Is There A Problem With Bitcoin’s Scalability?

First, let’s look at the facts. Counting the number of Bitcoin transactions per block is actually not trivial, as transactions themselves have different sizes. Large multisig transactions with multiple signatures and multiple public keys can be quite large, whereas Taproot transactions can be quite small with everything hidden under the hood. Transactions can have one input but multiple outputs; each extra output is essentially another payment to another party and the data size of an additional output is quite small.

With these multiple outputs, a single transaction can actually correspond to multiple payments, such as when a Bitcoin exchange makes a single transaction with multiple outputs to multiple customers. So, there’s a wide range of how many transactions you can actually fit inside a block. And the right unit of analysis is not the number of unique users per year, but simply the number of transactions. But regardless, there is a finite number of transactions on Bitcoin per year, and that number is less than the current world population. So, back to the original question: Is this a problem?

This is not a problem today, since even with ordinals and inscriptions, blocks are not always full. As the blocks start to fill up, the market will clear with higher transaction fees. These higher fees will perform the same role that congestion pricing plays on highways. High-value customers will be served, and low-value customers will not. This is efficient because the lower value customers simply do not have the willingness to pay the market price.

This leads to the classic debate between the engineer and the economist. Both see traffic on a highway. The engineer wants to build another road, but the economist wants to charge prices. If the objective is to serve the most users, then the engineer’s approach is correct. But this will not eliminate traffic; it will simply end up in an inevitable race to build more and more capacity, as more people will be tempted to drive as the costs are low. If instead the highway adopted congestion pricing, low-value users would substitute away from driving and into other forms of transportation, like walking or biking.

Taking this to Bitcoin touches the debate on the block sizes. Larger blocks will allow for more transactions per block, no question. More transaction volume will mean more individuals and institutions using Bitcoin, no question. But larger blocks also have a negative externality, in that they make the network less decentralized as it increases the cost of running a full node, slows network throughput, and will ultimately hurt Bitcoin’s decentralization. The block size wars fought these debates for years, and the small blockers won. (Read the "Block Size Wars" by Jonathan Bier for the full story.)

I see no problem with the economic solution, namely, higher transaction fees that will allow high-value customers to continue to transact on the chain. Given that consensus today is still for smaller blocks, this means that the major users of the blockchain in the future will likely be institutions. I predict Bitcoin will become a settlement layer between banks, with consumer use of Bitcoin shifted off-chain, either through Lightning or other Layer 2 innovations. The higher those transaction fees become, the greater the consumer demand for Layer 2 tech, and therefore the greater the incentive for entrepreneurs to meet that demand.

Those technologies are still working out their kinks, but I am optimistic that they will eventually handle all the consumer demand for Bitcoin off-chain, with the final settlement occurring on chain. This is still a massive improvement from today, since global settlement by financial institutions on an immutable, distributed, decentralized layer is still a vast improvement over the hot mess of the banks exchanging fiat currencies with each other today, and collecting vast rents in the process.

Not every human on earth needs to transact directly on chain for Bitcoin to have massive impact.