Bitcoin Is Scaling Exponentially With Lightning Network

Summary

• The lightning network is a critical network upgrade that will allow Bitcoin to scale by orders of magnitude.
• The lightning network is not a single protocol, but rather a collection of proposals and open source software that are designed to be synergistic.
• Lightning network technology is already spreading to other cryptocurrencies, such as Ethereum under the name Plasma.
• This idea was first discussed with members of my private investing community, Crypto Blue Chips. To get an exclusive 'first look' at my best ideas, start your free trial today >>

Introduction

Many have claimed that Bitcoin (BTC-USD)(COIN)(OTC:GBTC) and or blockchain cannot scale. There is some truth to this, but as we will see; scale is a moving target. There are many aspects to scaling and many approaches to "solve" the scaling problem. The Lightning Network is one such approach, which is also multifaceted. If the Lightning Network can deliver on the capabilities that its originators claim, then the argument that Bitcoin/blockchain cannot scale will have been dispelled (the theoretical speed is billions of transactions per day); at least for a while.

Why are blockchains slow?

In software development, we start off by thinking about what problem we are trying to solve before we ever write a line of code. Each piece of software (ideally) should be written to solve a certain problem the most effective way possible. I'll give you one example.

Let's suppose your problem is that you need to store and retrieve data. Usually, this problem is solved using a database. However, databases have certain limitations. One of those limitations is that even the largest databases do have storage limits. Also, if your data (or the query you need to run on that data) is complex, the time it takes to get your data out of that database could be longer than your customers want to wait.

Imagine you're Google (GOOGL). Someone searches for the term "bicycle." It turns out there are at least 744,000,000 results for this search term, and your users are expecting a response in a fraction of a second. I'll spare you the technical details, but there are certain strategies that Google will use to make this happen. Some of their strategies might be to denormalize the data, make use of caching, and serve the data to you from the closest possible CDN.

What in the heck does this have to do with blockchain?

Well, recall that blockchain is a slow, distributed data structure, in which it's difficult to add data (powerful computers must compete 24/7 for the chance to add a single entry every 10 minutes) and history cannot be re-written without recalculating the whole data structure (it's immutable).

The purpose of a blockchain was not to be fast. The purpose of a blockchain was to be difficult to change (Proof of Work, write only) and tamper-evident. This means if you make a fake entry into the blockchain (sending yourself fake coins for example), I can prove that your entry is false and the network will reject your dubious entry because the majority of the network will also find this transaction to be invalid.

Anyone can actually download the blockchain and make a change to it, but the problem is that everyone else can see the change when you try to sync with the network. If your change isn't valid, then the rest of the community "vote you off the island" so to speak. It's actually the fact that the blockchain is a distributed ledger that makes is immutable in practice. The longest proof of work wins, this is called Nakamoto Consensus.

The Byzantine General's Problem

To understand why this level of robustness is necessary, consider the problem of the Byzantine General.

Nakamoto Consensus is the first known solution to the problem of the Byzantine General; creating Byzantine fault tolerance. Essentially the problem is, how do you send or receive a message in a hostile environment?

Source: Ivan on Tech via YouTube

The speed of the Bitcoin blockchain is a design decision.

The blockchain is slow because it's not designed to be fast, it's slow because it's designed to be durable and tamper-evident. It's slow because it needs to be able to resist constant assault and remain as a source of truth.

What is the Lightning Network?

The Lightning Network is a collection of synergistic protocols. In a white paper submitted in 2016, Joseph Poon and Thaddeus Dryja suggest that it's possible to have instant payments, scalability and practical micropayments by using a layer two scaling solution. The existing Bitcoin blockchain would form the base layer, being the ultimate source of truth for value transactions. Meanwhile, the Lightning Network would form a second layer, where transactions could occur quickly and securely, occasionally syncing with the base layer.

This approach takes on scaling in two ways.

1. Activity is moved from the base layer onto layer two (the Lightning Network), reducing the need to process every transaction on the blockchain.
2. On the second layer, transactions move much faster and cheaper, creating an attractive outcome for vendors and users, which reinforces the power of the base layer while allowing scaling rooted in Bitcoin but orders of magnitude cheaper and faster.

Where can I learn more about the Lightning Network?

I cannot possibly provide a complete guide to the Lightning Network in this article. However, I can give you a summary of the key points and a list of places where you can go to learn more and expand your understanding. Below is a short list that should get you going.

• Lightning Labs - A company founded by the brilliant engineer Elizabeth Stark. Their project on Github is very active and they are well known on social media and even occasionally on the news.
• Blockstream - With the Eltoo Lightning Network protocol, created by one of the largest Bitcoin related companies in the space; founded by Dr. Adam Back, an old school cypherpunk.
• Zap - A lightning powered Bitcoin wallet from Jack Mallers, a software engineer who successfully coded, tested, and posted many early videos of the Lightning Network being used in the wild.
• Lightning Network Bolt - This is a place to see Lightning Network specifications that are proposed or accepted by the community. The code is all open source and the discussions around the specifications happen in the public.
• Lightning Network Stats - You can get these from several places, but I prefer P2SH on Grafana. The two key stats are number of channels and sum of channel value. As you can see these are both going up very quickly, but the network is still young (there is no data before January 18th of 2018).
• Lightning Network Visualizations - A picture tells a thousand words. What did the Lightning Network look like in the past versus now? Take a look...

Lightning Network - Jan 2018

Lightning Network - August 2018

How does the Lightning Network actually work?

The Lightning Network is a peer-to-peer protocol, which has many different software implementations, in which users can transmit bitcoin to each other over a network of payment channels. Payments are automatically routed quickly and anonymously using TOR technology (the onion router). At any point in time, a user can close their payment channel and return their funds to the main net (the Bitcoin base layer).

Consider the following example, for illustrative purposes only.

Imagine you're at your friend's house. You decide to play a game of poker, so everyone puts in $5 and gets 50,000 chips in varying denominations. Many hands of poker are played using those chips. At the end of the night, everyone settles up and goes home with (or without) dollars. Each hand would represent a Lightning Network transaction (a transfer of value that your spouse doesn't need to know about), while the amount of US dollars people go home with would represent a transaction on the bitcoin main net.

Benefits for vendors and users

If you happen to run a small business, say a coffee stand; then you know that most of your customers are going to pay with a card. The average fee you will pay is around 3%, which is painful if you're running a business with low margins.

If you could get people to pay in Bitcoin, using the Lightning Network, you could be paying 0.1%. That's the difference between going on vacation this year or not. That's the difference between staying in business during the next recession or not. It's a big deal.

If you're an "Average Joe," you might like this too. Why? Well, sometimes Average Joe shops at Target (TGT) and Home Depot (HD). You used your card like you always do, what's the big deal?

Well, Home Depot and Target were hacked and you had to spend hours on the phone, and weeks emailing and sending letters trying to fix your credit because the PoS systems in those stores were compromised. Sure, you got the money back eventually, but it took forever and your credit was tanked in the meantime. Using Bitcoin, that's a non-issue. Why?

Because when you use Bitcoin at the base layer, or on the Lightning Network you do not transmit any information that could be used to make a purchase at a later date. When swiping your credit card at a point of sale system, the card number can simply be stored and sold off later on the dark web. With a Bitcoin transaction, the information transmitted is only valid for that single transaction. Even if someone had that information, they would not be able to use it to do anything else.

Additionally, because the vendor doesn't have to pay 3% credit card fees, they may even lower their prices, which Average Joe also likes.

Criticism of the Lightning Network

Many have raised concerns about the Lightning Network. The largest group of dissenters seems to be the Bitcoin Cash (BCH-USD) group, who believe that on chain scaling will be the future. I have my reservations about this, but the Lightning Network is actually being used today by some early adopters. So, either it will work or it won't, but judging from what has been going on so far, the growth and excitement around the new technology would seem to suggest that it's working.

Lightning Network and decentralization

One concern about the Lightning Network is that it will not be decentralized. This remains to be seen, but I would like to point out that Bitcoin itself is not completely decentralized. Naturally, because of competitive advantage; there will be clusters of concentration in many ways. For example, miners flock to areas with low power cost where the weather tends to be cooler. Users tend to group around their favorite app or exchange, and the most successful hardware for cold storage and mining tend to attract the largest crowds.

I don't believe true decentralization is possible in our world. There will never be a perfectly uniform distribution in a competitive environment. But, I think it's still significant that we have systems today that are more decentralized, and therefore more robust than ones that are highly centralized. Sometimes centralized systems are a good thing, sometimes, not so much.

If you think about roads and the power grid, there's pretty much two approaches you could take to building these networks.

1. You could optimize for least resources.
2. You could optimize for robustness.

In planning the power grid of the United States, we had to keep in mind that if we were attacked, it would be a strategic weakness to have the entire grid going through a single point. This single point of failure would be an optimal target by adversaries. By making the electrical grid less centralized, it is possible to have areas down, but be able to reroute power in some cases and prevent total system failure.

This trade off does cost more, you need to run more lines, you need new ways to connect. But, it also provides protection from interruption, which of course we need because electricity is a critical system for today's world.

The electrical grid and our system of roads are not really centralized or decentralized, but kind of a mix of both. When we think about things on a spectrum like this, it becomes clear that the balance of trade offs is the real design decision and one not to be taken lightly.

How centralized is too centralized? I'll let people smarter than myself figure that out. However, I contend that even with some clusters of centralization in Bitcoin, it's still the most robust network in the world.

Are other cryptocurrencies working on similar technology?

Yes! I wrote about this briefly in my article on Ethereum (ETH-USD). Vitalik Buterin and Joseph Poon (from the Lightning Network) have proposed Plasma, which could do something similar for the Ethereum network, raising the amount of throughput by orders of magnitude and allowing the swapping of many different kinds of tokens at "lightning" speed (pardon the pun).

Conclusion

It is hard to understate the potential of the Lightning Network. I've just scratched the surface with this article, we could get lost in the weeds with cross-chain atomic swaps, side chains etc, but that rabbit hole would be a bit too deep for today. As the Lightning Network grows, I am watching it closely, because I think that Bitcoin's future will be determined largely in part by what happens with the Lightning Network.

Disclosure: I am/we are long BTC-USD, ETH-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.