Lightning Protocol mitigates the shortcomings of the Bitcoin network as an expensive, slow billing system like Visa does for the Fed Reserve: Report

Bitcoin (BTC) usage growth over the past 10 years has been “strong” and “steady,” and on this journey the flagship crypto has gone through various stages of “mixed use” from its “humble” beginnings, according to a new report from CoinShares.

Bitcoin started out as a “worthless geeky collector’s item” and soon evolved into a “niche instrument of speculation” before moving to its newer and “increasing use as a store of value or digital gold,” noted the CoinShares research team, adding such progressions to “move Bitcoin.” getting closer and closer to the last and most valuable application: A global and widespread new form of money ”.

However, the widespread use of BTC as money requires that it be “useful as such,” added the CoinShares report, noting that in order to achieve its ultimate monetary form, Bitcoin “is not enough to just be a store of value … it must also be “a useful medium of exchange.”

Bitcoin was created to reliably process peer-to-peer or P2P transfers without being dependent on third parties.

So it says in the research report:

“All decentralized systems are faced with this dilemma, since there is an inevitable compromise between decentralization and scalability at the blockchain level.”

To maximize security and robustness, the Bitcoin protocol promotes “decentralization in its network structure, which means that one does not have to rely on a specific person or group to ensure network availability,” the report noted, pointing out that a widespread infrastructure base “through. it is encouraged to keep the hurdles for joining the network as low as possible. “

The report added that by minimizing participation requirements (billing, storage and bandwidth), Bitcoin “can be effectively run by cheap and widely used computers, thereby keeping the network accessible to as many participants as possible”.

As mentioned in the CoinShares report:

“To optimize a reliable settlement final, Bitcoin enforces strict and complex rules that ensure that time and energy have been spent confirming transactions.”

While Bitcoin’s “recipe” for integrating security and finality “has proven fruitful in its pursuit of a peer-to-peer monetary system,” it involves some tradeoffs.

Bitcoin requires that its transaction record (the blockchain) “add new batches of transactions (” blocks “) in a process that proves the passage of time to otherwise uncoordinated network members, and as a result, Bitcoin payments are processed incrementally rather than instantly,” the report explained.

According to the rules, each new batch of transactions must be replicated across the network and each member must check the validity of each transmission. Transactions and blocks “also need time to reliably propagate across the network”.

To minimize the appearance of stale blocks, Bitcoin is “programmed to generate blocks every 10 minutes on average,” the report added, noting that this ensures that the likelihood of two miners finding blocks at the same time “decreases becomes, which means that a valid block is likely ”. in order to propagate completely over the network before an alternative valid block is discovered elsewhere. “

As noted in the report, the tradeoff is that it can take some time for a transaction to “get onto the blockchain, and once it’s on the level of settlement finality is determined by how many blocks deep the transaction is” . the blockchain (and the total cost of mining these blocks). “

Aside from handling batches of transactions or blocks on a “delayed schedule,” they are also “limited in overall size,” according to the report. Because these batches of transactions “are replicated across the network, each participating member must sacrifice storage space to keep their own records of transactions and bandwidth in order to send and receive them”.

The report further noted that this is a cost that node operators “have to bear to join the network and for which they (unlike miners) are not compensated by the protocol”. Bitcoin restricts these data requirements “to encourage participation and minimize barriers to entry”.

The report continued:

“Depending on the type of transactions that the market demands for inclusion in a particular block, Bitcoin’s rules require that each batch (or block) of transactions must not exceed a certain data size. Actual average block size is not static, but typically does not exceed ~ 1.3MB. The maximum theoretical limit is a little higher, but not by much. This size constraint effectively increases the decentralization and security of the network by ensuring that it remains inexpensive for users to support basic network activities. “

Bitcoin’s capacity constraints and its lazy batch processing “achieve a processing speed of roughly three to seven transactions per second,” the report added, noting that this “equates to around 600,000 transactions per day, which is roughly the daily number of transactions per day is equivalent to”. the FedWire settlement network. “

While it is likely to be sufficient for a billing system, “it is nowhere near the capacity needed for a retail payment system that can handle small, occasional transactions like Visa or MasterCard,” the report added.

In order to keep track of new payments during the settlement process, Bitcoin offers a queue that acts as a kind of waiting room for outstanding payments (so-called mempool). These pending payments are “ranked by the size of their offered fee and wait for a miner to add them to a block,” explained the CoinShares research team.

Because of its limited speed and capacity, Bitcoin “lends itself to congestion and waiting times that adversely affect senders of low-value transactions (whose transactions warrant less competitive fees),” the report added. It has also been mentioned that if transaction demand gets high enough, “low-paying fees may never make it onto the blockchain”.

As noted in the research report, Bitcoin needs layered solutions developed at the beginning of its settlement chain to handle the billions of daily remittances required for Bitcoin, the asset, “to play a role as a widespread medium of exchange.”

Centralized payment aggregators like Visa, MasterCard, PayPal and Square will likely “fill a significant part of that role, but this is a” risk “as these giants are competitors with clout and network effect that may undermine the benefits of Bitcoin’s decentralization,” added the report added.

But there are also “independent alternatives” that “retain full autonomy of a user over spending without relying on a centralized service,” the report says. Such a type of system is this Lighting protocol.

According to the report, the main innovation of Lightning is the “use of payment channels”. These enable two trading parties to “freely conduct peer-to-peer transactions with Bitcoin, but without having to use Bitcoin’s fierce finality process for anything other than initiating and completing a series of trades,” the report said.

This works much like a “pre-funded tab, with each entity continuously tracking a history of payments as they are streamed back and forth,” the report said. Then when they want to “finalize their trading partnership, they submit the final balance to the Bitcoin blockchain and go through their robust settlement process,” the report added.

The report also mentioned that payment channels “allow an opening and closing transaction to cover many historical deals”. This “increases the economic density of Bitcoin transactions and spreads their fees over a potentially unlimited number of individual payments,” the report stated.

As stated in the report:

“When Lightning works as visualized, it mitigates Bitcoin’s shortcomings as an expensive, slow billing system by adding a layered transportation network for cheap, fast payments. It’s pretty much like what Visa and MasterCard are doing for the Federal Reserve. “

The report also found:

“Most transactions in the dollar economy never touch the Fed’s systems, they are processed by payment aggregators, which in turn use intermittent commercial banks that then use the Fed for final settlement. Lightning does the same for bitcoin transactions and only uses the bitcoin blockchain for final settlement. “

To view the full report, click here.

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