Brought to you by the Liquid team to help you make sense of crypto.
One of the most frequently discussed terms in the cryptocurrency community over the past few years has been SegWit.
In this article, we'll look at what SegWit is, why and how it came to be, and its role in the cryptocurrency marketplace.
The basics of SegWit
SegWit = Segregated Witness
SegWit was implemented into the Bitcoin blockchain in August of 2017 – and it has had a major impact on Bitcoin and the broader cryptocurrency marketplace.
One of the major results of the implementation of SegWit was that a group of developers – who disagreed with the plan – created a hard fork in the Bitcoin blockchain and formed a new cryptocurrency, Bitcoin Cash, which also launched in August 2017.
Blockchain networks allow individuals to execute transactions between one another without the aid of a third party.
They do this by employing public key cryptography.
A user on the blockchain has a public and private key, and combining the two keys creates a digital signature, which verifies the user’s identity when making a transaction.
Transactions on the blockchain are executed when Person A attaches transaction data to Person B’s public key.
Person A uses his private key to form his digital signature and complete the transaction.
Blockchain networks have systems related to the network, and every time a transaction occurs, the transaction and its related information is communicated to every system and user on the network, which creates a distributed ledger: a public record of all transactions on the network for all users to see.
Once the transaction is recorded in the network, users on the blockchain confirm the transaction—the individual’s digital signature and the transaction data—and the block is added to the network.
The problem with this process is that the creation and verification of blocks requires significant data.
The generation of the digital signature consumes the majority of the data in a transaction – about 65%.
This data usage issue posed a unique problem for Bitcoin, because blocks on the Bitcoin blockchain were limited to only 1MB of space.
As more and more transactions occurred on the blockchain, all those blocks were adding up.
In the past few years, as the number of users on the Bitcoin blockchain have increased and other blockchains – alternatives to Bitcoin – have launched, this size limitation became an increasing issue for Bitcoin.
Because the blocks on the chain couldn’t be larger than 1MB, there were significant limitations in the frequency of transactions that could be processed on the blockchain – only about one every seven seconds.
This would limit Bitcoin’s scalability and its potential as a high-volume payment system.
Another issue in the Bitcoin blockchain was malleability.
Malleability allowed users on the blockchain to slightly alter the details of the transaction ID before the transaction was confirmed on the network.
This did not pose a significant problem for Bitcoin, but it did prevent the network from implementing smart contracts.
As the Ethereum network has gained attention and value – particularly because it enables smart contracts – and industries outside of the cryptocurrency marketplace have taken an interest, Bitcoin’s inability to generate smart contracts threatened to become an additional problem for the future growth of Bitcoin.
In 2015, at the Scaling Bitcoin Conference, Dr. Pieter Wuille suggested a solution to this scalability problem for Bitcoin.
Understanding that the digital signature and transaction data combined to form the data on a block and that the digital signature consumed the larger amount of data, Dr. Wuille put forth an approach called Segregated Witness.
Dr. Wuille’s idea was to reduce the data involved in a transaction by stripping the digital signature from the transaction data and moving it to a point in the structure later in the transaction.
Doing this would increase the limits of the block size from 1MB to 4MB, thus increasing the frequency of transaction data and improving the scalability of the Bitcoin blockchain.
Segregated Witness gets its name from the idea of segregating the digital signature date from the transaction data.
Since users on the blockchain verify, or “witness”, an individual’s digital signature, if the transaction data is separated from the digital signature, then, in effect, what is witnessed is separated from the transaction data.
Implementation of SegWit
A majority consensus of users on the Bitcoin blockchain agreed with Dr. Wuille’s proposal, and development on this new approach began.
Less than two years after he presented the idea, in August of 2017, Segregated Witness was implemented into the Bitcoin blockchain.
SegWit is a “soft fork” – a change in a blockchain in which nodes on the old blockchain can recognize the transactions on the new blockchain, so they can follow the new protocol while also honoring the old one.
This means that users of the Bitcoin blockchain who did not upgrade to the new protocol can still verify transactions on the blockchain.
The development of Bitcoin Cash
Although there was a majority consensus for SegWit in the Bitcoin network, not all developers agreed with it.
Instead of strip the digital signature from the transaction data, a group of developers wanted to simply increase the size of the blocks on the network.
So they did.
In August 2017, when SegWit was deployed as a soft fork on the Bitcoin blockchain, these users executed a “hard fork” fork on the network and created Bitcoin Cash.
A hard fork is a change to the original blockchain that makes the new blockchain incompatible with it. With a hard fork, the nodes on the new blockchain will not interact with or acknowledge transactions or nodes on the old blockchain.
The development of Bitcoin Cash is probably the most significant hard fork recently, particularly since it was related to the highest profile and most valuable cryptocurrency, Bitcoin.
Benefits of SegWit
SegWit allowed for the data size of a blocks on the Bitcoin blockchain to increase from 1MB to 4MB. This increase in block size has allowed for an increase in the frequency of transactions on the network.
An additional benefit of separating the digital signature from the transaction data and reducing the data size of the transaction is that more transactions can fit in a block.
So not only are the block sizes larger, but more transactions can take place in the block, thus allowing for an even higher increase in transaction frequency.
Additionally, SegWit achieved its goal of fixing the malleability problem on Bitcoin. No longer can users alter details of a transaction ID.
This allowed for an increase in development work on features that can enable the execution of smart contracts, which have an increasing value due to their benefits to many industries in the broader digital marketplace.
Although SegWit was rolled out in August 2017, the implementation of it was not immediate.
A minority of transactions on the blockchain (less than 25%) have been made using SegWit.
SegWit is an option for transactions, but not necessary.
A bigger issue facing SegWit was that although the protocol launched in August of 2017, many digital wallets were not able to support it. It took time for well-known wallets – including Trezor and Ledger – to enable it. Coinbase did not support SegWit until February 2018.
Although there have been issues and debate in the Bitcoin network about SegWit, its development provides a compelling example of how blockchain networks can evolve.
SegWit has shown how developers on a blockchain network can create a protocol to optimize a blockchain network for advancements in the technology and the changing marketplace.
It has also shown how developers in that same network can create a hard fork on a blockchain in response to that new protocol.
These changes to Bitcoin make SegWit an intriguing instance of the dynamic world of blockchain, and how technological advancements on a blockchain take place.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.
Providing liquidity for the crypto economy.