EKIP– Expert Club for Economics and Politics A Different Opinion
Blockchain technology is considered by many to be revolutionary, but it still has its drawbacks. The first and most popular cryptocurrency, namely Bitcoin, besides being considered revolutionary and eliminating the need for a bank intermediary, is slow and expensive. The drastic price jump in 2017 made it attractive to speculators and people wanting to get rich as quickly as possible ( get-rich-quick ).
The purpose of this post is not to analyze what its price should be, whether it will go up or crash, because it is a scam or a bubble, but rather whether it has a future as a means of payment. There is already an article on my blog on this topic, although not mine personally - link. It remains to be seen whether Bitcoin will fulfill the function of money in a society, for now it is only clear that there is a major obstacle to this endeavor and no one can say for sure what will happen if this obstacle is overcome.
If I were to send Bitcoin to someone right now, they would receive it in a few hours, and I would have to pay a hefty transaction fee. Any idea that can solve this so-called scalability problem is worth considering. The Lightning Network is one such idea, but before we can see what solution it offers to the problem, we need to understand what the problem itself is.
Why is blockchain slow?
Think of the blockchain as a ledger. It stores multiple pages (blocks), each of which contains multiple transactions. When a page is full of transactions, it must be added to the ledger before they can be written to the next page.
Before a page (block) is added to the ledger (chain), procedures are followed to verify that everyone on the network agrees that the page contains what it is supposed to contain. This process takes about 10 minutes for each block. The transaction contains information about both the sender and the recipient, the amount of money sent, and the fees for its execution. You can pay and “incentivize” miners to include your transaction in one of the mined blocks as soon as possible. It is entirely up to you how much you are willing to pay to speed up the process, but the higher the fee you pay, the faster the transaction will be completed.
At any given time, there are several transactions that need to be recorded on the current page (block). Miners, i.e. computers working on the network, have to decide which of the available transactions to include in the newly mined block. How do they choose which one to include? By comparing which one will bring them the highest reward, that is, has the highest fee involved. If there are enough transactions with a higher fee than yours, then the funds you sent will have to wait until the next block is mined. This wait can last several hours. The higher the fee you pay, the faster the transfer will be made. This is why blockchains are slow and expensive. And here comes the idea that aims to eliminate this problem – the lightning network, created by Blockstream.
What is the Lightning Network?
The idea behind it is that not all transactions need to be recorded on the Blockchain. Imagine that we exchange several transactions with each other. This way we can bypass recording them on the ledger (Blockchain) and keep them off-chain. How does this work in the simplest terms? We open something called a “payment channel” between us and it will be recorded in the block. So we can make an indefinite number of transactions on this payment channel and it can remain open for a certain period of time – hours, days, weeks, even decades. The only time it will touch the Blockchain is when we decide to close it.
Using the idea of a payment channel, we can create a network of similar channels that do not require the use of transactions on the Blockchain. Imagine three characters – Ivan, Pesho, and Mitko. If Pesho has a separate payment channel opened with both Ivan and Mitko, then Ivan can send money to Mitko through Pesho. This is the idea behind the Lightning Network. Since transactions will not touch the Blockchain, they will be carried out at lightning speed. Everything will be done in the payment channels.
What are payment channels?
Payment channels are like a safe deposit box where two people put the same amount of money and both lock it. The process of putting the same amount of money into the safe is recorded on the Blockchain as an “opening of a transaction,” and thus the payment channel is opened between the two parties. The idea behind the lock is that neither party can spend it.
Imagine that Ivan and Mitko each put 10 bitcoins into such a shared safe. Let’s assume that Ivan wants to send 2 bitcoins to Mitko - how would this happen? To do so, Ivan sends a “promise of ownership” for these 2 bitcoins to Mitko into the safe. After this transfer, if the safe is unlocked, Ivan will be able to receive 8 bitcoins, and Mitko – 12.
The next day, Mitko wants to send 1 bitcoin to Ivan. He will do exactly the same thing, sending a “promise of ownership” for 1 bitcoin to Ivan. After these two transactions, if the safe is opened, Ivan will be able to claim 9 bitcoins, and Mitko – 11. To summarize – a payment channel is a combination of pooling money and exchanging promises of ownership in a way agreed upon by the participants.
If one of them ever wants to close the channel, they can do so. Closing the channel is like opening the safe and taking the money out of it. Opening it happens on the Blockchain, where it is forever recorded who gets what part of the safe. The true power of payment channels can be revealed when two or more participants start working together to form the Lightning Network. With this type of payment channel, a huge portion of transactions can be taken off the Blockchain network and carried out outside of it.
As of February 25, 2018, there are 877 nodes and about 1,700 payment channels operating in the network. The capacity of possible transactions in the network is tens of thousands of dollars.
A bright future?
A few days ago, the crypto exchanges Coinbase and Bitfinex announced that they would implement SegWit. SegWit is a technology that reduces the size of a Bitcoin transaction, allowing more of them to fit into a single block. It is also necessary for the Lightning Network to work properly (in theory, it is not needed, but in its absence, the latter is much less efficient). If both were implemented, although Andreas Antonopoulos does not consider this possible, the two biggest drawbacks of the cryptocurrency would be eliminated to a very large extent.
