Bitcoin is set to hit the scaling wall again. Where’s the Lightning Network at?
Prices are rising, Bitcoin is still unscalable and the Lightning Network is still far from working.
- Bitcoin is starting to push its scaling limits once again.
- The Lightning Network is still far from serious real world use.
- Among the fixable issues, there are several endemic issues with Lightning Network design, suggesting it will never be workable.
With Bitcoin prices and general interest on the rise, Bitcoin transaction fees have naturally followed suit. This is what tends to happen. In fact, you can see an extremely clear correlation between average Bitcoin transaction fees and Google Trends search interest in "Bitcoin."
Here they are side by side for the last two years, one after the other, just to really drive the point home. Note the recent, comparatively small, uptick in both.
Google Trends search interest for "Bitcoin"
Average Bitcoin transaction fees
The currency of the future
That small uptick is significant. It represents a more-than-twenty-fold difference between average fees of 10 cents or less per transaction to average fees of over US$2. That's already a major difference.
Even at this point, the cost alone rules out small payments, makes Bitcoin too expensive to be worth using for most purchases and is enough for people to be less-than-impressed by this decade-old currency of the future.
At the same time, the fuller mempool is seeing transaction start to slow down. If volumes pick up more consistently, transaction fees could skyrocket very quickly. Scaling solutions like SegWit notwithstanding, Bitcoin isn't ready for another manic period yet. Even this comparatively minor resurgence is already stressing Bitcoin.
Bitcoin could really use a working Lightning Network right about now. So how's development going there?
The Lightning Network is being held up as a solution for Bitcoin's scaling issues, but it's still experiencing some minor teething issues like the tendency for payments to disappear entirely, the fact that you can't receive payments without being online, the inability to settle without paying on-chain transaction fees, limited liquidity in the network and a maximum payment amount of 0.042 BTC (currently about US$220) as a precautionary measure because of all those kinds of issues.
These issues can be engineered away eventually, but the solutions won't be ready in time if the current rises continue, which might put a lid on what kind of prices are possible.
Last time Bitcoin started going to the moon, it was easy to point out that the Lightning Network was still in its very early days and just wasn't ready for prime time. In fact, the first real money Lightning Network transaction wasn't even completed until Bitcoin prices had already halved from their all-time highs to around $10,000.
Unfortunately, more than a year later, the Lightning Network is still in its very early days and still not ready for real transactions. Even more problematic, the intervening year has seen more backing for arguments that the Bitcoin Lightning Network will never work at all.
In some respects, the more work that goes into the Lightning Network, the less complete it gets.
The question isn't whether the Lightning Network will be ready in time for the next bull run because it's increasingly clear that it won't be. The question is whether it can ever be feasibly ready. Several arguments suggest the answer is no.
Will the Lightning Network
be ready in time ever work?
Beyond the inevitable centralisation of the Lightning Network around hubs, there are other more specific existential problems.
1. Using the Lightning Network is only economically rational if the only other alternative is on-chain Bitcoin transactions
Two of the benefits of digital currency are that it can be used to instantly settle payments and enable extremely low fee transactions. This cuts costs dramatically by freeing up capital and minimising extraneous costs like insurance for the unsettled funds.
But using the Lightning Network requires people to lock up channel liquidity if they actually want to send payments.
So if a merchant wants to accept Bitcoin payments over the Lightning Network, they'd need to lock up a bunch of money to actually accept payments. The exact amount they'd need to lock up would depend on factors like how often they want to settle payments on-chain, how many customers pay with Bitcoin each day and so on.
It will not be a free payment system. But exactly how much it costs will depend on how well-optimised the merchant's Lightning Network channel is for their business and the current cost of on-chain Bitcoin transactions. All things considered, actually optimising the value for money of using the Lightning Network will be a royal, ongoing headache for any business.
In this way, the presence of the Lightning Network lets users choose the lesser of two evils. If they don't want high fees, they can lock up capital in the Lightning Network. If they don't want to lock up capital, they can just swallow the high fees of on-chain transactions.
This is a royal headache, but it's still a big step up from traditional international payments that force both of those evils (high fees and slow settlement) onto users. It's also a big step up from Bitcoin because it provides an alternative option for avoiding the high transaction fees.
But on a more objective scale, it's still pretty bad. Needing to choose between the lesser of two evils is still worse than not needing to choose between the lesser of two evils. It was once theorised that people would be routing payments, and earning small payments for doing so, to compensate for the cost of that locked-up capital, but the resulting liquidity issues have since seen this idea fall to the side.
In a world where Bitcoin has high transaction fees and there are other digital currencies with low transaction fees and instant settlements available (i.e. the real world), it is economically irrational to accept Lightning Network payments. Even if the entire process was incredibly seamless and easy, it just wouldn't make financial sense.
Bitcoin's entire security model assumes that participants will always act in their economic self-interest, but the same assumptions also say no one will ever use the Lightning Network.
2. Bitcoin in the Lightning Network is non-fungible
The value you can obtain from a coin in the Lightning Network is dependent on where exactly in the network it sits. This is because the maximum amount of value that can be transferred depends on how much value is held in nearby payment channels.
This issue has been demonstrated with the Bitcoin Lightning Torch game. It's a game where you pass around a transaction to someone new each time, adding a few cents to it with each pass. It's all very inspirational, but at somewhere north of US$150 in value in the torch, it's gotten difficult to move due to the problems with on-channel liquidity.
So you could have $200 sitting in a payment channel, but if your peers on the other side only have $100 of liquidity, you can only transfer half of the value you think you have. But if you have another $200 in a different payment channel, and all your peers on the other side have $200 or more in liquidity, you can extract the full $200 of value from your coins there.
The slightly mind-bending result is that the actual on-paper value of Bitcoin in the Lightning Network is dependent on its location in the network. It's possible for some Bitcoin in the network to be much more or much less valuable than others at any given time.
It's also speculated that this will lead to a situation where the Lightning Network mimics the geographical discrimination of the traditional financial system. A poorly connected person's money will simply be worth less than a well-connected person's money.
In this way, the Lightning Network introduces an entirely new element of non-fungibility to Bitcoin as an asset class. There are probably some amateur economists somewhere with a strong opinion on what that means for the inherent value of Bitcoin.
3. Lightning Network payments are not trustless below a certain threshold
The Lightning Network's payment channels are not actually trustless for smaller payments, which means it will likely never be able to handle micropayments – removing another potential use case from the table.
HTLCs don't work for micropayments (below tx fee level), though single satoshi payments can be securely made within a channel. Pretending 1-satoshi HTLCs are a thing is setting people up to be disappointed...
— Tadge Dryja (@tdryja) March 2, 2019
The meat of Lightning Network payments are called "hashed time-locked contracts," or HTLCs. They're basically the rules for passing payments between strangers on the Lightning Network to ensure that none of the third parties steal someone else's money as it passes through the network.
The problem is that these rules can only be enforced for transactions of a certain size and that they start falling apart for smaller payments.
With the current way the Lightning Network is designed, one of the thresholds at which payments risk falling apart is at the current Bitcoin on-chain transaction fee. In other words, if an on-chain Bitcoin transaction with a $10 fee wouldn't go through, you can't be sure a $10 Lightning Network payment will go through either.
This is because once your payment drops below that threshold, a third party is able to render the payment unspendable. In oversimplified terms, they can basically do this by running out the clock on the HTLC at which point the transaction should be automatically returned to the sender on-chain. But because there's not enough money in the transaction to pay the network fees, it will never arrive.
But to be fair, this might end up being more of an unsolved problem rather than an unsolvable one. It can join the backlog with all the other Lightning Network problems, and eventually it may or may not be solved.
But with so many potentially unsolvable problems still out there, it might not even matter in the end.
- Inevitable centralisation: The centralisation of the Lightning Network around central payment hubs can be seen in visualisations.
- Users report lost funds: Christoph Bergmann
- The Lightning Network is economically irrational when there are other instantly settling digital currencies available: Peter Rizun
- Businesses can't afford to lock up so much capital in the Lightning Network: Jason Smith
- Bitcoin in the Lightning Network is non-fungible and subject to different value based on the region of the payment graph: Emin Gün Sirer
- The Lightning Network does not support micropayments: Tadge Dryja
- The trustless threshold for Lightning Network payments is the current Bitcoin dust threshold (workable on-chain transaction fee): Peter Rizun
Disclosure: The author does not hold any cryptocurrencies at the time of writing.
- SEC crackdown on Binance, Kraken – What it means for Aussie investors
- Sam Bankman-Fried found guilty – what it means for Australian FTX victims
- Bitcoin’s price soars over 10% on ETF rumours – here’s why
- New regulations for Aussie crypto exchanges: What it means for investors
- Sam Bankman-Fried’s FTX trial starts tomorrow – what it means for FTX customers