Pensions

Many Governments around the world have huge pension liabilities. This is not limited to developed countries in the West but also developing countries such as China for example which has a huge ageing population and due to the one child policy of its past means the proportion of workers to retirees is set to increase. Even if economies grow as normal many of these liabilities are unplayable which is common knowledge. The conventional wisdom is there will be a huge drawn out economic crisis due to the drag of such future liabilities. Theories range from lack of workers, lack of money and lack of economic output to support such payouts. While I generally agree that many public and even some private sector final pension schemes will have to cut back I actually think pensions will be the new economic driving force in particular here in the UK where I live. After the recent pensions revolution I will explain why everyone should put money into one and why they will help transform economic growth.

Finally salary schemes, ones that have a fixed income at the end of the employment, are very rare now to any new employees. Instead many of us are now enrolled onto defined contributions schemes whereby you save during your working years and then at retirement draw down on that money. The former legacy pension is a drag on the economy the latter new style pension will help drive economic growth. There are huge advantages with saving into a defined benefit scheme but yet many people still don’t but as time goes on people will come to realise its benefits. Why are final schemes generally a drag on the economy for example many public sector pensions? The money to pay the pensioners come from current taxation in other words they are an expenditure that is not paid for by any form of prior savings. Companies who are still paying down their final benefit schemes can have a surplus for its pension fund however generally they are always in deficit and it costs the company a lot of money and can drag on a companies performance as they try to fill the gap. All of these have a cost in current economic growth. Its a similar story with state pensions, they amount to promises to pay in the future as the Government saves nothing upfront in advance to pay for it in a future date.

Why would a defined contribution, a new type of pension be any different? With my defined pension its based on real savings. I could leave that savings in cash but like many others it generally gets invested in equities, company stocks as over time I want to increase my pot above the rate of inflation so it increases in real terms. The stock market is a wonderful concept. What it essentially does is marry up two sets of interests. We have a bunch of people with spare capital and savings and who don’t know what to do with it. Then we have another set of people, the entrepreneurs and businesses that have all the ideas to meet consumer demands but don’t have the capital to deliver their ideas. The stock market therefore channels real savings into such ventures. These businesses create consumer goods we all use and love, that create wealth for us all in the form of new gadgets and products. As a bonus, as an investor, I get a return on my savings that not only beats inflation but grows in real terms above this over the long term (at least that has been the trend for the past 100 plus years).

The process I have described above creates lots of economic growth. Countries get rich by saving money along with a good dose of entrepreneurial ingenuity, that essentially is the secret recipe to wealth. All wealthy nations or nations that have grown at relatively fast rates have followed this process. Whether its Britain in the 19th Century, Germany and Japan during post World War 2 or China during the 1980’s through to the 2000’s. Without savings the entrepreneur can’t realise his vision or his idea therefore he needs to borrow it from others which is why savings are such a critical ingredient to economic growth. With defined benefit pensions people will save hundreds of thousands each as genuine savings which will get lent out to businesses. In the past this never happened this is why I believe over the next 10–20 years economic growth will actually pick up at some point and get out of the recent stagnant growth of the past 10 years. People are slowly beginning to save and once people realise the benefits of the new UK pension benefits which I will highlight later people will become net savers. It may seem bonkers now where a good majority of people live paycheck to paycheck but I believe more people will look at savings and see others do it.

Some people may disagree in the ability to save hundreds of thousands of pounds and believe that most people will never be able to save that much. Its probably because they have never heard of compound interest. To accumulate sums of money you don’t need to save huge amounts you just need time. The earlier the save the more money you are able to accumulate in your pension. I’m a person who likes numbers and facts to do the talking so I have put together some numbers here. Click the link but to summarise some of the numbers I have assumed a 7% growth rate. There is various literature on why you can assume this if invested in equities, indexes like the S&P 500 the main index in the US has returned 8–9% for any 20–30 year period even during periods of serious bear markets. This return is not equal every year, some years you will get higher returns, some years you will get losses but over the long term this is what the returns even out to. In the sheet titled “Saves in 20's” the person saves £2,500 per year for 10 years during their 20’s. Now with 20% tax relief actually the sum needed is less (I’ll get onto tax relief later). Yet at age 70 the time the person would get state pension they have amassed a pot well over £500K, in effect turning £25K into half a million pounds. Thats the power of compounding. Playing with the percentages can have a dramatic effect on this. If you raise the rate of return to 9% then you will be a millionaire. Think you can’t get 9% return? Well historically thats what the S&P 500 has done. Some indexes return double digit over the long term. The FTSE mid Cap has returned over 14% for the past 60 years, the NUMIS NSCI which is a small cap index is over 15%. Rate of return is vitally important. For any young people out there they should be 100% in equities with some tilt towards aggressive smaller cap indexes.

There are three vital components to generating a pension. First you have to save. If you don’t put any money in then you will never get a pension pot built up. Second you need real rates of returns and assets with a long track record such as putting your money to work in equities. Third you need to time. Time is crucial. One of the best times to save for your future is as soon as your born. The best time is actually before you are even born. This is obviously impossible unless you have parents that have the foresight to do this on your behalf. For others your 20’s are a great time to start. On another worksheet “Save 30’s-50s” this person saves nothing during their 20’s however saves throughout their 30’s, 40’s and 50’s again £2,500 each year. Over 30 years they save £75K therefore three times as much as the person in their 20’s in the previous example. This is where time comes into play along with compound returns. Despite saving far more they never actually catch up to the person who saved in their 20’s. In reality the person in their 20’s would continue saving and would have around double the money of the other person who failed to start early. For the price of an extra £25K during your 20’s amounts to £500K when you turn 70. No wonder compound interest is described as the 8th Wonder of the World.

In the examples above the sums involved were quite modest. For anyone thinking they can’t save that then I beg to differ. For example if you buy a couple of coffees every day at £2.50 each and apply 20% tax relief then thats £2,190 there. Take your own sandwiches to work and you can more then save £2,500 per year and even more. Then numbers above don’t take into account pay rises over time, or even a more aggressive growth rate depending on the funds you pick and the charges on your account. Up the growth rate to 9% and you will have nearly £2.5M at 70 by just paying in a total of £100K (actually with 20% tax relief its £80K, even more if you become a 40% tax payer). 2% extra returns may sound trivial but over time with large sums the differences involved are millions.

The great thing about all of this is it encourages people to become savers which in turn drives economic growth. In old age people become self sufficient being able to support themselves. There are a number of other benefits with pensions in the UK.

Tax Relief

As mentioned if you work and pay taxes you get tax relief. In other words if you are a 20% tax payer then your pension payments come out of your pay cheque before taxes therefore giving you instantly 20% free. Even if you don’t earn money the Government will top up payments upto around £3K. If you are lucky enough to be a 40% tax payer then you in effect get 40% free money for your payments. Along with this many employers match your payments to various amounts. For example my employer will match me up to 6% of my salary. If I was to match this then then I put in 6% and get double money. Being a 40% tax payer means I only pay 3–4% but yet in total I’m saving 12%. Its literally free money. 40% tax relief may get pulled at some point in the future so best use it now.

Tax Free Gains

All gains inside a pension are tax free. You only pay taxes once you draw money out of a pension at your income tax level.

25% Lump Sum

Once you decide to take your pension you can take up to 25% of it tax free to do as you please. You get tax relief on the way in and on the way out. More free money. If you are prudent with money then you would be a fool not to take up this feature and take out the full 25%.

You don’t need to buy an Annuity

In the past everyone was forced to buy an annuity whereby you would trade in the value of your money to another company and they would give you a fixed income for the rest of the life. The catch is you gave up that pot of money. Now you can manage it yourself and pass it onto future generations. If you keep the majority of it in good returning assets for example stocks then you can extract 4% safely for life and pass on basically the whole pot to others (the 4% draw down rule is a highly interesting topic that you should explore).

Outside Inheritance Tax

With the recent pensions revolution should you not choose to buy an annuity, then the remaining balance can be inherited by your Children outside of your estate. Whatever you don’t draw down gets passed to your spouse completely tax free also and they can use it just like you would. Its a game changer that allows families in the UK to provide pensions for successive generations.

With all the above benefits it amazes me that people are still not saving. Some common objections are “you can’t spend it when you are dead”. True, you could die tomorrow and you would have missed all the consumption you could have done today with the money. However as a father of three if I was to die tomorrow then I would have done everything I could to leave a financial support for my family which is better than the worry of no money and living paycheck to paycheck. In short I would be glad I had made those short term sacrifices. Another objection is “I won’t be rich until I’m dead”. Many people live into their 70’s, 80’s even their 90’s. With the examples given earlier the savings may provide you for 30 years to live comfortably. Why not do it? Again you could die tomorrow but if you have dependants then you have left them in as good financial condition as you could have. Some would say “I don’t want to invest in volatile assets that could go down” I would say why does it matter when you are not going to touch the money for 30 years. Volatility is your friend. Warren Buffet puts volatility brilliantly, bonds on the other hand, seemingly stable assets, are laden with risk:

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power — after taxes have been paid on nominal gains — in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date. 

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk. 

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge. 

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control. 

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.” 

For tax-paying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human. 

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments — and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Equities are your pensions friend. Embrace volatility, I only invest in volatile assets. I am an investor in Bitcoin, I wouldn’t recommend you put your pension there or invest in it at this current time but returns of $100 to $75 million in 7 years is impressive returns, in fact historic returns. The volatility on it is crazy but you buy and hold and don’t care about short term moves. Goes down 10–20% in a day, ignore it, that’s a good thing. Your pension could fall 50% in year, ignore it, it will come back and more over the long run and will give you significant gains in real terms, this is the trick to investing getting real term returns as Warren Buffet states. Pensions are not some boring discussion with men in suits. They could change you and your families life. As the Chinese saying goes “The best time to plant a tree was 20 years ago. The next best time is now”.

Tory Majority - Again?

I only have time for a quick post on this before the voting closes. Despite the polls getting closer I believe the Tories will get a comfortable majority. See my 2015 post for similar reasons. After the 1945 Labour Government, Britain has never voted again for a left of centre political party. Harold Wilson and Tony Blair had to go to the right to get into power. I see no different in this election despite the recent upsets we have seen with Brexit and Trump. Corbyn is too left wing to win. Expect the next Labour leader to be more right leaning.

Bitcoins Stagnation

I first discovered Bitcoin back in mid 2012. Around 2014 I lost interest primarily because of the block size debate that was on-going at the time (it had begun years before 2014). I could see the community fracturing so decided to leave it alone and let it all play out. 18–24 months later I decided to revisit Bitcoin as there had been an increase of articles in the news mentioning its recent price rises. To my wonder the block size debate had barely moved on and the hard coded 1MB block limit was still in place. I believe many still involved with Bitcoin are thinking with their heart rather than their head. They like to say everything is still rosy as they have dedicated their lives to the technology. This article is from the head which I think many in the community need to hear. Not all is doom and later I discuss why I am still optimistic about the technology and how a few individuals are trying to reverse the current stagnation.

I’ve decided to write this as to me Bitcoin has not progressed as it should have. Back in 2013 I used to tell all sorts of people about it, show them it, tell them how it was going to be used by everyone and change the world. Now in 2017 I wouldn’t bother. Rather then telling them to buy some (with the caveat “only put in what you can afford to loose”) I would now tell them to stay clear. Why this sudden change? For me the current block size is holding Bitcoin back.

There are reasons for keeping the block size at 1MB and there are reasons for increasing it. What I think is that on chain and off chain scaling should be occurring simultaneously. However many are capping the 1MB block size in my opinion for an artificial period of time. Some say Bitcoins best feature is its decentralisation, the common argument used for taking no action. If we raise the block size it may reduce miners profitability is another. Security may be compromised. All are usual talking points, however I will try to tackle many of these objections. In reality all take second place to the most important goal of Bitcoin, going mainstream. The whole point of Bitcoin is to be a global currency that everyone can use. I will explain why users are the most important goal of bitcoin and on chain transactions, the blockchain, is what will get more people involved in the ecosystem. By not allowing the block size to increase in line with technological advancements Bitcoin has become a stagnant technology.

Bitcoins Recent Price

The first thing I have noticed since re-entering the space is the community raving about the recent price rises. I would argue what price rises? Back in late 2013 the price was over $1,000. Its only just hit that price recently more than 3 years later and only for period of a few days. For a technology that should be growing at an exponential rate its price should have risen rapidly however the price shows how far Bitcoin has fallen. The fact that people live, breath and sleep Bitcoin and think the current price is good shows how disconnected they have become from reality and let me explain. There’s been a halving in 2016, India and China have had currency meltdowns with combined populations of around 2.5 Billion people and people think Bitcoins price of $1,000 is a success? Back in early 2012-13 the price rocketed from around $15 to well over $200 when the last halving occurred (halving was the backend of 2012) and when a small island called Cyprus had banking issues. Later that year it continued rising after mild interest from China and others to over $1,000. Some think getting back to that level after 3 years is a sign that Bitcoin is strong. I think people have lost sight of Bitcoins price potential, 3 years on it should have been at the very least hovering around the $5,000 mark, albeit it with lots of volatility. The fact that its struggling to stay at $1,000 confirms the fact that Bitcoin has not picked up any new users (in fact its been driving them away). Now Bitcoin may well gain some more value, it may rise in a linear fashion, possibly more with a financial crisis however in comparison if on chain transactions were allowed to scale this will be far short of its true exponential potential.

Why is price important? Bitcoin is a currency and its price signals its utility. Nothing did more to promote Bitcoin then when its price went from pennies to over $1,000 in the space of a few years. It brought in entrepreneurs and venture capital that made it easier to use, new wallet services which in turn brought in new users. All these factors are vital to grow an ecosystem which is needed in order to bootstrap Bitcoin. Once the majority of people use Bitcoin then everyone has a vested interest in making it succeed. 2016 saw a slow down in venture capital and businesses like Circle have turned their backs. Since revisiting Bitcoin I’ve seen no new innovations to make Bitcoin easier to use targeting to reach the average consumer. I remember when Circle came out with their wallet and thought it was brilliant; I could sell this to my parents. I know what the hardcore among us will say. Bitcoin is all about owning your own keys. In reality some people will use Bitcoin like this but to go mainstream most users are not going to want to handle their own keys they will want services like Circle making it easy to use. I’m a software developer, I store my funds with my own keys. But I completely get it that most people will not want to do that. The fact that people in Bitcoin are saying good riddance to Circle or saying Bitcoin is more resilient than one company are missing the point, indeed have become highly isolated in their gated community. People have lost the goal that Satoshi had of Bitcoin, that EVERYONE should be a user in the ecosystem. By driving such companies away they are moving back in time to 2011–2012.

Centralisation vs Decentralisation

One of the central arguments against increasing the Block Size is that it will lead to greater centralisation. Again I think people have lost sight of the overall picture and as someone that is more detached perhaps I can shed more light on this area. For years now mining has been centralised in a select number of pools long before we even hit the current 1MB block ceiling. Ever since the evolution from CPU, GPU then to ASIC mining, it has become more centralised and specialised and so it should. This romantic notion that miners should run on peoples laptops and be completely decentralised is nonsense. The current pool quasi-centralisation is not a bad thing (and by that I mean new pools can form and open as required if others are shut down). People mine with specific hardware whose sole purpose is to mine Bitcoin. All this equipment is not cheap and is practically useless for anything else. This means miners are even more incentivised to be honest on the network and ensure Bitcoin remains sound for as long as possible. For anyone to make an attack means spending millions of dollars on equipment for the right to change only the most recent transactions on the network while simultaneously risking crashing the price as Bitcoins trust model is compromised, thus they get no ROI for the initial outlay of all their equipment. Contrast this with the early days of CPU mining which is actually far more insecure, for example someone could mount an attack using general purpose computers. I could co-ordinate with a number of malicious users over the internet all with our own laptops to attack the network in tandem. In this situation the initial outlay is nothing except a bit of electricity. My point is the recent centralisation into a few pools has actually made the network more secure and robust to attack and all these alt-coins focusing on CPU mining algorithms are missing this key point. So how would increasing the block size centralise Bitcoin any more then what it already is? It wouldn’t, a few large pools would continue to operate, pools would come and go based on market forces. As Bitcoin Unlimited has proposed, if miners could set the block size then this would change in line with hardware limits.

What about Government censorship, with the current centralised pools its easier to shut down bitcoin? First of all this problem already exists with the current cap. Second Bitcoin is global and it would require some form of global government action which wouldn’t happen. Three, and this is the key point, if specialised ASIC mining pools were all shut down simultaneously then we would just revert back to home GPU mining. Using a model like Bitcoin Unlimited the block size would self adjust to home broadband levels.

The decentralised debate also misses the key point in Bitcoin. Just like how it operates now, it doesn’t need to be hugely decentralised. In fact it’s in Bitcoins interest to keep centralised mining in the hands of a few in order to scale the network and reach more people. Bitcoins strength is the fact it has the capability of decentralisation baked in from the start. If centralised mining pools can be compromised (just like now) then people boot up their laptops behind tor and Governments can’t do squat. Governments can’t shut down a single company because there is none. They can’t arrest a CEO because there isn’t one. Nodes can enter the network as needed in the most extreme case of censorship. Again we miss the larger picture. Bitcoins decentralised design is there in order to bootstrap the currency otherwise Governments would shut it down as they have in the past with prior centralised currencies. Once you get the user base and everyone is using it then you don’t need decentralisation as much, all you need is all actors working to the original protocol. Once everyone is using it then Governments will not be able to shut it down as people will derive so much utility from it that even Government officials will have their wealth tied up in it. Its the mere threat and the in-built feature of decentralisation that keeps the system robust from attack. Censorship is in fact easier now when no one is using Bitcoin. The best way to secure Bitcoin is to go mainstream, once jobs and everyone’s money is tied to it then it becomes politically a lot harder to get rid of.

Transaction Fees

There appears to be a worry that we need to already start thinking about how Bitcoin will run when the Block reward dies out. For one that isn’t going to happen in any of our lifetimes so we don’t have to worry about it for decades. Two, if Bitcoin is gaining in value then the money just from the block reward alone is more than enough to run a large scale network. The current theory is that because the blocks are full and people have to compete for space, thus driving up transaction fees, that this is giving extra money to the miners and is healthy. I would argue the opposite. As Bitcoin has stagnated this in turn has meant the price for a Bitcoin is far less then what it should be, as mentioned user adoption has stagnated even gone backwards for the past 3 years. This in turn has meant mining has not been able to grow as much as an industry. Smaller blocks are stopping Bitcoin from growing thus depriving miners from more funds as Bitcoins price is far below its true potential.

The more crucial point that is missed in the transaction fee debate is what if they are never needed or only need to be paid by premium users? I remember getting my first email account back in the 90’s. Back then you had to pay for email even though there was a cap of 1MB storage (for extra you could have 10MB, I remember thinking at the time who would need 10MB for their emails?). You could only use it on a single home computer and had to use specific software and everyone I knew except for one friend, didn’t have it. Now many of us don’t pay for email accounts and get GB’s of storage, never having to delete any of our emails. Back in the 90’s this would have been inconceivable at the time but somehow the market did the impossible and gave most us a free lunch (as markets do on a regular basis). The point I’m trying to make is once you have half the world using Bitcoin, including all the big banks and existing financial infrastructure then everyone has a vested interest in keeping the network going. Banks may run nodes just to keep their own business models going. Just like Google who give emails away for free, businesses may opt to do this with blockchain transactions making money on their premium services layered on top of the Blockchain. As for Bitcoins early adopter phase, transactions should be as close to zero as possible and miners will be able to earn lots of money from block rewards alone. By having zero fees, I can sell this to the skeptical 98% of people, the mainstream. Having dollar fees for trivial amounts, I can’t. Whilst we have scarce block space and for a more detailed discussion of why increasing the block size does not remove the transaction fee market see the following whitepaper by Peter Rizun.

An argument for the current direction of Bitcoin in avoiding increases to the block size and focusing on off chain transactions is if we just scale on chain then we don’t see innovation for off chain technologies. However the same could be said with the current direction. By preventing Bitcoin from gaining mainstream adoption and scaling on chain we are missing out on all the extra venture capital and entrepreneurs entering the space and coming up with novel ways to run the Blockchain for next to no costs. The blockchain is just a large file and is only GB’s in size. Companies are already scaling filesystems in not just terrabytes or petabytes but now to exabytes (they are even talking about zetabytes in the near future). We miss out on innovations to scale on chain transactions, Bitcoins true selling point. People could work on novel ways to prune the blockchain, compress it over time, ways to copy it, even distribute it more efficiently; indeed hardware and software would be improved to scale it. We miss a lot of innovation as on chain transactions are not been allowed to increase (later I will mention a group of people in Bitcoin Unlimited and other projects who are doing a lot of good work to scale on chain transactions).

The Blockchain is the Disruption

I’m completely puzzled by the current direction of development in Bitcoin Core. Their plan is to cap on chain transactions (as mentioned the very selling feature of Bitcoin) in favour for off chain transactions. This is before we have even tried to scale on chain and before Bitcoin has hit any form of adoption curve. Off chain transactions are exactly what the existing banking infrastructure does today. Many state that they don’t want Bitcoin to become a payment processor like paypal or visa, yet ironically by stopping on chain transactions and by opting first for off chain is exactly what they are doing to Bitcoin. The Blockchain is Bitcoins true innovation and attraction, instead we are leaving it to stagnate.

Some argue we need to come up with off scale solutions now as the Blockchain will have a limit. I absolutely agree but we don’t know what that limit is. Again if the Blockchain can go to to 4MB or 8MB then thats 4x — 8x growth. That’s more users, more venture capital, more businesses all discovering Bitcoin, driving the price up, creating more buzz, creating faster innovation and further improving the scaling of the network. Once we hit a block limit as dictated by current hardware capacity then we can use transactions fees to limit transactions and think about off chain transactions. Then we continue to innovate to fit more on chain.

Even before the current 1MB limit was hit, exchanges and wallets were already doing off chain transactions. If two customers of Coinbase transferred money to one another then Coinbase would ledger that on their own internal systems. Likewise if Bitcoin went mainstream then traditional banks could use their own ledgers. Users could then still have their own private Blockchain address that they would manage and ask the bank once a month to settle a percentage of their account back on chain, therefore using off chain transactions for day to day items. As we can’t scale Bitcoin on chain then how can I or others sell this to a normal person? If from the early adopter stage I mention this thing called a Blockchain when the direction is to move transaction off chain, how exactly is this different to what they do with their pay pal account today? Most people could not see the benefit.

Segwit and Lighting

To top it off and to add to the puzzlement two solutions are touted as the alternative to raising the block size but in my opinion are just classic over engineering. Segwit has been delayed for months, is a series of complicated changes that has effected pretty much the whole code base introducing complexity that in my view is not needed. The result is in effect a block size increase of 1.6 - 2MB (to add to it all it may not even get activated as quite a few people rightly have concerns over it). As a software developer I understand that complexity of software can add up very quickly. The whole point of Bitcoin is to handle monetary transactions and do that one job very well and as simple as possible so as to not risk bugs or cause extra costs in maintenance. Yet Segwit goes against that, it reminds me of software developers that I have worked with in the past. Instead of doing a simple change i.e. raising the block size limit they come up with an exotic, elaborate change that in fact causes more issues in the long run and ultimately doesn’t fix anything. Once we scaled to 100MB blocks and had hundreds of millions of users on the system something like segwit would have been worth pursuing but not at this stage in Bitcoins evolution. It doesn’t even solve the current scaling issues.

The other theoretical solution is the lightening network to carry out the off chain transactions. Two years ago it was an idea and by the looks of it, it still is (despite recent alpha announcements). The proposal is to have transactions in off chain transactions that will somehow be trusted. Again we go back to off chains being just like the old banking infrastructure today. These off chain payment channels still rely on broadcasting back to the Blockchain. If we already have congested blocks then how is Lightening even going to work? The transaction fees and intermittent nature will still be present as these channels will only scale so far and we would still need to figure out how to scale on chain. Lightening just seems like a complex theoretical model when in fact off chain should be simple. If we go back to my Coinbase example it can just be on a central database. Various payment providers keep track of their own ledgers, in fact this is what banks do today the technology is already there. Users could choose to have a Bitcoin account with say a mainstream bank like Barclays. Most of their transactions occur off chain on ledgers just like today. Then the user may demand once their balance reaches a certain point to automatically post a set amount to a private bitcoin address they own. They may choose just to use a bank to handle their bitcoin. Remember Bitcoin can meet everyone’s need. People can still use their paper wallets (I have a couple) but for 99.9% of people they will want a bank to manage their Bitcoin.

So not only is all the above both in my opinion unnecessary and complex but how the heck am I going to explain Bitcoin to others? It was hard enough when there was just the Blockchain with terms such as distributed consensus and miners and digital wallets (and I had to pray they didn’t ask what wallets were and if there were coins). Now I’ve got to explain these exotic off chain solutions on top of all that. To me its almost like people are working on ways to make Bitcoin more complicated and in the long run make it more unpopular.

P2P Payment Scaling Limitations

Some may accuse me of not covering the scaling limitations or that running a peer to peer computer system where all nodes in the architecture are essentially duplicating the work of one another is hard to scale. In traditional data centers requests are divided between a number of nodes all executing concurrently on different servers that are co-located. To scale you just add more nodes and ideally they scale in a linear fashion. Bitcoins P2P nature puts it at a disadvantage as all nodes must validate, process and broadcast their work to one another. The big problem Bitcoin faces is to broadcast blocks when they are confirmed by miners. However some in the community appear to have decided that due to this architecture that we can’t scale it at all without even trying first.

When someone says we can’t increase the block size from 1MB then ask them what size it should be? Is 1MB currently too large and puts at risk decentralisation? Maybe we should have had the limit set at 500KB (as we know Bitcoin was fine going past that limit and we would have lost out on gaining more users and acceptance). What about 2MB? Where is the mathematical proof for an optimum value? The block size should not be some hard coded arbitrary value it should be given to the miners in order to determine what the optimum value is they can tolerate and still be profitable.

There are developers and researchers who have set out to improve and scale the Blockchain using engineering and rigor. One such innovation proposed is Xthin block propagation. Rather than once a block has been discovered and broadcasting the whole block contents to all the nodes, it instead relies on the fact that many nodes already have many of the current latest transactions in their mem pool. Nodes in the network take this into account and broadcast only a subset of the block thus propagating messages far quicker in order to get the reward. When tested against the Great Firewall of China, the results are very impressive. Once a block has been discovered the miner then needs to validate it which can take a lot of processing time in which the node can no longer propagate further transactions. Xpress Validation is an attempt to solve this problem. Again it works on the premise that the node will have already validated existing transactions in its mem pool. So it re-uses this cached knowledge to only re-validate any new transactions that come in on the newly discovered block. Both of these are actually under test and contained in a forked Bitcoin client called Bitcoin Ultimate. There is also an interesting whitepaper proposal called sub-chains. Again the idea is to speed up the transaction verification process by essentially breaking blocks down into smaller sub-chains, it’s purpose is to increase block propagation to ensure quicker confirmations and reduce orphan blocks. The point is there are ways to scale Bitcoin we just need to use engineering to fix them.

Can we store all financial transactions?

There is a rationale that the Blockchain will never be able to scale to meet all transactions that people want to perform therefore we shouldn’t bother to scale it at all. Its quite the straw-man argument for a number of reasons. One, if we accept this premise then why didn’t we just stick to a limit of 500KB or 250KB? If it will never scale then why did we bother raising it in the past. And the answer is even if we could only scale it to 2MB or 3MB then why would we not do it? This helps bring more users onto the system, more interest and investment and so on. Can you imagine if pay pal had this attitude? In their early days they may have had a maximum limit of 5 transactions per second and decided that their product would be so widely used that there was no point in scaling it as they would never be able to keep up with future demand. Of course this didn’t happen at some point saturation hits in and with pay pal I don’t have the exact figures but I believe its around 45–50 tps today and they were able to scale to meet this point. Even with Bitcoin if it does reach full market saturation one day, for the 7 billion people around the world there will be a drop off point. We can only make so many transactions, we have to sleep, eat, we do other things in our lives then just make financial transactions. Lets say for example that Bitcoin only ever gets 100,000 tps and after that never gains any more due to market saturation and people using other platforms (for example off chain transaction may be far more cheaper thus take the micro-transaction market). We may not hit those figures for 20 years and over this period there would be a gradual increase in transactions.

Currently with 1MB blocks Bitcoin can deal with 3 tps so every 10 minutes on average it can process 1,800 transactions. Very basic calculations would mean that 100,000 transactions would require 55 MB/s connection, actually faster in order to keep up with lag, multiple nodes and so on. That may seem like an unattainable number however already on domestic connections here in the UK they can handle 200Mbs which is 25MB/s (for £40 a month). Commercial connections exceed that. 20 years ago the fastest domestic connection you could get was around 128Kbs. Today its over 1000 times faster. In another 20 years domestic connections could be 200Gbs, 25GB/s far more than required for the 100,000 tps. If that seems unbelievable than 20 years ago 200Mbs was not being dreamed of. I remember hearing about commercial lines running at 1Mbs which I thought you would never need faster than that. With more data streaming through the internet all the time, speeds will keep getting faster. The global population is not increasing at exponential rates meanwhile as the years go on technology continues advancing at exponential rates. If people can only ever make so many financial transactions in their day to day lives but technology keeps advancing at exponential rates then won’t those lines cross and technology will surpass our Blockchain transaction requirements? In 50 or 100 years time can we imagine how much bandwidth will be available? Over time the only real technological limiting factor is the speed of light. Along with further investigation in how to make Blockchains more efficient who knows how far we can scale it? We will only know when we start trying. As mentioned mining will become more and more professional so scaling will get ever more attainable. Allowing scaling on chain is a critical path to take in order for these innovations to take place.

Bitcoin Codebase

The current core developers have their own reasons for making their current decisions. However I find if quite odd that they have become more conservative then the current banking system in terms of innovation as the block size limit is holding this back. With my bricks and mortar bank I’ve since got a contact-less bank card and more internet banking services making it easier to use yet Bitcoin has progressed very little in terms of usability, if at all (thus widening the gulf). I am a Java Software developer by trade (I also use a wide variety of other languages and technologies) however I’m not a C++ developer or a cryptographic expert so can’t fully comment on Bitcoins code but similar principles apply. After having a quick glance over the Bitcoin code I think core are being quite manipulative by giving the impression that no one else can read or maintain it. I work for a commercial company and have to work with millions of lines of Java, Python, Nodejs, Ansible, Javascript and Groovy lines of code (to name just a few languages). I decided to pull the Bitcoin code from github into my Intellij IDE and did a statistical analysis of it. As of writing there was around 393,000 lines, of which some files were README’s etc. I then went to some of the projects I deal with in my day job. A recent AWS microservices project that a few of us started on the side last year already contains over 100,000 lines. Our legacy microservices has over 2.5 million lines of code. One of our tomcat applications (of which we have several) has over 500,000 lines of code, that one alone beats Bitcoin. Our team consists of around 12 full time members. Now I’m not saying lines of code is the be all, Bitcoins peer to peer network is very complex and I can imagine very hard to write reliable code for, nor am I saying that I’m a rock star developer however there are thousands of talented software developers out there who have to work with code bases that are millions of lines in total and quite often they didn’t write the original code. As Andrew Stone one of Bitcoin Unlimited developers put it in a recent post, Bitcoin developers are not Gods. Core at the end of the day did not even write the original code base and inherited it from Satoshi. Many in the Bitcoin community have had the wool pulled over their eyes as they are not Software Developers thus blindly believed Core in everything they have said regarding the block size debate and have even praised them, blindly following them like some sort of deity. At the end of the day Bitcoin is just a code base.

Blockstream Controversy

There have been a number of theories and even conspiracy theories linked to the Bitcoin company Blockstream where a number of its developers are involved in Bitcoin core. All I will say is there is quite clearly a conflict of interest. Blockstream have received millions of dollars in investment where their business model is to make money from off chain transactions. This is quite clearly a conflict of interest and have avoided scaling on chain. It’s odd that many early adopters of Bitcoin ignore this conflict and quite readily submit to their authority. These are the same people who bemoan the Federal Reserve or other privileged financial institutions yet can not see the contradiction in their current views towards Bitcoin Core, who have become the Federal Reserve in Crypto Currencies.

Why I got into Bitcoin

I like many others got into Bitcoin because of the Blockchain. I didn’t go out and buy some back in 2012 because I thought it was safe. I put skin in the game to take risks and like many others because I want to help change the world. I told people about it, gave them wallets, showed them what it did and how it was going to evolve. Back then I didn’t sign up for a tiny Blockchain where it will become so expensive to use that only large corporations will be able to afford to use it and the rest of us would work off chain. Why, because that’s called the existing banking system, the very system Satoshi wanted to disrupt, not replicate. If we scale blocks and break bitcoin then so be it. I like many others would loose money but at least we tried something different, we tried to change the world rather than copy existing systems. We would then at least know that Bitcoin was a nice experiment that’s probably not going to supplant gold and the traditional banking system instead remain as a niche service.

Multiple Options is Bitcoins Destiny

Bitcoins very design is decentralised in nature yet the community can’t agree on the block size to use and the decision of this is currently centralised in the hands of a few developers. That is not right and needs to change. To adhere to Bitcoins philosophy there needs to be a fork or an alt-coin or an alternative Bitcoin Client in order to resolve the current dispute. I believe an alternative client will either force core to scale the block size or another client will take market share. Bitcoin Unlimited may do that. It certainly makes sense to allow the miners i.e. market forces to determine what block size can be supported based on hardware constraints. I hope they succeed but even if they don’t there will be other attempts to challenge the current direction of Bitcoins development.

Despite all that I have written I still remain optimistic about Bitcoin. I believe that there is a growing discontent over the current artificial block size limit and that more and more people are going to realise this over time. Bitcoin was started by one person so all it takes is one person to start another movement and the market will choose what best serves consumers. Eventually market forces will play out and the block size will increase and we will see all the magic come back into the community once more. The price will go parabolic, billions of venture capital money will pour in and some of the brightest minds will once again enter the space. I really like what the Bitcoin Unlimited developers/community are doing and I think they are doing invaluable work for the ecosystem. Its good to know there are other people out there who understand where Bitcoin needs to go and it has kept me optimistic about the future of the technology.

I remember when Mike Hearn said “Bitcoin is Dead” many dismissed it as another one of those doomsday predictions we are all so familiar with. However I could understand the sentiment at the time and from such a prominent member of the community I don’t think Mike Hearn really thought it was dead per se he was probably like me, frustrated at the direction and knew if Bitcoin was not allowed to scale it would never enter the mainstream thus would either be a failure or stay as a niche product. It was more like a parting shot to indicate until the block size is raised Bitcoin is going no where. Like me, I bet he still believes in Bitcoin. Only time will tell when other people start to realise that on chain transactions must be scaled.

Posts at Medium

Just a quick note that I will also be posting at medium here. I will replicate posts here also but I've been reading more and more there so I thought why not? My first post is already posted there in advance called Bitcoins Stagnation. Its an in depth look at the current state of the Bitcoin ecosystem and my thoughts on where it needs to go.