Payments Via Lightning Network Will Likely Face Regulation – Here is why

It is likely that the Lightning Network will face regulation soon. As companies like Domino’s or Twitter offer or enable payments on the network. This means that the anonymity of LN could become a thing of the past. At least when using it to pay businesses. Transactions on their own might be anonymous but regulators can easily prohibit businesses from relying on LN if they do not comply with regulations. This is due to the design of LN which is fundamentally different from other transactions.

Risks require Regulation

In order to open a LN channel, you have to deposit a certain amount of Bitcoin. Obviously, this is fundamentally different from any other type of transaction. It is not comparable to prepayments for example. As a channel gives both Alice and Bob access to the funds deposited in the channel. A client usually conducts a prepayment through a third party service. Prepayments in cash are de-facto unregulated but bear certain risks. Just as the Lightning Network.

A user on the Lightning Network has to maintain a node. This means that a Lightning channel bears the same hacking risks as a hot wallet. Of course, you can reduce those risks by using the latest anti-malware software and by taking the usual precaution. But depending on which end of the channel holds the funds, it is as difficult to estimate the risk as it is for funds on an exchange wallet. In the end, the risk cannot be eliminated.

That alone would already justify clarifying the liability in such a case, i.e. to regulate businesses using LN. It probably won’t be necessary for transactions between two private persons in a non-commercial context. But from the regulator’s perspective, the regulation of LN in B2C-relations makes as much sense as regulating Mt. Gox, QuadrigaCX and BitGrail.

Custody – the Crucial part about Lightning

The crucial part of maintaining a channel is not that there is no middleman involved. But that Alice and Bob become custodians of each other’s funds and that they have to settle their balance once they decide to close a channel. “Custody” in that sense literally makes LN users becoming their own banks from a legal perspective. As they even earn Satoshis for facilitating transactions. Therefore, it is likely that you will need to submit KYC/AML information in the future for using LN. At least in the case of buying a pizza at Domino’s.