Bitcoin, the Next Level

Nevermind the price — the technology is making progress

There are many ways to measure the value of bitcoin, but most proponents of the decentralized cryptocurrency agree that the more people use it, the higher its value will be.

One of the reasons bitcoin’s market capitalization is only $145 billion is that not many people are using it as currency. While millions have opened accounts at popular bitcoin exchanges like Coinbase, few actually transact in it, except for speculation. At the moment, the number of confirmed transactions on the network is around 200,000 per day, which is about half of the network’s capacity.

But even if bitcoin gains more users as a decentralized currency independent of the banking system and not just as a means of speculation, the current network capacity (400,000 to 500,000 transactions per day) will be too low, too slow, and too expensive in the long term.

“If this truly becomes a global currency we use for transactions of any size, and if we promise people they will be able to do micropayments … then we need to have scalability,” said Christian Decker, core tech engineer at Blockstream, a blockchain technology company that supports the main version of bitcoin, Bitcoin Core.

Blockstream, based in San Francisco, is one of three companies working on the next-level solution for bitcoin scalability, called the Lightning Network. Other major players are French company Acinq SAS and San Francisco-based Lightning Labs.

The open-source Lightning Network, which does not have one simple application for the wider public yet, is a second-layer network built on top of the original old and slow bitcoin blockchain. Right now, the network has about 1,700 expert users, according to Decker, mostly computer programmers.

Users can fund accounts on the Lightning Network using bitcoin, which remain on the blockchain and don’t move. Transactions on the Lightning Network are done off the bitcoin blockchain, making it competitive with traditional credit cards and banks in terms of speed and cost.

The network is capable of processing millions of transactions per second, and fees are proportional to the payment amount, so they may be only a fraction of a cent. This is different from the bitcoin network, where even small transactions can be expensive because they are proportional to the data used in the transaction, not the amount of money sent.

“Right from the get-go, I always wanted bitcoin to be a currency first and foremost—not some safe haven where I can store my money,” said Decker.

A Simple Goal

The exact workings of the Lightning Network are complicated, like everything in the blockchain world. The first transaction funds a so-called “channel,” an account shared with a counterparty. This first transaction is done on the original blockchain.

Once the channel is funded, payments are sent on the Lightning Network, and only settlement transactions, in which bitcoins are removed from the Lightning wallets, are recorded on the blockchain again.

“In the best-case scenario, we have two transactions happening on the bitcoin blockchain. That is the channel creation to a wallet that is controlled by both parties. … Once we decide to settle the channel, we create a second transaction, and it takes the funds from the joint wallet to wherever we agreed upon first,” said Decker.

For Lightning transactions, users transfer funds from party A to party B quickly and cheaply by using the channels of other participants.

However, Decker says the end-goal is for consumers just to think about having bitcoin and using it as payment.

“We do not want people to think about channels,” said Decker. “If you have a bitcoin wallet in any form, I would like people to think about the Lightning Network like a normal bitcoin wallet. It would show you one screen with one single balance.

“From this one balance, you can perform Lightning and normal bitcoin payments. What you end up with is a small app that you can run on your computer or your mobile phone that will get the needed information on its own.”

Scaling Gold

The whole system is not unlike the scaling of physical gold centuries ago. People used physical gold as a means of payment, but it was hard to carry around and it was difficult to find exactly the right amount, making it expensive to transact in gold.

The physical gold scaling involved storing it with a goldsmith or a bank and using paper receipts as payment, which were easier to carry, could be replaced when lost, and could be modified to reflect exact amounts.

The biggest problem with this system was that people needed to trust the goldsmith or the bank not to issue too many receipts for too little gold. After all, people seldom withdrew the gold and didn’t know how much was kept in the vaults, nor how many receipts were issued against it.

The Lightning Network does better in this regard.

“The bitcoins are on the blockchain that we can audit in real time, and we know the coins are there and they won’t be moved without our agreement,” said Decker.

So the Lightning Network can only operate if it is fully reserved, and there cannot be an overissuance of bitcoin to fund Lightning channels.

What Lightning doesn’t solve is the old trade-off between decentralization and scalability. The original bitcoin network has hundreds of programmers working on it around the world. No single person or company can change the code. Mining and usage is also relatively decentralized globally, compared to other cryptocurrencies or centralized banking solutions.

Lightning only has three companies working on it, each of which has the power to change the program, so the speed comes at a price.

But Lightning is designed to handle millions of mostly small transactions and compete with traditional banking and credit cards, all of which are 100 percent centralized. Users will likely only put a small amount of funds at risk to gain access to faster and cheaper payments in bitcoin.

So when can the average user try the new network with a neatly designed app on their phones?

“One year, maybe two. The theory is all there; it’s very sound,” Decker said. “What is unpredictable in the space is how much engineering time and effort is needed. We do have the plans, and now we have to follow them. The devil is in the details.”