September 2021

The Growth of Bitcoin's Lightning Network

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Bitcoin is becoming globally recognised as money, but slow settlement and high transaction fees remain a critical barrier to adoption. The solution to these issues is the Lightning Network.

Bitcoin is becoming globally recognised as money. On 7th September, El Salvador became the first country in the world to adopt Bitcoin as legal tender. In the digital domain, Twitter’s Jack Dorsey has stated that it is “only a matter of time” before Twitter integrates with Bitcoin. This puts Bitcoin on track to handle millions of transactions daily, and yet transactions on the Bitcoin main chain take up to an hour to settle and have an average fee today of over USD3. The solution to these high transaction costs and scaling issues is the Lightning Network. This layer 2 scaling solution allows for instant and near free Bitcoin transactions, which will transform how Bitcoin is used. This month we will dive into what the Lightning Network is and how it works. We will review its adoption to date and explore how its explosive growth will impact Bitcoin and digital assets in the years to come.

The Lightning Network is a layer 2 scaling solution that allows users to transact bitcoin off-chain. The aim of the Lightning Network is to increase the number of transactions that Bitcoin can handle, to allow transactions to settle instantly and to make each transaction extremely cheap (and in some cases free). There are two key parts to the Lightning Network; Lightning nodes and payment channels. Lightning nodes are the servers that are operating the network, akin to Bitcoin miners. These nodes are paid small transaction fees for settling transactions through payment channels, which are private transaction bridges between two or more parties wanting to transact.

To use the Lightning Network, a Bitcoin user must first lock up bitcoin in a payment channel and their recipient must do the same. Once both parties are on the Lightning Network, the two counterparts can send bitcoin back and forth very cheaply and with fast settlement. At any time, one of the parties can close their payment channel and send the bitcoin owed to them back to their Bitcoin address on the main chain. This system is very similar to State Channels in Ethereum and was first proposed in the Lightning paper in 2016. Since then, several engineering teams have released their own implementations of the Lightning Network, including Blockstream and Lightning Labs.

Determining the size and daily transaction volume of the Lightning network is not easy. Today, there is 2,392 Bitcoin (roughly USD110m) of “network capacity” in the 70,000 public channels on the Lightning Network. This is known capacity of the network and does not include the many thousands of “unadvertised” or “private” channels. In 2020, BitMEX research estimated that 27.8% of all channels are unadvertised, and that these channels have 12% of all capacity. In addition, payments made on the Lightning Network are private. So, while the capacity of a public channel can be seen, the volume of payments being routed through channels is not public. This makes it impossible to accurately report payment volumes.

Despite the true capacity and payment volume of the Lightning Network being impossible to know, there are other metrics that clearly indicate growth of the network.

The number of online nodes and public Lightning channels have been steadily increasing since 2018, with both nodes and channels doubling so far in 2021. In addition to this growth in quantity, the quality of participants is also improving. At least seven major crypto exchanges and trading desks, including OKEx, Okcoin, Bitfinex and River Financial have integrated Lightning into their platforms, with the Kraken exchange’s integration slated for this year. With over USD100m of capacity on the network (Bitcoin available for transactions), it seems highly likely that billions of USD are already being routed across the Lightning Network on an annual basis as this capacity is utilized.

Over the next few years, increasing adoption of the Lightning Network seems inevitable. El Salvador is the first nation state to make Bitcoin legal tender. The Bitcoin bill has just gone into effect and every citizen can claim a Bitcoin wallet that is pre-loaded with USD30 of Bitcoin that is on the Lightning Network. Merchants are obliged to accept Lightning Network payments and citizens will get used to using the network. From a physical nation to a digital one, and Jack Dorsey has stated that Twitter will launch products that make use of the Lightning Network. Dorsey is also the CEO of Square, a payments company. It is highly likely that Square would follow Twitter in integrating Lightning into its product suite.

Companies in El Salvador, such as MacDonald have already implemented Bitcoin Lightening Network payments. As an aside, on a much smaller scale, some restaurants in Hong Kong Central have done so as well.

There are three implications of a growing Lightning Network for Bitcoin. Firstly, the Lightning Network means that Bitcoin can now be used as a means of payment. In recent years the narrative surrounding Bitcoin has been that it is a store of value and a digital version of gold. This was in part a reflection of Bitcoin being expensive and difficult to use as a currency. With the Lightning Network, transactions are instant and incredibly cheap. Some channels even offer free transactions between select parties. There is a real chance that Bitcoin will now actually be used as a means of payment, both in real world countries like El Salvador and digital “nations” like Twitter.

Secondly, the Lightning Network enables micropayments unlike any system before it. While it is simple to make a USD10 online transaction today, it is not viable to make a USD0.01 transaction as the fees associated with such a small transaction would be more than the transaction itself. Lightning’s ability to facilitate micropayments of less than USD0.01 will open the door to an entirely new breed of applications. For example, there is a new podcasting app called Fountain that allows listeners to “stream” micropayments to their favourite podcast creators as they listen. Another app, called sMiles, pays users tiny amounts of Bitcoin to complete tasks and to take part in daily offers.

Thirdly, and most subtly, the Lightning Network introduces users to the denomination of Bitcoin in “satoshis” or “sats”. One satoshi (“sat”) is the smallest unit of Bitcoin, amounting to 0.00000001 BTC. Given that the Lightning Network is focused on low value transactions, it makes sense to denominate payments in sats rather than in BTC. As people get accustomed to paying in sats, the high price tag of 1 BTC will become less meaningful. Anecdotally, at CMCC Global, we have discovered that paying 10,000 sats over the Lightning Network feels to be less of a mental hurdle than selling 0.0001 BTC. While we do not like to sell our own Bitcoin, we are more amenable to parting ways with sats, as it creates the feeling of supporting adoption. We believe that denominating Bitcoin in sats will result in Bitcoin Hodlers being more open to using BTC as a payment currency.

When the Internet became cheap, fast, and widespread we witnessed an explosion of new use cases. From ecommerce to social media and ridesharing, the rapid growth of the Internet redefined global industries. Through the Lightning Network, Bitcoin is now becoming extremely cheap and fast. As it is adopted more broadly in the digital and physical world, we expect to see a host of new applications being created that makes use of micropayments and Bitcoin’s unique properties. With the limited supply of 21m bitcoins, increased adoption for payments, and a transition from thinking in full bitcoin units to thinking in satoshi units, we foresee explosive growth in the value of Bitcoin over the coming decades.