Why the Lightning Network Could ‘Spark’ Wide-Scale Adoption of Bitcoin
Oct 18, 2018
Since the inception of Bitcoin in 2009, members of the cryptocurrency community have endeavored to find a scaling solution for the benchmark digital asset. A scaling solution that does not force cutbacks in security, increase transaction fees, or require a software change is a tall order, but one that is perhaps addressed by the Lightning Network. Proposed in a 2015 white paper by Thaddeus Dryja and Joseph Poon, the Lightning Network has since risen into the best hope for a scaling solution for the world’s largest cryptocurrency.
The Lightning Network is a scaling solution designed by Lightning Labs to be built on top of the main Bitcoin blockchain to allow for instantaneous peer-to-peer payments while significantly reducing transaction fees. The Lightning Network’s protocol employs the use of smart contracts in order to scale Bitcoin from a limit of 7 transactions per second to a capability of processing millions of transactions per second.
The Lightning Network works by employing smart contracts layered on top of the Bitcoin blockchain that allow for fast and cheap off-chain transactions between two parties -- so, how does this work? When two parties are interested in transacting with each other, a mutual, two-party “payment channel”, which is essentially a mutual wallet, is created and each party is assigned a private key. After its creation, this mutual wallet is saved to the public Bitcoin blockchain alongside a smart contract structured as a balance sheet to prove how much Bitcoin belongs to each of the two parties.
Once the payment channel is established, the two parties are able to conduct unlimited transactions between each other without ever requiring a change to the actual Bitcoin blockchain. After each transaction, both parties are required to sign off on an updated balance sheet to constantly reflect how much Bitcoin stored in the mutual wallet belongs to each party. If a dispute occurs, or one of the parties decides to close the payment channel, each party shares their most recent copy of the updated balance sheet and payouts from the mutual wallet are distributed to their respective owners.
A key feature of the Lightning Network is that users do not have to open a new payment channel every time they wish to transact with a new party -- instead, the Lightning Network is able to connect two parties via pre-existing network channels. Imagine, for example, Bob wishes to transact with Lisa, but Bob and Lisa do not have a pre-existing payment channel. Well, if Bob happens to have a pre-existing payment channel with Jimmy, and Lisa also happens to have a pre-existing payment channel with Jimmy, then Bob is able to transact with Lisa through Jimmy’s node. In theory, any individual on the Lightning Network should be able to transact with any other individual on the Lightning Network through just a few different nodes.
A full and complete version of the Lightning Network would introduce a plethora of positives to the cryptocurrency industry. First and foremost, the Lightning Network would allow Bitcoin to truly scale by enabling the world’s largest cryptocurrency to process millions of transactions per second, compared to the current measly limit of 7 transactions per second. The Lightning Network also allows investors to perform the smallest of transactions due to the proportional nature of transaction fees relative to transaction sizes. Often times, transaction fees on the Lightning Network equate to fractions of a penny.
The main reason, however, the Lightning Network is sought after so highly by developers is because it offers a scaling solution to Bitcoin without requiring a software update, or hardfork. A hardfork forces developers to upgrade their software and often causes a split of the main cryptocurrency into two separate blockchains while also dividing the community backing the coin -- two notable examples are the Bitcoin/Bitcoin Cash split and the Ethereum/Ethereum Classic split. Some experts also highlight privacy as an additional positive of the Lightning Network, but is it really?
Because the Lightning Network processes transactions outside of the main Bitcoin blockchain, most payments made through the Lightning Network are near untraceable. While some see this privacy as a positive, we see it as a potential drawback. Ideals of untraceable transactions and anonymous payments in Bitcoin would clash directly with regulators and the regulatory guidelines they are pushing on cryptocurrencies. These regulations largely focus on removing anonymity from cryptocurrencies to avoid the use of digital assets as a medium for illegal activities. The degree of privacy created in Bitcoin through the Lightning Network could potentially cause regulators to push back, hurting Bitcoin and other cryptocurrencies in the long-term.
There are several other potential drawbacks to the Lightning Network. For one, an unresponsive payment channel involved in a transaction could cause the transaction as a whole to take hours compared to fractions of a second. The Lightning Network also is not ideal for larger transactions because payment channels involved in the transaction may not possess enough funds to successfully process the transaction. Another glaring shortfall of the Lightning Network is that it still encourages centralization! Because payment channels are rewarded with a small portion of the transaction fee when funds flow through them, centralized payment channel hubs are encouraged to form as it would result in additional transaction rewards -- we have seen similar developments in the cryptocurrency mining industry.
March 15th, 2018 marked a huge milestone for Lightning Network developers as they launched a beta of the Lightning Network on the main Bitcoin blockchain. The beta launched with roughly 1,000 nodes participating in the Lightning Network, a transaction limit of about USD$400 per payment, and a payment channel limit of approximately USD$1,400 per channel. Below, you will find a visual representation of the Lightning Network’s nodes as of January 22nd, 2018, two months before launching its beta.
Lightning Network Nodes as of 01/22/2018
A few months later on June 25th, 2018, Blockstream announced the beta release of c-lightning, a new implementation of the Lightning Network with a completely rewritten protocol and new architecture designed to be more user-friendly to the average individual. At the time of the announcement, the Lightning Network maintained a capacity of 26 BTC with roughly 7,800 open nodes, a 4,084% increase in capacity and a 16,856% increase in open nodes since 6 months prior.
Three months later on September 5th, 2018, the Lightning Network received a massive boost to its adoption when payment processing startup, CoinGate, announced it was adding all 4,000 of its merchants to the Lightning Network. By that time, the Lightning Network’s capacity had increased to a record of 100 BTC. Below, you will find another visual representing the Lightning network on August 22nd, 2018, just two weeks before the CoinGate announcement.
Lightning Network Nodes as of 08/22/2018
The Lightning Network has come a long way since launching its beta in March 2018, but not without facing hurdles. On June 25th, 2018, Diar, a digital asset research publication, released a study suggesting that the Lightning Network is ineffective at routing payments and its reliability is low, especially for larger payments. Diar, however, failed to mention anywhere in its study that the Lightning Network is in its beta and that there is a USD$400 payment limit for transactions. Cryptocurrency industry experts, including Bitcoin core developers Jonas Schnelli and Peter Todd, promptly slammed Diar and came to the defense of the Lightning Network.
Outlook for the Lightning Network
Although a beta of the Lightning Network has been running on the main Bitcoin blockchain for a larger part of the year with strong levels of success, the off-chain scaling solution still has a long way to go. Limits of USD$1,400 per payment channel and USD$400 per payment distort whether or not the Lightning Network could operate at a larger scale while the anonymous nature of the Lightning Network may set it on a collision course with regulators down the road. However, the Lightning Network has shown true promise in the level of adoption it has already seen, and the recent 4,000 merchant boost provided by CoinGate further bolsters said promise. As we move deeper into 2018, investors should not expect a full implementation of the Lightning Network this year, however, a release in 2019 remains plausible. If fully launched and successful, the Lightning Network may provide Bitcoin with the scaling solution it so desperately needs to achieve mass adoption.