On Tuesday, finance minister Arun Jaitley chaired a meeting with multiple participants from the government on Bitcoins. It was not immediately clear what the agenda was, with a news report only saying that no decisions were taken.
But the fact that the meeting was attended by IT and telecom minister Ravi Shankar Prasad, NITI Aayog vice-chairman Arvind Panagariya, home secretary Rajiv Mehrishi, economic affairs secretary Tapan Ray, financial services secretary Anjuly Chib Duggal, among others, means the government is seriously looking at Bitcoins.
Not a day too early.
Less than five weeks from now — August 1 to be precise — a proposed protocol change in the Bitcoins system could upend the virtual currency universe setting off massive volatility. Though Bitcoins is tiny compared to real world currency, equity and bond markets, some of the volatility may even rub off on broader financial markets given the fungibility between real world and virtual currencies.
At the core of the coming storm is a feature improvement proposed to the Bitcoin system called BIP-148. Not all parties in the Bitcoin ecosystem are agreed on the new feature
At the core of the coming storm is a feature improvement proposed to the Bitcoin system called BIP-148. Not all parties in the Bitcoin ecosystem are agreed on the new feature leading to comparisons with the Y2K bug
that was predicted to shut down computer systems worldwide at the turn of the century. The transition from 31/12/1999 to 1/1/2000 went off without incident, however.
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Besides the unprecedented volatility predicted in Bitcoins in the weeks ahead, exchanges dealing in the virtual currency may be forced to go offline towards the end of July 2017 and there could also be a split in the Bitcoin universe, experts say.
“Right now there are a group of miners supporting this and there is another group not supporting this. Eventually if all of them do not unite, there is a chance that this will become like two different blockchains altogether,” says Sathvik Vishwanath, CEO and cofounder of Bitcoin exchange Unocoin. “Then, both will have different sets of transactions and each will maintain its own checks and balances.”
Besides the unprecedented volatility predicted in Bitcoins in the weeks ahead, exchanges dealing in the virtual currency may be forced to go offline towards the end of July 2017 and there could also be a split in the Bitcoin universe, experts say
In India, Bitcoins have been on the rise
since demonetisation. The cryptocurrency was on a bull run over the past couple of months with its price topping Rs 2 lakh for each BTC from about Rs 50,000 late last year — making it among the best performing financial asset classes. Even though the Bitcoin price is holding steady close to $2,400 per BTC, the virtual currency is very volatile and could crash suddenly like the crash of Ethereum, another cryptocurrency, last week
triggered by a fake news of its founder’s death.
A Bitcoin primer
If you are familiar with Bitcoins, dear reader, please skip the next six paragraphs that explain the virtual currency, how it works, the main actors in the Bitcoin universe, and the currency’s place in today’s world.
First, blockchains. Blockchain is a large, distributed and public ledger that stores records of transactions. Unlike current day, mother of truth, single ledgers, Blockchains are distributed in thousands of places and updated in real time making it as transparent.
Bitcoin is a blockchain-based virtual currency, also known as cryptocurrency, which is created and held electronically. Bitcoins are decentralised, meaning that it is not issued or managed by a central authority.
On purpose, the process of Bitcoin mining has been designed to be resource-intensive and requires brute computational power and electricity to power these systems. The difficulty in this process is to have a control over the number of Bitcoins mined
They are produced using a process called “Bitcoin mining” that involves adding transaction records to Bitcoin’s public ledger of past transactions records or its blockchain. Transactions are added to the block which in turn is added in a linear sequence to make up the blockchain, which is also used to confirm transactions to the rest of the network.
On purpose, the process of Bitcoin mining has been designed to be resource-intensive and requires brute computational power and electricity to power these systems. The difficulty in this process is to have a control over the number of Bitcoins mined.
Bitcoin is not the only popular cryptocurrency out there. Some of the other popular cryptocurrencies include Ethereum, Litecoin, Dogecoin, Dash and Ripple among others. With over $39 billion in market capitalisation, Bitcoin is the largest by that measure.
Today, China is the world leader when it comes to Bitcoin mining and controls a huge part of the Bitcoin network. Earlier this year, Bitcoin was accepted as a legal mode of payment in Japan. But the legality of it status is ambiguous in many countries including India.
Devil in the bit
Next, a little on the BIP-148 proposal, scheduled for a changeover on August 1.
Bitcoin Improvement Proposals (BIP) is a design document used to share proposed features or improvements to Bitcoin. The number 148 stands for the 148th proposal in the document.
Bitcoin Improvement Proposals is a design document used to share proposed features or improvements to Bitcoin. The number 148 stands for the 148th proposal in the document
According to the UASF Working Group
, a group of Bitcoin developers overseeing implementation, “BIP-148 is a UASF that is designed to cause the existing SegWit MASF deployment to cause activation in all existing SegWit capable node software (which currently is 80% of the network nodes).” UASF is short for User Activated Soft Fork, which is a change in blockchain protocol that invalidates previously valid blocks or transactions; this does not require a software upgrade among users as it is backwards compatible. MASF means Miner Activated Soft Fork, which is set off by Bitcoin miners. And, SegWit is “segregated witness”, which according to Investopedia, “is the process by which blocks on a blockchain are made smaller by removing signature data from Bitcoin transactions”.
What does this mean? The site says that, once BIP-148 is activated on August 1, miners will be required to signal readiness for SegWit. This, in turn, will cause all SegWit ready nodes, which make up over 80% of the Bitcoins network, to activate and begin enforcement of the new protocol.
the protocol do? The rationale behind BIP-148 is sound, even if it is a little Band Aid-like. One of the major issues the Bitcoin ecosystem is currently facing is a scalability problem due to the insufficient size of each block (which, to remind readers, is a transaction and blocks of Bitcoin transactions combined together to form the Blockchain).
Currently, each block has a size limit of 1 megabyte. With the growing number of Bitcoin users, the number of transactions is increasing at an exponential rate. This, in turn, is causing a slowdown in the Bitcoin system. Users have to wait hours — sometimes for days — for transactions to be confirmed because the number of transactions/blocks that have to be processed is spiking. With the current rate of growth in the Bitcoin user base, this problem is only going to get worse.
The site says that, once BIP-148 is activated on August 1, miners will be required to signal readiness for SegWit. This, in turn, will cause all SegWit ready nodes, which make up over 80% of the Bitcoins network, to activate and begin enforcement of the new protocol
Enter SegWit. SegWit was created, by the Bitcoin Core developers, a group that maintains and manages the Bitcoin codebase, as a solution primarily to this problem that the Bitcoin network faces. In simple terms, what SegWit does is that it skips witness data/signature in a transaction block. The witness or signature data will still be sent but it won’t be included within of the transaction. And, being a soft fork, SegWit will work even if some of the users don’t update their software to the newer version making implementation easier.
To be sure, there have been many successful soft forks — analogous to system upgrades on computers or smartphones — in the past like BIP-66
, which dealt with signature validation, and P2SH
that altered Bitcoins address formatting. BIP-148, by far, is the contentious protocol change with wide ramifications.
Band Aid protocol
Once BIP-148 and SegWit are activated, congestion and scalability problem will be solved, experts believe.
At least for now.
“The issue right now is that the number of transactions that can fit in a block on the blockchain for Bitcoin is very limited. It could be somewhere around 2,000 transactions or something like that and more than that is quite hard. Once BIP-148 is implemented it will enable more transactions to fit into the block and this will reduce congestion,” says Vishwanath of Unocoin.
But like many sceptics of the BIP-148 implementation, Vishwanath also feels that with the rate at which Bitcoin popularity and transactions are increasing, this implementation will only be a temporary solution. “At the rate at which Bitcoins are gaining popularity, just being able to fit in two times the number of transactions won’t be an improvement in the long run. We will be back to a similar situation maybe in another six to eight months when the number of transactions will increase,” he says. That’s also the reason many in the Bitcoin ecosystem aren’t falling behind BIP-148, he adds.
BIP-148 will also see a change in the transaction fee charged by miners but they will not be losing much as the volume of transactions should increase, according to the Unocoin CEO. Miners currently prioritise transactions where they are paid more to carry them through. With BIP-148 when transactions go through without much friction, that revenue will disappear, says Vishwanath. But, eventually, they will be compensated with the rise in volumes of transactions, he adds.
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Still, if the miners don’t agree to the transition, it could result in more than a hiccup. “When this protocol implementation happens, there is a possibility that miners who don’t switch to the new protocol will continue to mine the old coins which are not compliant with BIP-148,” says Benson Samuel, CTO and founder of Bitcoin exchange Coinsecure.
“We will have to wait and see what happens and whether the Bitcoin blockchain will stay as one or it will split. The chances of splitting are quite less. It looks like BIP-148 will fully get implemented” — Sathvik Vishwanath, CEO and cofounder, Unocoin
Vishwanath feels that the transition will go through. “We will have to wait and see what happens and whether the Bitcoin blockchain will stay as one or it will split. The chances of splitting are quite less. It looks like BIP-148 will fully get implemented.”
Another Bitcoin exchange, too, agrees that the two factions will come to a truce. “I personally don’t think there will be a fork going to happen, before that mid-July or close to end of July we’ll come to a conclusion. We will have a lot of news and fireworks happening before that but in the end, it will settle down is what we believe,” says Saurabh Agrawal, co-Founder of Bitcoin exchange ZebPay.
Rough seas ahead
Either way, market volatility is a given. Like any equity or commodity market, uncertainty brings volatility to the market. The Bitcoin market has been a bit volatile of late after its bull run. It is likely to get more volatile towards the middle of July as the date of BIP-148 implementation nears.
The number of people who want BIP-148 implemented is more than the people who do not, says Vishwanath. “Because there are people on either side there will be some market volatility because there is an uncertainty factor,” he says.
Agrawal of Zebpay says most even in the Bitcoin ecosystem know of the August 1 shift. “Nothing is happening now because the news is not so widely spread. I think it will start by 10th of July and that’s where you will see a lot of volatility,” he says.
Samuel of Unocoin sees an opportunity if the BIP-148 implementation goes through fine. “The volatility we see right now is not because of this but more of a normalisation in prices. After this implementation, the Bitcoin scalability doubles so we are expecting a positive volatility, he says, cautioning there will be “negative volatility” if something goes wrong.
Meanwhile, most exchanges are planning to halt transactions towards the end of July and resume functioning once there is more clarity in the markets post BIP-148 implementation.
Most exchanges are planning to halt transactions towards the end of July and resume functioning once there is more clarity in the markets post BIP-148 implementation
“In our case, around the July 30-31 night, we will be stopping all the transactions and will wait for two-three days for this whole to settle down. After that, we will decide which chain we want to support depending on what is the consensus,” says Agrawal of Zebpay.
Coinsecure also plans to stop transactions during the period of implementation and plans to support the dominant chain, in case there is a split when they resume operation. “We will most likely stop services on the 31st. After the implementation, once we identify which is the dominant chain, we will support that. We will only support the dominant chain and won’t be supporting the chain that is left behind,” says Samuel.
Vishwanath of Unocoin, on the other hand, feels that there is no need to halt transactions in case there is a unanimous decision on the implementation. “If a unanimous decision is taken then there is no need to stop transactions on the exchange but if the difference continues then maybe the exchanges will stop transactions for a day or two to figure out exactly which side has complete support. So if it’s like a 5% and 95% vote then we still need not halt but if it’s like a 60% and 40% vote we might have to halt.” (In an unrelated development, Unocoin has closed
its exchange over a security flaw.)
Users: Go offline
As a precaution, most experts are recommending that users ensure their Bitcoin transactions are completed and they take their Bitcoins off online exchanges and wallets before August 1.
“People who have Bitcoins should definitely move it out of exchanges and wallets completely. They should hold their private keys on their own servers until this entire thing happens” — Benson Samuel, CTO and founder of Coinsecure
“People who have Bitcoins should definitely move it out of exchanges and wallets completely. They should hold their private keys on their own servers until this entire thing happens. That way they themselves can decide what they want to do with the coins, whether they want to go with BIP-148 complaint Bitcoin or any other implementation of it. We will be notifying our customers about this over the week,” says Samuel.
Agrawal is also of the same opinion. He adds, “We are letting all our users know that if they want, they can take the Bitcoin out in their control in their own wallets which are not controlled by Zebpay. So, in that case when the fork happens they can decide which chain they want to continue with.”