In recent years, Bitcoin and its underlying infrastructure, the Blockchain, have been proven to be safe and reliable technologies. However, despite its continued popularity and high-demand from businesses, Bitcoin still cannot be used as a functional currency to date. Some of the few merchants that had accepted Bitcoin as a payment option, like Valve, removed their support for Bitcoin. Another example is Stripe, a leading payment processing firm for online businesses, ended its Bitcoin support due to lengthy transaction times and growing fees. The fact that out of the leading 500 internet sellers, just three accept Bitcoin indicates that Bitcoin is becoming less popular among merchants and users for use in everyday commerce. Instead, Bitcoin is perceived to be a modern day equivalent to gold as consumers holding it prefer to profit from its price increase rather than spend it on products and goods that could be purchased via fiat currencies. Peter Thiel recently stated that Bitcoin is “like bars of gold in a vault that never move”, adding that it is too cumbersome to be used as a payment system.
I don’t agree. I believe that the success of Bitcoin will be greatly impacted by its tradability and its ability to impact our everyday commerce. However, in order for that to happen, we need to face Bitcoin’s shortcomings which prevent it from being accepted by consumers and merchants as a functional currency:
- Payment is not instantaneous. The Blockchain contains blocks, where each block documents several transactions. As soon as a block has been filled with transactions, it needs to be added to the chain before starting to record transactions on the next block. However, before a block can be added to the chain, there is some processing that needs to be done to ensure that everyone agrees with the contents it contains. This process is called mining. With the Blockchain architecture, a payment is accepted once a transaction has been mined into a block. However, on average, it takes between 9 to 10 minutes to mine a block.
- Lack of scalability. In order to maintain its decentralized nature, the Blockchain limits a block size to 1MB. Because of the block size and the minimum delay between blocks mining, the Blockchain is only able to process 2 to 12 transactions per second. For Bitcoin to play a meaningful role as a payment system, transaction processing power needs to increase by at least 3 orders of magnitude.
- High cost of transactions fee. Transactions speed limit is causing network congestion, with thousands of transactions waiting to be confirmed and delays reaching several hours. The nature of the Blockchain architecture (in which miners can be incentivize to include a transaction in a block sooner than others) inherently drives an increase in transaction fees, as users are willing to pay higher fees to get their transaction at the front of the queue. Unfortunately, any temporary decrease in transaction fee can be attributed to lower transaction volume, which defeats the purpose…
Lightning Network (LN) lays the foundation in which Bitcoin can be evolved to become a functional currency. Lightning Network offers an off-chain transaction model which addresses the current Blockchain deficiencies. This model enables:
- Instant Payments. Lightning-fast Blockchain payments without worrying about block confirmation times. Security is enforced by Blockchain smart-contracts without creating a on-Blockchain transaction for individual payments. Payment speed measured in milliseconds to seconds.
- Scalability. Capable of millions to billions of transactions per second across the network. Capacity is better than legacy payment rails by many orders of magnitude. Payments are now possible without custodians.
- Low Cost. By transacting and settling off-Blockchain, Lightning Network allows for exceptionally low fees, which enables instant micropayments.
The innovation behind LN is that not all transactions are required to be recorded on the Blockchain. In cases where two parties transact a few times among themselves, they can bypass the recording of transactions on the Blockchain and carry them off the Blockchain (off-chain). LN’s fundamental technology is a local two party consensus, also known as a payment channel. When two parties are ready to transact, a payment channel is opened and recorded on the Blockchain (an on-chain action). From now on, the parties can transact any number of times through this payment channel and it can stay open for any duration. The only time the parties interact with the Blockchain again will be when they would want to close the channel. Then, the parties record the final status of the transactions that occurred through the channel on the Blockchain. This notion of payment channel enables the creation of a network of payment channels such that it would be only rarely required to transaction on the Blockchain. Meaning, all payment channels can be connected to enable tractions between parties that do not have a direct payment channel between them. In this architecture, because on-chain interactions are reduced to a minimum, transactions are happening at lightning speed.
Lightning Network is a potential breakthrough in transforming Bitcoin to be used as a functional, tradeable currency. LN can help Bitcoin to deliver on its promise, but, in order to do so, most of everyday transactions will need to be processed via LN payment channels, while the Blockchain will only exist as a secure fallback to ensure honest commerce. IMHO, Bitcoin’s success depends on Lighting Network’s ability to flourish as vibrant network, relying on the security infrastructure provided by the Blockchain, but reducing Blockchain transactions to a minimum.
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