Bitcoin’s Lightning Network Will Likely Fail Due To Several Possible Reasons

ECONOMIC CASE IS ABSENT FOR MANY TRANSACTIONS

The median Bitcoin (BTC) fee is $14.41 currently. This has gone parabolic in the past few days. So, let’s use a number before this parabolic rise, which was $3.80. Using this number, opening and closing a Lightning Network (LN) channel means that you will pay $7.60 in fees. Most likely, the fee will be much higher for two reasons:

  1. BTC fees have been trending higher all year and will be higher by the time LN is ready
  2. When you are in the shoe store or restaurant, you will likely pay a higher fee so that you are not waiting there for one or more hours for confirmation.

Let’s say hypothetically that Visa or Paypal charges $1 per transaction. This means that Alice and Carol would need to do 8 or more LN transactions, otherwise it would be cheaper to use Visa or Paypal.

But it gets worse. Visa doesn’t charge the customer. To you, Visa and Cash are free. You would have no economic incentive to use BTC and LN.

Also, Visa does not charge $1 per transaction. They charge 3%, which is 60 cents on a $20 widget. Let’s say that merchants discount their widget by 60 cents for non-Visa purchases, to pass the savings onto the customer. Nevertheless, no one is going to use BTC and LN to buy the widget unless 2 things happen:

  1. they buy more than 13 widgets from the same store ($7.60 divided by 60 cents)
  2. they know ahead of time that they will do this with that same store

This means that if you’re traveling, or want to tip content producers on the internet, you will likely not use BTC and LN. If you and your spouse want to try out a new restaurant, you will not use BTC and LN. If you buy shoes, you will not use BTC and LN.

ROAD BLOCKS FROM INSUFFICIENT FUNDS

Some argue that you do not need to open a channel to everyone, if there’s a route to that merchant. This article explains that if LN is like a distributed mesh network, then another problem exists:

“third party needs to possess the necessary capital to process the transaction. If Alice and Bob do not have an open channel, and Alice wants to send Bob .5 BTC, they’ll both need to be connected to a third party (or a series of 3rd parties). Say if Charles (the third party) only possesses .4 BTC in his respective payment channels with the other users, the transaction will not be able to go through that route. The longer the route, the more likely that a third party does not possess the requisite amount of BTC, thereby making it a useless connection.”

CENTRALIZATION

According to this visualization of LN on testnet, LN will be centralized around major hubs. It might be even more centralized than this visualization if the following are true:

  1. Users will want to connect to large hubs to minimize the number of times they need to open/close channels, which incur fees
  2. LN’s security and usability relies on 100% uptime of relaying parties
  3. Only large hubs with a lot of liquidity will be able to make money
  4. Hubs or intermediary nodes will need to be licensed as money transmitters, centralizing LN to exchanges and banks as large hubs

What will the impact be on censorship-resistance, trust-less and permission-less?

NEED TO BE LICENSED AS MONEY TRANSMITTER

Advocates for LN seem to talk a lot about the technology, but ignore the legalities.

FinCEN defines money transmitters. LN hubs and intermediary nodes seem to satisfy this definition.

Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies

“…applicability of the regulations … to persons creating, obtaining, distributing, exchanging, accepting, or transmitting virtual currencies.”
“…an administrator or exchanger is an MSB under FinCEN’s regulations, specifically, a money transmitter…”
“An administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations…”
“FinCEN’s regulations define the term “money transmitter” as a person that provides money transmission services, or any other person engaged in the transfer of funds. The term “money transmission services” means “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.””
“The definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies.”

FinCEN’s regulations for IVTS:

“An “informal value transfer system” refers to any system, mechanism, or network of people that receives money for the purpose of making the funds or an equivalent value payable to a third party in another geographic location, whether or not in the same form.”
“…IVTS… must comply with all BSA registration, recordkeeping, reporting and AML program requirements.
“Money transmitting” occurs when funds are transferred on behalf of the public by any and all means including, but not limited to, transfers within the United States or to locations abroad…regulations require all money transmitting businesses…to register with FinCEN.”

Mike Caldwell used to accept and mail bitcoins. Customers sent him bitcoins and he mailed physical bitcoins back or to a designated recipient. There is no exchange from one type of currency to another. FinCEN told him that he needed to be licensed as money transmitter, after which Caldwell stopped mailing out bitcoins.

ARGUMENTS AGAINST NEED FOR LICENSING

Some have argued that LN does not transfer BTC until the channel is closed on the blockchain. This is not a defence, since channels will close on the blockchain.

Some have argued that LN nodes do not take ownership of funds. Is this really true? Is this argument based on a technicality or hoping for a loophole? It seems intuitive that a good prosecutor can easily defeat this argument. Even if this loophole exists, can we count on the government to never close this loophole?

So, will LN hubs and intermediary nodes need to be licensed as money transmitters? If so, then Bob, who is the intermediary between Alice and Carol, will need a license. But Bob won’t have the money nor qualifications. Money transmitters need to pay $25,000 to $1 million, maintain capital levels and are subject to KYC/AML regulations[1]. In which case, LN will have mainly large hubs, run by financial firms, such as banks and exchanges.

Will the banks want this? Likely. Will they lobby the government to get it? Likely.

Some may be wondering about miners. FinCEN has declared that miners are not money transmitters:

https://coincenter.org/entry/aml-kyc-tokens :

“Subsequent administrative rulings clarified several remaining ambiguities: miners are not money transmitters…”

FinCEN Declares Bitcoin Miners, Investors Aren’t Money Transmitters

Some argue that LN nodes will go through Tor and be anonymous. For this to work, will all of the nodes connecting to it, need to run Tor? If so, then how likely will this happen and will all of these people need to run Tor on every device (laptop, phone and tablet)? Furthermore, everyone of these people will be need to be sufficiently tech savvy to download, install and set up Tor. Will the common person be able to do this? Also, will law-abiding nodes, such as retailers or banks, risk their own livelihood by connecting to an illegal node? What is the likelihood of this?

Some argue that unlicensed LN hubs can run in foreign countries. Not true. According to FinCEN: ““Money transmitting” occurs when funds are…transfers within the United States or to locations abroad…” Also, foreign companies are not immune from the laws of other countries which have extradition agreements. The U.S. government has sued European banks over the LIBOR scandal. The U.S. government has charged foreign banks for money laundering and two of those banks pleaded guilty. Furthermore, most countries have similar laws. It is no coincidence that European exchanges comply with KYC/AML.

Will licensed, regulated LN hubs connect to LN nodes behind Tor or in foreign countries? Unlikely. Will Amazon or eBay connect to LN nodes behind Tor or in foreign countries? Unlikely. If you want to buy from Amazon, you’ll likely need to register yourself at a licensed, regulated LN hub, which means you’ll need to provide your identification photo.

Say goodbye to a censorship-resistant, trust-less and permission-less coin.

For a preview of what LN will probably look like, look at Coinbase or other large exchanges. It’s a centralized, regulated and censored hub. Coinbase allows users to send to each other off-chain. Coinbase provides user data to the IRS and disallows users from certain countries to sell BTC. You need to trust that no rogue employee in the exchange will steal your funds, or that a bank will not confiscate your funds as banks did in Cyprus. What if the government provides a list of users, who are late with their tax returns, to Coinbase and tells Coinbase to block those users from making transactions? You need Coinbase’s permission.

This would be the antithesis of why Satoshi created Bitcoin.

NEED TO REPORT TO IRS

The IRS has a definition for “third party settlement organization” and these need to report transactions to the IRS.

Though we do not know for sure yet, it can be argued that LN hubs satisfies this definition. If this is the case, who will be willing to be LN hubs, other than banks and exchanges?

To read about the discussion, go to:

Lightning Hubs Will Need To Report To IRS

COMPLEXITY

All cryptocurrencies are complicated for the common person. You may be tech savvy enough to find a secure wallet and use cryptocurrencies, but the masses are not as tech savvy as you.

LN adds a very complicated and convoluted layer to cryptocurrencies. It is bound to have bugs for years to come and it’s complicated to use. This article provides a good explanation of the complexity. Just from the screenshot of the app, the user now needs to learn additional terms and commands:

“On Chain”

“In Channels”

“In Limbo”

“Your Channel”

“Create Channel”

“CID”

“OPENING”

“PENDING-OPEN”

“Available to Receive”

“PENDING-FORCE-CLOSE”

There are also other things to learn, such as how funds need to be allocated to channels and time locks. Compare this to using your current wallet.

Recently, LN became even more complicated and convoluted. It needs a 3rd layer as well:

Scaling Bitcoin Might Require A Whole ‘Nother Layer

How many additional steps does a user need to learn?

ALL COINS PLANNING OFF-CHAIN SCALING ARE AT RISK

Bitcoin Segwit, Litecoin, Vertcoin and possibly others (including Bitcoin Cash) are planning to implement LN or layer 2 scaling. Ethereum is planning to use Raiden Network, which is very similar to LN. If the above is true about LN, then the scaling roadmap for these coins is questionable at best, nullified at worst.

BLOCKSTREAM’S GAME PLAN IS ON TRACK

Blockstream employs several of the lead Bitcoin Core developers. Blockstream has said repeatedly that they want high fees. Quotes and source links can be found here.

Why is Blockstream so adamant on small blocks, high fees and off-chain scaling?

Small blocks, high fees and slow confirmations create demand for off-chain solutions, such as Liquid. Blockstream sells Liquid to exchanges to move Bitcoin quickly on a side-chain. LN will create liquidity hubs, such as exchanges, which will generate traffic and fees for exchanges. With this, exchanges will have a higher need for Liquid. This will be the main way that Blockstream will generate revenue for its investors, who invested $76 million. Otherwise, they can go bankrupt and die.

One of Blockstream’s investors/owners is AXA. AXA’s CEO and Chairman until 2016 was also the Chairman of Bilderberg Group. The Bilderberg Group is run by bankers and politicians (former prime ministers and nation leaders). According to GlobalResearch, Bilderberg Group wants “a One World Government (World Company) with a single, global marketplace…and financially regulated by one ‘World (Central) Bank’ using one global currency.” LN helps Bilderberg Group get one step closer to its goal.

Luke-Jr is one of the lead BTC developers in Core/Blockstream. Regulation of BTC is in-line with his beliefs. He is a big believer in the government, as he believes that the government should tax you and the “State has authority from God”. In fact, he has other radical beliefs as well:

So, having only large, regulated LN hubs is not a failure for Blockstream/Bilderberg. It’s a success. The title of this article should be changed to: “Lightning Will Fail Or Succeed, Depending On Whether You Are Satoshi Or Blockstream/Bilderberg”.

SIGNIFICANT ADVANCEMENTS WITH ON-CHAIN SCALING

Meanwhile, some coins such as Ethereum and Bitcoin Cash are pushing ahead with on-chain scaling. Both are looking at Sharding.

Visa handles 2,000 transactions per second on average. Blockstream said that on-chain scaling will not work. The development teams for Bitcoin Cash have shown significant on-chain scaling:

1 GB block running on testnet demonstrates over 10,000 transactions per second:

“we are not going from 1MB to 1GB tomorrow — The purpose of going so high is to prove that it can be done — no second layer is necessary”

“Gigablock testnet initiative will likely be implemented first on Bitcoin Cash”

Peter Rizun, Andrew Stone — 1 GB Block Tests — Scaling Bitcoin Stanford At 13:55 in this video, Rizun said that he thinks that Visa level can be achieved with a 4-core/16GB machine with better implementations (modifying the code to take advantage of parallelization.)

Bitcoin Cash plans to fix malleability and enable layer 2 solutions:

The Future of “Bitcoin Cash:” An Interview with Bitcoin ABC lead developer Amaury Séchet:

“fixing malleability and enabling Layer 2 solutions will happen”

However, it is questionable if layer 2 will work or is needed.

GOING FORWARD

The four year scaling debate and in-fighting is what caused small blockers (Blockstream) to fork Bitcoin by adding Segwit and big blockers to fork Bitcoin into Bitcoin Cash. Read:

Bitcoin Divorce — Bitcoin [Legacy] vs Bitcoin Cash Explained

It will be interesting to see how they scale going forward.

Scaling will be instrumental in getting network effect and to be widely adopted as a currency. Whichever Coin Has The Most Network Effect Will Take All (Or Most) (BTC has little network effect, and it’s shrinking.)

The ability to scale will be key to the long term success of any coin.