Bitcoin Lightning Network: BTC’s Savior or a Spectacular Failure?

Bitcoin entered the mainstream awareness through innovation of the P2P payment industry. It has become the gold standard that all other coins are compared against, and has spawned numerous similar altcoins that implement its blockchain technology.

Although Bitcoin might always be considered the original and most valued coin of all, altcoins have caught up in terms of price, speed, and utility. The market has responded with a shift towards these alternative currencies and more efficient networks.

Introducing Bitcoin’s Many Problems

Back in 2017, the company SatoshiPay stated that it would no longer support the Bitcoin blockchain for processing payments, and has since moved its business to Stellar. The move was due to Stellar offering cheaper transaction fees, as well as providing a more up to date platform for developers.

Then in December, Steam announced that it would no longer accept Bitcoin as a payment method. The complaint again was due to the coin’s high fees and volatile price fluctuations.

Then in a move that astounded everyone, Emil Oldenburg, who is the co-founder of Bitcoin, told investors to exchange their Bitcoin holdings for Bitcoin Cash. His complaints were about Bitcoin’s slow transaction speeds and high fees.

As a solution to the above problems and more, the Lightning network has been proposed to increase the Bitcoin network viability as a payment method.

What is the Lightning Network?

Lightning is a new method that can speed up transactions, as well as reduce fees of the Bitcoin network. LN may also enhance the security and privacy of its users to address the competition from privacy-centric altcoins such as Monero.

The network was proposed to address Bitcoin’s processing speeds. Today, Bitcoin has one of the slowest transfer and settlement times out of all online payment methods available. To put this slowiness into perspective, Visa is can handle a maximum of 65,000 transfers per second, whilst Bitcoin can only handle 7.

For large retailers such as Amazon, this makes the coin unusable from a commercial standpoint. Amazon can reach up to 600 transactions each second during its busiest times, far more than what the Bitcoin network can handle.

The good news for Bitcoin is that the Lightning Network could change everything for small and large companies. It’s possible that the change could allow Bitcoin to handle billions of transactions each day, which would restore its competitiveness as a blockchain for commercial use.

How Does the Lightning Network Work?

The Lightning Network employs what is called off-chain technology, which means that not all transactions are recorded on a blockchain. This method would reduce processing times and the required fees to miners who verify each transaction.

As an alternative to the blockchain, the Lightning Network will use a parallel platform that is created when two users engage in regular Bitcoin transfers. It would function similar to an escrow service, with one person depositing a sum into a third-party account, and then releases some of the amount with each purchase.

A different balance sheet would record each transfer in the lightning network, and would then be associated with an individual’s payment channel. These transactions would only be recorded on the blockchain under 2 situations: when a payment terminal is open, or closed.

When it is terminated, the newest form of the balance sheet is pushed back to the blockchain and it is then verified by miners. Like all things related to the blockchain, this process will be fully automated, and there will be no possibility of interference by third parties or hidden fees.

Also, each transaction on the Lightning Network will be made through a private channel and not stored on a public ledger, which would allow for private transactions.

In spite of the above changes and optimism by the coin’s earliest adopters, the Lightning Network is not guaranteed to fix Bitcoin’s scalability problems. In fact, its implementation could prove to be a disaster for cryptocurrency.

How The Lightning Network Could Fail

Assuming first of all that people actually use the Lightning payment channels, this means that there will be a significant liquidity pool of coins spread across the network. The issue is how will those coins be shared? And is there enough supply of the coins for the Lightning Network to even be viable?

The developers who are working on Lighting have designed a routing protocol that checks what nodes in the network have enough funds to complete a transfer. This routing facility will also calculate the shortest viable route to payment and also completes the transaction.

However, it’s not guaranteed that this process will work. There are two reasons why.

The first issue is due to a lack of supply of coins in users’ lightning channels. People may decide to keep low amounts of Bitcoin in their accounts rather than making balance adjustments. The second reason is that the amount of funding in the channel will be in a constant state of flux.

People could decide to fund their channel, and then pay off the balance over time. After the funding, there might be a large amount of coins, but then after the balance could be reduced to almost zero.

And if a large amount of users decide to fund and withdraw from their accounts at around the same time, the liquidity across the network would see a huge amount of volatility. In a practical sense, this would mean that the network would not be able to find a payment route due to a lack of liquidity in the Lightning Network.

Lightning’s Liquidity Downfall

As of right now, Lightning could share the same liquidity problems as Bitcoin.

But the network’s illiquidity could be addressed. The use of large payment channels has been proposed. These accounts would be fully funded and available for payment routing at all times. The problem with these channels is that it mean Lightning is not totally decentralized.

Another problem that these large accounts would be valuable targets for thieves, and would create an obvious weakness in the network. All it would take is for one of these hubs to be compromised to effect the entire Bitcoin network.

An alternative would be to allow the channels to go into a kind of virtual debt as the payment pases through. This would mean that each payment gets settled. But again, this would breach a fundamental tenet of Bitcoin, as it goes against the “gold standard” that the network was founded upon. In this case, if you don't have enough “gold”, then you simply can’t settle transactions. This is why the gold standard struggles in a practical sense, and why banks today use fractional reserve lending.

Of course, Lightning is still being worked on. Yet it’s hard to see how it can fix Bitcoin’s problems that seem to become more obvious as the network expands.

How Do We Fix Bitcoin?

The question of how to fix Bitcoin’s weaknesses has been a focus of developers, investors and miners for years, all of who want to see the coin succeed as virtual currency. The problem with Bitcoin is due to how it was designed.

When someone trades with Bitcoin, that transaction is announced to the whole Bitcoin network. It doesn’t matter how large or small the trade is; every payment is recorded on blockchain, which takes 200,000 computers to keep it going. And as the currency expands as a form of payment, so do the network requirements in terms of bandwidth and disk space.

After all, the blockchain is made up of literal blocks of data: with each transaction forming a chunk of the whole. For a transaction to be verified, miners need to perform an intensive calculation to place it into a new block, which takes about 10 minutes on average. There are around 2,000 transactions per block, so unfinished transactions are common. So the point is that the network is slow as a consequence of its outdated design.

Another limitation of the network is the finite block size. As there is only so much space per block, this then incentivizes miners to include their own transactions before others. This is what causes the backlog of overdue payments, with big spenders offering large fees for miners to verify their transactions. This brings us to the second weakness in Bitcoin’s design: high transaction fees, and the impractical use of miners.

If the Lightning Network proves to be a successful venture, then Bitcoin’s future as a form of payment could be saved. The miners could be utilized to confirm transactions only when there is a need by its users, with most transactions being made in private. Another benefit is that microtransactions could become a reality, such as for when you really want to spend your Bitcoin on a cup of coffee.

Bitcoin's Scalability Problems

Like other cryptocurrencies, some people believe that Bitcoin is going to revolutionize our financial system. Yet the network scalability problems have to be resolved.

As stated previously, the Bitcoin network can only handle a theoretical maximum of 10 transactions per second. But in reality, it can only manage 4-5 transactions per second, with 10 being the theoretical maximum.

When this is compared to Paypal or Visa, 4-5 transactions per second is abysmal, as these platforms can handle a maximum of 56,000 transactions every second. It’s interesting to note that these companies never actually process these many transactions per second, even during the busiest times of Christmas and the new year. Paypal currently handles 10 million transactions every day and 115 transactions per second.

The low capacity of Bitcoin to be used as a payment network is one issue preventing it from seen in commercial environments, but there are other problems with its scaling, too.

Bitcoin Is Now Centralized

Since its inception, the power of Bitcoin has been the fact that it is decentralized, which means that no single entity could influence the network. However, this is no longer the case. More than 70% of the currency’s hash rate and mining power is now being sourced through China. Additionally, the largest four mining pools account for over 50% of the network’s combined hash rate.

Pooling these resources together is a logical effect to how the protocol was developed, as it rewards miners via economies of scale. But this also means that Bitcoin is no longer the decentralized network that it once was. This might not be a problem, provided that the Chinese mining pools can be trusted. However, the government in China has already made a move to ban initial coin offerings, and these mining pools are the next thing for them to regulate.

Bitcoin Energy Consumption

Finally, the energy consumption of Bitcoin is wholly unsustainable. To power the network, the proof of work algorithm requires an inordinate amount of power. One study showed that a single Bitcoin transaction used the same amount of electricity as an American household for 1.5 days. This means that the annual energy consumption of Bitcoin will result in 16 terawatt hours.

As the block size increases, so will the energy costs to keep the network alive. This problem is made worse as most of the Bitcoin mining farms are located in China, powered through coal and other unsustainable energy sources.

While miners could always change to greener forms of energy, that still leaves the problem that Bitcoin is still a waste of energy. Besides mining and verifying transactions, the complicated calculations of its Proof of Work consensus provides no value whatsoever. For this reason, unless Bitcoin would change to a different protocol, the amount of energy that Bitcoin will continue to rise at an unsustainable rate.

The Lightning Network might be able to help with all of the above problems and more if developers can keep the network liquid. This new method of transacting across the network could be enough of an incentive to draw its detractors and former users back to Bitcoin, yet we will need to wait and see if Lightning can live up to its expectations, or if it will be a spectacular failure.

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