The Phonon network has advantages over state-channel based solutions such as Lightning (LN) and Raiden, in that it does not require lock-up of capital in unique counterparty channels and/or the use of intermediary “hubs” to forward payments. Rather, every phonon in the network can always be transacted independently of any other phonon with any other participant. The “lock-up” in the Phonon network is a normal blockchain transaction, and the funds can either be instantaneously moved around Phonon or the blockchain without a challenge period. Additionally, because the rules are enforced by the hardware and software on the smart card, the participants don’t need to continuously monitor the state of the blockchain. Monitoring the chain is currently a requirement for state-channel based solutions. Participants need to be vigilant and connected so they can challenge fraudulent withdrawal requests during a challenge period. This highlights a major economic issue with the ability of state-channel based systems to scale namely the cost of capital. Although LN is effectively free at the moment, this is only due to the fact that hubs are attempting to garner greater market share. Over time, these hubs will demand payment for use of infrastructure and capital in forwarding payments across the network. The cost of a lightning transaction will require the payment of interest to each forwarding hub to cover the cost of capital for the duration of the multilateral channel. This means if we assume a “risk-free” rate of return of 3%, a payment which passes through one hub, in a channel that is open for one month, will require a fee of ~0.3% to be paid to the hub operator. This fee will increase linearly with the number of hubs through which a transaction must transit as well as the duration of the channel. Inevitably, this means that lightning will ultimately be a network dominated by a few low-value, rent seeking intermediary hubs similar to Visa/Mastercard today.

The Phonon network in some ways is most similar to Plasma. However, instead of relying upon a node operator to maintain up-time, connectivity, and honesty over time, the Phonon network relies upon the cards continuing to perform as designed. Plasma also provides a much richer state, replication of the EVM, whereas the Phonon network is only focused on basic payments. Plasma provides the users with the ability to present fraud proofs in the event of an operator becoming nefarious, whereas the Phonon network has no recourse mechanism. However, one could argue that practically fraud proofs may not work. If a Plasma chain is of sufficient complexity and scale, although the use of fraud proofs is possible, they may not be feasible to use at scale due to throughput limitations on main chain. Interestingly, although Phonon network participants are depending on card manufacturers to make well behaved cards, if the manufacturer were to become nefarious, only assets that were directly exchanged with the manufacturer would be able to be compromised by the manufacturer. Assets that are exchanged between users or stored on cards would be unaffected and could be moved back to chain. The Phonon network provides attack segmentation whereas a nefarious Plasma operator would affect all funds in the Plasma system.

Root of Trust

The Phonon network is not completely trust-less — each card is signed by the card issuer and may only transact with other cards which are similarly signed by the same issuer. This is manifested in the form of a “certificate”, which is installed on the card in the manufacturing process. This means the Phonon network requires participants to trust the card hardware manufacturer, the software running on the card, and the process by which certificates are generated for the cards. This is a lot of things to trust.

Manufacturer certificates are the root of trust

However, because the cards are distributed and the off-chain assets are atomic (i.e. non-fungible), breaking the root of trust only compromises specific, physical cards (which, if trust is broken, can be presumed to be nefarious). This means the only real way to compromise the system is to inject malicious cards with valid certificates and, as such, there is no global honeypot — only the phonons held by cards which interact with malicious ones. Clearly the incentives are towards honesty because continued trust of the system will lead to greater sales of smart cards. Furthermore, if one of the participants becomes rogue, the fraud would easily be traceable back to that actor by network participants (after assets are withdrawn on-chain) and one would expect the market share of competing card manufacturers to grow in response.

Many card manufacturers may participate in the Phonon network. The code for the Phonon network is an open-source Java applet. If Alice wants to modify the Phonon source, provision and sign software on a smart card to allow her to move Grin across the Phonon network she could. However, she would only be able to interact with other cards which recognize Alice’s certificate as being valid. This certificate essentially functions as an entity’s (in this case Alice) attestation that the function and performance of the card follows certain rules. Generally, the most basic rule within the Phonon network is that assets shouldn’t be double spent. The consequence of this is that an asset that is moving across the Phonon network that has a different root of trust, say Alice vs. GridPlus, would not be interoperable assets. They could be thought of as sub-assets say A-ETH and GP-ETH. Like with all other aspects of the Phonon network, the recipient of funds is able to decide which card issuers or certificates and therefore assets they are willing to accept.

Phonon Network Use Cases

Although, it isn’t typically discussed, all blockchain payments have risk in settlement. There is never a point in time at which the probability of an Ethereum or Bitcoin transaction being reverted goes to zero. Based on the Byzantine fault tolerant incentive structures currently in place, the certainty of finality of a transaction never becomes 1, but rather logarithmically approaches 1. The number of blocks at which a counterparty is willing to accept a payment as finalized is that counterparties’ pricing of risk. In Bitcoin this is often assumed to be 6 blocks and in Ethereum it may be 30. This is the amount of risk a counterparty is willing to take against a transaction of a given size. Larger transaction amounts would require a larger number of block confirmations to maintain the same risk price for a transaction. There is also the implicit cost of time-to-wait for settlement that also goes into the transaction. It is up to the recipient to determine what level of risk they are comfortable with, juxtaposed with how long they and their counterparty are willing to wait for settlement. In this context, Phonon provides a new paradigm for conducting transactions wherein the transaction costs are ~zero, and the settlement time is instantaneous. However, this is weighted against the network participants pricing the risk of losing assets if they interact with a nefarious actor that manages to compromise a card on the Phonon Network. Therefore, in its nascent stage, we believe that most users will find Phonon is especially well suited for transactions that were previously conducted using cash in addition to micropayments that are not economically feasible to settle on mainnet.

Cash Payments

Each phonon on the network is an atomic, non-fungible packet and is represented in part by a public-private key-pair. This means that creating a Phonon requires a payment to be sent to an address generated by a card. Additionally to be redeemed to the blockchain an input must be processed for each phonon. This creates an economically viable lower bound for the size of a practical phonon based on the network fee. For Bitcoin, payment inputs can be aggregated together in one transaction making the redemption per phonon less expensive. Given the current transaction costs of Bitcoin, the cost per phonon when redeemed is shown below.

Phonons are most similar to cash

The transaction cost even when multiple phonons are redeemed together puts the lower bound on the transaction cost of ~$0.50 for Bitcoin. If we assume the highest fee someone is willing to take in transaction fees is 10% this makes the smallest economically viable phonon $5. For Ethereum, we believe it will cost roughly 50k gas to create and then 50k gas to redeem a phonon, though many phonons can be created in a single transaction thus drastically driving down the cost per phonon to create. Given current gas prices as well as similarly aggregating phonons to minimize transaction costs, an economically viable phonon would be 10 times ~$0.01 or a $0.10 Phonon. Although, this is a simple analysis creating an economic lower bound for the size of an independently transacted phonon, the story gets more complicated and the lower bound decreases with more vibrant economies and markets.

Micropayments Payments

If a phonon is created which is too small to make economic sense to redeem to the blockchain (a “microPhonon”) , would it still potentially be useful? Why? The exact same reason that a Bitcoin is useful. It is a fungible unit that represents value, can easily be exchanged, and has a known deterministic monetary policy which creates scarcity. Therefore, the microPhonon would still be a useful mechanism of account for certain use cases. There would likely be third party service providers that would allow individuals to buy and sell microPhonons for phonons or on-chain assets. These service providers could charge a fee for the matching service much like a bank or Coinstar performs for coins today. As long as there are use cases which continue to demand microPhonons, there will be a market that creates an exchange rate that in equilibrium would be slightly below par. This means that the lower bound of usefulness for a microPhonon is now significantly lower than what it would need to be to allow redemption to chain. The lower bound is now determined by many factors including, electricity, bandwidth, and the size and lifetime of the memory on a smart card. Considering these factors, our estimate for the practical lower bound of a useful microPhonon is ~$0.0001. There are some additional, theoretical security trade-offs for microPhonons that don’t exist for Phonons, however, these are complex and won’t be addressed here. Any device that has a smart card chip, or is connected to a device with one (e.g. the Lattice1), will be able to perform machine based micropayments.

GridPlus Lattice1 can Leverage The Phonon Network for payments

Why the Phonon Network

The Phonon network will allow blockchain networks to scale to handle all of human commerce as well as machine based micropayments. There are some trade-offs in lower transaction costs and increase to risk of loss of funds. However, we believe that these trade-offs are much like the trade-offs inherent to using cash. Phonons are similar to cash in that the benefits of lower transaction costs and instantaneous settlement outweigh the risks (e.g. counterfeiting). The Phonon network could find a niche for everyday commerce and it does not suffer from requiring intermediaries like other L2 scaling techniques. There is no upper bound on the scale of perfectly private transactions on the phonon network, it scales linearly with the number of secure hardware devices that exist. This starts with the first 5,000 Lattice1 being produced by GridPlus and available for pre-order, but is expanded by the SafeCards (also available for pre-order) on the network. The Phonon Network will be further extended by any other manufacturers of smart cards that run the Phonon code.

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