes ETH’s total supply uncertain.
In the blockchain space, activity is inherently tied to transactions. Accordingly, the network with the cheapest transaction costs will have a distinct advantage in the long-term. The inefficiencies of an account-based system will likely preclude any networks implementing these systems from being competitive with cash-like systems at scale. These account-based systems include legacy financial systems, Ethereum, XRP, Chainlink, BNB, EOS, Tezos, Polkadot, and most other blockchains that aren’t based directly on Bitcoin, like Bitcoin SV and Bitcoin Cash. Even BTC, through initiatives like replace by fee, has transitioned towards an account-based system from a user experience standpoint.
At Unbounded Capital, we believe that a commitment to scale is necessary for success in the blockchain space. The only network with a commitment to massive scale which can actually achieve it by being a cash-like system is Bitcoin SV (BSV). Ultimately, we believe that BSV’s performance, buoyed by its cash-like structure, will exceed the capabilities of legacy financial networks as well as all other blockchains by many orders of magnitude, at which point any business looking to integrate blockchain technology will have only one rational choice. Until then, we will see continued frustration across the industry as account-based systems repeatedly fail to deliver the necessary performance.
Special thanks to Brenton Gunning, founder of UC portfolio company Run, for his contributions to this piece.