I want my stuff now: Bitcoin and immediate transactions

By now you know that a bitcoin transaction can take at least 10 minutes to verify and process. And to be really sure that it is permanently and indelibly on the blockchain, you’re supposed to wait for another 6 blocks (at least!) to pile on top. So, technically, a bitcoin payment could take over 1 hour to go through. This obviously is not ideal if you want to buy something with the digital currency. Imagine if you were told that you had to wait at least an hour for your pizza. Or that you had to come back to the store later to pick up your new jacket. You’d be right in thinking that this could be a significant barrier to bitcoin adoption.

So, how do we get around that?

by Sean McAuliffe for Unsplash
by Sean McAuliffe for Unsplash

One method used “back in the day” and which has fallen out of favour is “green addresses”. These are bitcoin addresses that are set up by a “trustworthy” institution (probably an exchange or a wallet) that is willing to advance the funds to the seller, while waiting for confirmed reception from the buyer. If I wanted to send you bitcoins, and I wanted you to feel secure that you had received them immediately, I would open an account with a well-known intermediary, I would send them the bitcoins, and I would ask them to pay you using a green address. They would do so immediately, without waiting for confirmation that my transaction to them was valid. They would trust me because of our working relationship, and probably because I have a balance of bitcoins held with them. The receiver (the seller) would have heard of the intermediary, and would trust their reputation enough to accept that the green address payment is valid. In effect, the intermediary “vouches” for my payment, and the seller trusts the intermediary enough to accept that.

One of the reasons that this system is not used so much any more is that two of the main green address intermediaries back in 2011, when this form of transaction verification was at its peak of popularity – Mt. Gox and Instawallet – ended up imploding. Obviously, trusting intermediaries is no longer an obvious thing to do.

Another drawback is that green addresses are not as private, since the name of the intermediary has to be disclosed. The intermediary’s records would then identify the buyer. Without a green address, the receiver (the seller) has no idea through which intermediary the funds arrived.

Furthermore, using a green address creates an additional bitcoin transaction, which, given the current intense debate about bitcoin scaling, is probably not the most efficient solution.

And, there is the irony of depending on a centralized trustworthy entity to make a purchase with a currency designed to work in a decentralized environment where no trust is needed. 😉

bitgo instant

Some wallet companies are coming up with ingenious work-arounds. Earlier this year BitGo launched BitGo Instant to make immediate transactions possible. After initial risk checks, BitGo Instant guarantees the funds for the receiver. How does it do this? By co-signing. The keys to a BitGo Instant wallet are held by three participants: the user, BitGo Instant and a key recovery service (a third party that generates, stores and protects public and private key pairs). Two signatures are required on every transaction, and in most cases, those two signatures will be the user’s, and BitGo Instant’s. Obviously before co-signing, BitGo Instant will check that the coins have not been previously spent. If that condition is met, BitGo Instant’s co-signature implies a guarantee that the funds will be paid. The only way that those funds could be double spent is if the user enters into a conspiracy with the key recovery service to send those very same coins somewhere else. To prevent this, the service is required to inform BitGo before it co-signs anything. Also, the key recovery service adds a layer of assurance that the bitcoins will still be accessible in the event that BitGo Instant stops operating, as it could provide the necessary second signature, allowing the user to access the funds. BitGo Instant’s risk in this is low, as it can easily verify that the bitcoins are there. And it is an original way to monetize BitGo’s reputation.

As with green addresses, the privacy of this type of instant transaction is lower than the standard, slow option, as the receiver knows that BitGo is involved. With that information, it is possible to figure out who the buyer (sender of bitcoins) is. So these transactions will most likely be of interest to average users who want instant purchase confirmation, and traders who don’t want funds tied up, not even for an hour. Privacy is probably not their main concern.

We will probably (hopefully) see the emergence of other clever ideas that improve the efficiency of bitcoin over the coming months. Instant transactions will not only increase the liquidity in the system by increasing the circulation. It will also dramatically increase the use cases, by offering instant bitcoin trading settlement, instant purchase confirmation, and less risk that the bitcoin exchange rate will move during the waiting time.

“Zero confirmation transactions”, or transactions that have not yet been embedded on the blockchain, are accepted in some cases, but the risk is high, so the practice is actively discouraged. For bitcoin to one day be widely used as a payment method, the “zero confirmation transaction” risk needs to be resolved. Some exchanges and wallets have been looking at probability approaches, but the system needs to find a simpler and more secure way to transact quickly. Even transactions that are one or two blocks deep in the chain are not free from risk of a block re-write, and waiting over an hour (after which the probability of the block being modified falls to practically zero) is often not practical. And until using the digital currency becomes practical, the talk of bitcoin one day replacing cash will remain just that: talk.

Leave a Reply

Your email address will not be published. Required fields are marked *