Will off-chain transactions cause damage to the Bitcoin network?

The Lightning Network has always been seen as a solution for Bitcoin blockchain expansion. At the Bitcoin Expansion Conference held not long ago, developer Peter Todd also believed that the Lightning Network is a very good choice, but will "off-chain transactions" destroy the original intention of the Bitcoin network? There are several reasons for this.

The reason people are so interested in Bitcoin is that this distributed consensus protocol is a powerful weapon to prevent transaction fraud, and Bitcoin's public blockchain is perhaps the world's most important tamper-proof digital ledger.

First, services such as ChangeTip, Circle, and Coinbase can hide all transaction activity from the Bitcoin blockchain. For example, if Alice, Bob, and Charlie all use Coinbase accounts, and Alice sends 30 BTC to Bob and 70 BTC to Charlie, these two transfers may never be recorded on the Bitcoin public blockchain. Instead, Coinbase acts as a "black box" as funds are moved around in an internal database before they are settled on the public blockchain. If Alice closes her Coinbase account, the public blockchain will only correctly show that her total balance has decreased by 100 BTC, but will not show to whom the funds were sent. Therefore, as a public ledger, the Bitcoin network can no longer be used as a reference for the primary source of accounting data. If Coinbase is hacked and malicious records are inserted, claiming that Alice sent 100 BTC to a terrorist organization, how can Alice prove her innocence?

Second, when payment channels for daily Bitcoin transactions can be opened and closed at any time, all transaction activities within a channel can be hidden, which causes considerable trouble for accountants responsible for developing accurate accounts. For example, Dan hired Ethan as his contractor for 100 BTC. Dan opened a payment channel in October 2015, and then every time Ethan completed a target, Dan would pay Ethan a certain fee. These payments were all off-chain, and Dan and Ethan tracked these fund transactions in a private spreadsheet. The payment channel was closed in March 2016. When the accountant went to the public blockchain to view these fund transactions, Dan's accountant only saw the transaction record of 100 BTC being sent to Ethan, but could not determine how much Dan paid in 2015 and how much he paid in 2016. Similarly, Ethan's tax advisor could not accurately determine the amount of tax Ethan should bear in 2015 because the blockchain did not record the date he received the payment. If Dan and Ethan accidentally deleted their private spreadsheet, their accountant would be completely in the dark.

Third, since payment channels need to be tracked manually, they introduce a "moral hazard" mechanism (a concept in the field of economic philosophy) that allows channel participants to conceal their transaction intentions and obfuscate their financial history. For example, Frankie hired her good friend George with an annual salary of 500 BTC. Frankie and George opened a payment channel to issue and receive salaries every month. A year later, George won the lottery and became rich. As good friends, Frankie and George agreed to close the payment channel, provided that Frankie's account balance does not decrease by 500 BTC. Frankie and George decided not to inform the tax authorities of this fact, because the public blockchain can only prove the existence of this payment channel, but cannot show what kind of transaction activities have taken place in it, thus reducing their risk of being exposed.

Some might say that technology shouldn’t bear this responsibility, and that people should consciously maintain a good record. It should be easy to get good transaction records from companies like Circle and Coinbase. But it turns out that it is difficult to get complete records, especially for Lightning Network transactions, because when they were designed, these transactions were to pass through multiple payment centers and temporary sites. As a result, accountants have to ask for records from many untrusted third parties and try to restore the off-chain transaction records, but this seems to go against the original intention of the Bitcoin blockchain as a shared public ledger: everyone with a computer can verify the transaction records.

Bitcoin enthusiasts love the network's triple-entry accounting feature, which solves the problem of how to securely store verified transaction records. Traditional double-entry bookkeeping can hide fraudulent transactions. That's how a rogue trader took down the world's second-oldest commercial bank in 1995. A blockchain-based triple-entry accounting system could improve risk management by providing a real-time view of a company's financial health. While moving transactions off-chain seems like a step backward for the Bitcoin network, the traditional accounting industry may be able to move forward with blockchain technology.

If the future growth of Bitcoin transactions comes from off-chain transactions rather than regular transactions, then the public blockchain is likely to change from the peer-to-peer cash system originally designed by Nakamoto to a scaffold for a settlement network. Over time, businesses engaged in off-chain transactions may introduce Bitcoin re-hypothecation and fractional reserve wallets, which have long been criticized. Fortunately, the Bitcoin network is an open system, and people are free to choose whether to use these services. The success or failure of the Bitcoin network and off-chain transactions depends largely on the market. The Bitcoin expansion roadmap seems to plan to permanently add the Lightning Network solution to the Bitcoin network, which may forever change the nature and value proposition of Bitcoin as a shared public ledger. Trying to solve the block expansion problem by forcing transactions to move off-chain may be counterproductive.

Original article: https://makebitcoingreatagain.wordpress.com/2015/12/28/why-off-chain-transactions-hurt-bitcoin/
Translator: Bibit
Editor: printemps
Source (translation): Babbitt Information (http://www.8btc.com/off-chain-hurt-bitcoin)