The Lightning Network is great, but it also faces various types of problems

In this article, I want to share with you some of my thoughts on the Lightning Network. First of all, I think the idea of ​​the Lightning Network is very advanced. It is an amazing application of 'smart contracts' that can realize a new financial system that has never existed in the world. This is a technical concept that cannot be simply applied to real-life banks and courts.

If you accept Bitcoin as the final arbiter of transaction verification, transaction time sequence, and the integrity of all signatures, then you can create a new financial system that has never existed in the world.

It is so new and unique that it is hard for people to understand the concepts. This is a practical challenge facing the Lightning Network; this uniqueness also presents such a problem. No existing financial laws can be applied to the functions of the Lightning Network.

I’ve previously explained how the Lightning Network works in a non-technical way. If you want to learn more, you can read that article.

First of all, I want to clarify a few points about the Lightning Network that are worth affirming:

1. The purpose of the Lightning Network is to enable secure off-chain transactions. It's unfortunate that the Lightning Network has this particular name. The reason for this name is that the system requires a 'network' to communicate on this second layer. However, it does not specify any particular network. Anyone can implement a Lightning Network; not just one specific company. There may be many coexisting and competing Lightning Networks in the future.

2. Because the Lightning Network requires a peer-to-peer Layer 2 communication network, this can lead to many people misunderstanding what exactly a Lightning Network transaction is, or who holds custody of the funds at a specific time.

3. Lightning Network transactions are Bitcoin transactions. This is crucial. The Lightning Network never holds custody of anyone's funds. All funds are held in multi-signature funding transactions on the Bitcoin network. All the Lightning Network does is make it easier to sign transactions between parties, but only the Bitcoin network itself holds or releases these funds.

4. Lightning Network transactions are unconfirmed Bitcoin transactions. It is essentially a mechanism that uses hashed time-locked smart contracts to securely perform 0-confirmation transactions. First, all unconfirmed Lightning Network transactions are based on existing confirmed fund transactions. These funds have been confirmed in multi-signature addresses on the Bitcoin network, and the unconfirmed Lightning Network transactions are based on these confirmed transactions; second, using some very clever 'smart contract' features, users can feel that these unconfirmed transactions are as safe as gold (or as safe as Bitcoin).

6. The technical details of how unconfirmed transactions are safely accepted are extremely complex, but very reliable. Of course, no one can trust such a system right away. It will undoubtedly take time for the community to create a new trusted financial layer. It will take a long time for people to be willing to entrust large transactions on the Lightning Network.

It is for these reasons that I feel strongly that the Lightning Network is the 'killer app' for on-chain decentralized transactions. If we can perform billions of small transactions (millionths of a cent if we wanted) in real time for free, then the Lightning Network solves a lot of problems. It's really an amazing and exciting invention.

Unfortunately, small transactions are the only clear use case for the Lightning Network, and other transactions involving small amounts using the Lightning Network have many practical problems that are difficult to solve.

So while I think the Lightning Network small transaction use case is a slam dunk, it’s important to understand the problems with it and why no one expects the Lightning Network to handle large amounts of payments anytime soon. It’s important to understand that truly small transactions are impossible on the Bitcoin network because the minimum fee is already larger than the average small transaction. This means that the only use case we know of for the Lightning Network can’t actually handle any transactions on the Bitcoin network because the Bitcoin network can’t handle small transaction use cases.

So, what are the problems facing the Lightning Network?

The Lightning Network does not exist yet. This is a fact of life. But while the concept is amazing and can be summed up in one slide, actually creating such a usable network would require a lot of work. The Lightning Network does not exist yet, and it will not exist for quite some time. There are many technical challenges to creating a fully decentralized peer-to-peer layer 2 network, and it is extremely difficult, though not impossible, to achieve.

Lightning Network scales transactions, not users. It is often claimed that Lightning Network will solve Bitcoin's scaling problem, but the reality is that it absolutely does not scale users. Bitcoin's current block size is capped to support only 100,000 semi-regular users. At best, it can only support a few million users twice a month. When you realize these issues, you realize that the Bitcoin community is actually very small. Indeed, many people who say they are Bitcoin users, but have never done anything on-chain (Coinbase, Circle, customers), have never gained the benefits of the Bitcoin network. Coinbase and Circle users are subject to AML/KYC and a high degree of government regulation. If we really want the Bitcoin network to be a place where people can safely hold assets on-chain, block size must increase significantly. Although Lightning Network can handle billions of transactions, it can only support 100,000 people holding assets on the Bitcoin network at present. Lightning Network requires on-chain transactions to open and close a channel, and Bitcoin block size determines the maximum number of channels that people can open. In the Lightning Network slides, they suggest that the average person needs to open no more than 1 channel every 6 months. This post goes on to discuss why this is unreasonable advice.

If the Lightning Network exists, people will not trust it right away. Trust is earned, not granted. And, let’s be honest, Blockstream, the company that promised to create the first Lightning Network, has not done a very good job of engaging with the community. From this point of view, other companies may have a better chance of implementing Lightning Networks. The bad influence has been left, and it will be difficult to erase. How many people are willing to use the Lightning Network created by Blockstream? Probably not many. How much financial value are people willing to entrust to the Lightning Network? Not a lot. In fact, I predict that it will take many years for people to trust the Lightning Network enough to entrust a large amount of value to the network; this has been the case so far with other cryptocurrencies, including Bitcoin. You can tell people that Lightning Network transactions are Bitcoin transactions, but people are not willing to entrust large amounts of value to the system until they have seen the network run securely for a long time.

If the Lightning Network exists, there won’t be wallets or payment providers supporting it anytime soon. It will take years before you can actually spend your Bitcoin online. I remember when we used to get excited when we heard about merchants accepting Bitcoin payments. Many Bitcoin enthusiasts even helped others run their businesses because they were one of the ones accepting Bitcoin payments. It takes years to develop the software infrastructure to integrate a completely new payment system; and the Lightning Network is, of course, a completely new payment system. Even if it is released, it will take a long time for Bitcoin wallets to be able to send and receive Lightning Network payments seamlessly, and it will take a long time for individual payment processors (Bitpay, Circle, Coinbase, exchanges, and other commercial sites) to support Lightning Network. So even if someone at Blockstream claims that they will have a working version of Lightning Network in the next 6 months, it doesn’t mean anything. It will take years for the network to gain people’s trust and be integrated into the ecosystem.

Lightning has problems with large value transactions. Lightning requires users and businesses to lock up the amount of Bitcoin they need for the duration of the transaction. For the use case of small transactions, this is not a large transaction. Locking up $5 or $10 in value is obviously not a problem. However, if the 'reasonable use case' suggested on the Lightning Network slides is that each person only opens one channel every 6 months, this is obviously not feasible. Each person only opens one Lightning Network channel every 6 months, which means that the channel needs to lock up the maximum amount of value that user holds in that time period. First, this requires full trust in the network, which I have already said will take a long time to achieve. Second, people cannot predict their payroll every two weeks, let alone 6 months of funds. Essentially you can think of Lightning as a prepaid credit card. You need to top up in advance, and you need to guess how much you will spend and when you will spend it. It is not practical for people to only open one channel every 6 months.

Payment channels on the Lightning Network will lead to a certain degree of centralization. No matter how hard engineers try to create a completely decentralized Lightning Network, the economics of payment channels will generally work in the direction of centralization. Payment channels require locked-up funds to process transactions. While technically every Tom, Dick, and Harry could pool their own Bitcoins to lock up in payment channels to earn transaction fees, the reality is that individual users cannot provide liquidity for Lightning Network operations at scale. The only payment channels that will work at scale will come from major businesses and financial service providers. There will be 'Circles', 'Bitpay's', and 'Coinbases' in the world for you. All of these businesses will undoubtedly be subject to close government regulation. You can keep repeating that "because technically Lightning Network doesn't require people to monitor other people's funds" (technically it is true), the reality is that financial regulators will not listen to such arguments. The bottom line is that if businesses want to use Lightning Network to process large amounts of transactions, they will be subject to financial regulation. There is no way around it. If Lightning Network proponents claim that regulators don’t need to regulate it ‘because nobody actually regulates other people’s money’ and it’s a ‘fully peer-to-peer decentralized network’, then these proponents are being overly idealistic. Likewise, these same people keep saying how important it is to keep the Bitcoin network completely decentralized to avoid government threats, but fail to realize that business activities on the Lightning Network cannot escape regulation. Financial regulators may incorrectly apply outdated laws to the Lightning Network, or they may simply rewrite new regulations. The bottom line is that if major companies process billions of dollars worth of transactions on the Lightning Network, they will be subject to government AML/KYC laws. Why or how Blockstream thinks they can be exempt from this is a mystery to me.

Unbalanced channels and large amounts of locked Bitcoin make the Lightning Network economically challenging. The Lightning Network is built using bidirectional payment channels. Each channel is based on existing and confirmed funding transactions on the Bitcoin blockchain. Once a user opens a channel, they can transact up to the amount of value that has been pre-locked in the funding channel. So if someone opens a payment channel for $100, the most they can send is $100. If they want to send $101, they can’t. The channel is full, they can close it, and create a new one, or do an on-chain transaction; of course, they can’t do an on-chain transaction as easily because their Bitcoin is locked in the Lightning Network channel. If a user opens a payment channel for $100, they can send up to $100 in value, but they can’t receive a single cent! If the user wants to receive a payment, the second party must also delegate funds. So if the user wants to be able to send and receive $100 in value at the same time, the other party must also be willing to delegate $100 in value. Now, once the initial user sends $100, he can theoretically receive up to $200 worth of value from the other parties. The 'channel' allows them to transfer their current balances to each other; but within their own initial transaction limits. However, this gets ugly when the whole network is up and running. This interconnected network of payment channels immediately becomes unbalanced. Now, if you want to send money from one person to another, you have to find a working channel among the large number of unbalanced channels. Unless these channels are entrusted with a large amount of funds, it will be difficult to find such a channel. The problem this leads to is that if you want to process a large number of transactions on the Lightning Network, people will need to entrust a large amount of Bitcoin so that these channels can remain open and have sufficient liquidity. We have to ask, is it a good idea to lock up a large amount of Bitcoin in payment channels to provide liquidity? At a large scale, it seems that it does not make economic sense.

Locking funds in channels means they are subject to market volatility. We all want Bitcoin to become a mainstream currency, and we all want it to appreciate due to its deflationary properties. If that were the case, then there would be no problem with locking Bitcoin in payment channels for a long time. Why not? You can collect transaction fees and see your Bitcoin appreciate. Unfortunately, this is not the case. The fact is that although Bitcoin is not as volatile as it used to be, it is still very volatile. Imagine if billions of dollars worth of Bitcoin were locked in payment channels, and suddenly Bitcoin experienced a huge market volatility. Can you imagine a large number of Lightning Network payment channels closing? Market forces will prevent large amounts of entrusted funds from opening payment channels because it will expose them to a large volatility risk. When the market fluctuates violently, it will bring instability to payment channels because they will close channels in large numbers, which will create a backlog of transactions on the Bitcoin network, causing transactions to be unable to confirm.

Lightning Network users need to have a 'hot wallet'. Currently, the best and safest practice for Bitcoin users is to store daily spending amounts in a 'hot wallet' (a wallet that can be connected to the internet and hosted on a computer or smartphone), and other funds can be stored using 'cold storage' or other offline methods. Users can transfer funds to their hot wallets securely by using a hardware wallet like a 'Trezor'. However, because the entire Lightning Network operates on funds locked in payment channels, these funds must be sufficient to maintain economic activity for the period of time the channel is open, and if you want to be a participant in the network, the software must act as a hot wallet to sign transactions in the network, which is obviously a risk that many Bitcoin users want to avoid. The Lightning Network operates by splitting a large number of signed transactions between participants. In order to function properly, all of these participants need to be running software and connected to the network at all times in order to sign transactions. If a user's device is infected or hacked, the attacker can theoretically steal funds. Obviously, this is a risk that individual users need to manage, and for the use case of small transactions, hot wallets containing only small amounts of funds, this is an acceptable risk. But can you imagine keeping all transactions for 6 months in a hot wallet? This is very attractive to hackers.

In summary, the Lightning Network is a great concept that offers great promise for small transaction use cases, but it faces many challenges before it can handle a large number of daily Bitcoin network transactions. More importantly, the Lightning Network does not scale to users, so even if it can increase transaction capacity, it can only meet the daily use of the current 100,000+ geek users.

The only layer 2 systems that could potentially scale to more users are altcoins or sidechains. This means you can move the value of your funds to a completely different network.

Original article: http://codesuppository.blogspot.jp/2016/02/the-lightning-network-is-so-great-that.html
By John Ratcliff
Translator: Next (8btc.com username)
Bitcoin address: 1Mwmes1CAwgvy5SEpjPAkbnp94BYtsRw66
Editor: printemps
Source (translation): Babbitt Information (http://www.8btc.com/lightning-network-so-great)