When I was first introduced to bitcoin it was presented as a technology that would make everyday transacting smooth, fast, and trustless and that would make micro transactions a reality. As easy as it would be to send an email, I would be able to send any amount of money (from micro, to big amounts) all over the world while avoiding the limitations of the current transaction systems, such as slow transaction times (e.g. wire settlement can take days), high fees (e.g. average credit card fees range between 1 and 3%). In reality I came to find out that confirmation times on bitcoin are rather slow and transaction fees are generally nontrivial. Hence, at the present mainstream adoption of bitcoin as a payment’s mechanism has not materialized.
So, I asked myself the question: “What will it take for bitcoin to go mainstream as a payment mechanism?” If bitcoin wants to go mainstream as a payment mechanism it needs to be able to scale the number of potential users. This requires faster confirmation times while keeping transactions fees low. Only then will bitcoin be able to be broadly adopted as a payment mechanism by merchants and consumers.
As I explain in the article below, it appears layer 2 solutions on top of the bitcoin blockchain, such as the Lightning Network, look to be promising scaling solutions for bitcoin. But first let me briefly explain why bitcoin confirmation times are slow and the average transaction fees on the bitcoin network are relatively high.
1. Why are bitcoin confirmation times slow and the average transaction fees high?
Transactions broadcasted on the bitcoin network are batched together, verified and approved by mining nodes in so called ‘bitcoin blocks’. This process is commonly referred to as ‘bitcoin mining’.
1.2. The average bitcoin block time of 10 minutes
On average bitcoin blocks are mined (i.e. validated and added to the blockchain) by a mining node every 10 minutes. In accordance with the bitcoin protocol, the size of a bitcoin block is limited to 1MB of data. This limits the number of transactions that can be inserted in a single bitcoin block. This effectively means that (1) on average a single transaction will only have been confirmed once after 10 minutes (comment: it is common practice to wait for multiple confirmations before a transaction is accepted as final) and (2) on average the bitcoin network can only settle about 4-7 transactions per second in total.
If you compare that to traditional payment processors who are able to process thousands of transactions per seconds, such as Visa, it’s no match.
1.3. Transaction Fees
Transaction fees on the bitcoin network fluctuate as they are determined by the free market. In other words, transaction fees on the bitcoin network depend entirely on what users of the bitcoin network are willing to pay to bitcoin miners in order to prioritize their transactions. As the number of users on the bitcoin network continues to grow over time, more transactions need to be processed at any given time, all competing for the same limited space of 1MB per bitcoin block every 10 minutes. Given this increased competition, users of the bitcoin network are willing to pay higher transaction fees to bitcoin miners in the hopes of getting their transactions processed in a timely manner.
Given the limitations set forth above, it is rather obvious that the bitcoin blockchain itself is not well suited to be used as a payment mechanism by merchants and consumers for day-to-day commerce.
So why were these limitations inserted in bitcoin’s source code in the first place?
2. Why is the average bitcoin block time set at 10 minutes?
The average bitcoin block time of 10 minutes was deliberately chosen and included in bitcoin’s source code by the creator of bitcoin, known under the pseudonym Satoshi Nakamoto.
It is generally accepted that Satoshi Nakamoto has chosen said time interval of 10 minutes as a trade-off between (1) the speed of the bitcoin network and (2) the stability of the bitcoin network.
A bitcoin block that is mined is immediately relayed throughout the entire bitcoin network. A miner who gets notified of a new block will verify the validity of said newly minted bitcoin block and, if valid, update its version of the bitcoin blockchain by adding the newly minted bitcoin block to the blockchain.
The size of the bitcoin network is such that a short period of time may elapse before the broadcast of a newly minted block propagates throughout the entire bitcoin network. Hence, it can sometimes occur that a new block is mined, even though another mined block containing the same transactions had already been broadcast to the bitcoin network but had not yet been received by the miner who minted the most recent block. In such case, 2 different versions of the bitcoin blockchain will temporarily exist at the same time. This is what is called a ‘hard fork’. Generally, such split in the bitcoin network will be resolved quickly and the network will reconverge to one single version (i.e. the longest blockchain).
By ensuring that on average a sufficient amount of time (in casu 10 minutes) elapses between newly mined blocks, the risk of a fork materializing is mitigated, though not entirely excluded. A shorter time interval would increase the risk of hard forks occurring more frequently, which would destabilize the bitcoin network.
3. Why is there a maximum bitcoin block size?
The maximum block size of 1MB was also deliberately inserted into the bitcoin source code by the creator of bitcoin, Satoshi Nakamoto. The size limit was only added to bitcoin’s source code in 2010, i.e. more than a year after the bitcoin protocol was released in 2009.
It is generally thought that Satoshi Nakamoto added this size limit to ensure the long-term decentralization of the bitcoin network. In this regard, it is argued that larger blocks would make full nodes more expensive to operate. By keeping the maximum block size to 1MB, the average person is able to operate a full node on a consumer grade laptop or PC.
Now that we know why the 10 minutes block time and the maximum block size are materially important for the bitcoin blockchain, we understand that alternative solutions are needed if we are to scale the bitcoin network such that it becomes useful for day-to-day commerce on a broad scale. One such solution may well be the layer 2 scaling solution that is commonly referred to as the ‘Lightning Network’, as I explain further below.
4. What is the Lightning Network?
The Lightning Network is a payment protocol that integrates with the bitcoin blockchain, enabling instant and ultra-low fee transactions among members of the lightning network. Transactions on the Lightning Network are highly efficient because they’re not subject to the above-mentioned limitations of the bitcoin blockchain, i.e. no 10 minutes confirmation times.
The Lightning Network operates based on payment channels between transacting parties. Said payment channels are only settled once on the bitcoin blockchain on a net basis, if and when the transacting parties decide to close their payment channel. As long as the payment channel remains open, the transactions which are executed within that payment channel are not broadcast to the bitcoin blockchain.
In other words, when using the Lightning Network you gain in efficiency (e.g. suitable for many small transactions), while maintaining the immutability of the bitcoin blockchain but only as a final settlement layer (as opposed to a payment layer).
You can think of the following analogy: Picture walking into a bar and having to swipe your credit card every time you order a drink. That would get frustrating fast and would slow you and the bartender down. Instead, you open up a tab once at the beginning of the night and settle up your tab once at the end when you’re done drinking. In this situation, you only have to bother the bartender one time. By analogy, the first example would be a transaction on the bitcoin blockchain (i.e. highly secure for the bartender, but inefficient). The latter would be a transaction on the lightning layer (i.e. highly efficient, but less secure for the bartender until the tab is settled at the end of the night).
Work started on The Lightning Network in 2015 by Joseph Poon and Thaddeus Dryja. But it wasn’t till March, 2018 that Lighting labs would announce the initial release for developers to begin testing their implementations.
5. Can the Lightning Network take bitcoin mainstream as a payment mechanism?
Before we explore the answer let’s first define what mainstream means.
Per dictionary:
Mainstream: the ideas, attitudes, or activities that are regarded as normal or conventional; the dominant trend in opinion, fashion, or the arts.
For bitcoin to be regarded as a normal or conventional payment mechanism, I believe it’s going to need to be adopted by the world’s major merchants (e.g. Amazon, Walmart, Apple, etc.). Once major merchants start adopting bitcoin as a payment method, this will likely encourage smaller merchants to start adopting it too.
Up until recently, merchant adoption has not been possible due to the inherent limitations of the bitcoin network, making it inefficient as a day-to-day payment mechanism (i.e. too slow and expensive). However, the Lightning Network seems to solve these limitations. The speed and ultra-low transaction costs on the Lightning Network may even make it an economically more attractive payment mechanism for major merchants, as well as consumers, compared to the traditional payment mechanisms (e.g. debit and credit cards).
In this regard, you could image in the near future, retail giants having Lightning nodes set up at every register where you can instantly swap fiat dollars into Bitcoin on the fly. You’ll be able to do this with no delay in settlement and at nearly zero cost.
If the Lightning Network turns out to be economically more efficient than traditional payment methods, it will likely drive adoption by major merchants and, in such case, one can even imagine major merchants starting to incentivize consumers to use bitcoin via the Lightning Network with rewards and perk. This could be a key driver for the mainstream adoption of bitcoin as a payment mechanism.
6. What are the benefits of adopting the Lightning Network?
The benefits of the lightning network are plenty, but I’ll talk about a few that are relevant to this article.
6.1. Lower fees
In the current system, merchants have to pay transaction fees to an intermediary (e.g. average credit card fees range between 1 and 3%). The fees on the lightning network are substantially lower so more profit per sale for the merchant. With more profits, merchants can build strategies to use that extra income in the form of sales, promotions, or add to the company’s treasury.
6.2. No chargebacks
Traditional payment mechanisms leave merchants exposed to the risks of chargeback after the completion of a sale. Even when contested by the merchant, chargebacks are usually settled by the bank in favor of the customer.
Chargebacks are not possible on the Lightning Network. This could be another major economic incentive for merchants to adopt the Lightning Network.
6.3. Lower barriers to entry for individuals
Not everybody (especially in countries of the so-called ‘developing world’) has access to a bank account and, as such, debit and credit cards. This makes it difficult for them to transact and save, and to participate in the economy.
The Lightning Network has the potential to lower the barriers to entry for people who are unbanked to participate in day-to-day commerce, as they would in essence only require a smartphone and an internet connection.
6.4. Instantaneous international money transfers
The Lightning Network makes it possible to send money (no matter the currency) internationally instantly at extremely low costs. This can have a major positive impact on the global money remittance industry.
A prime example would the application called Strike, developed by Jack Mallers and his team, which allows you to send money instantly, with no fees, anywhere in the world.
6.5. Micro payments enabling new business models
The ability to send instant micro payments via the Lightning Network enables the possibility of creating new business models for, amongst others, content creators.
More in particular, one could imagine consumers paying content creators (e.g. podcasters, game developers, etc.) by the minute or by the second, as opposed to paying a set amount (e.g. subscription model).
A great example of this is the in-app Lightning podcast player from bitcoin wallet Breez, which lets users stream bitcoin payments to podcasters while they’re listening to the podcast.
By author, Jose A. Burgos
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