Bitcoin's Lightning Network: the peer-to-peer Misconception

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If Bitcoin is ever to become the main medium of exchange, its network need to be lightning-fast and black-Friday-sale-cheap.

Before we delve into the details, let’s talk a bit about network topology.

Usually, when we think about the network of Bitcoin, we picture a peer-to-peer network, similarly how torrent sites work. Each user is a node or “hub” on the network. It turns out that this is not the case. Any network can be considered decentralized if it does not have a single main hub. However, that does not mean that centralized hubs don’t exist on the network. If there is more than one centralized hub, the network is thought to be decentralized.

The network we often picture when we hear “decentralized” is actually one of distributed topology. Where there are no centralized hubs and all users, serve as hubs. Currently, Bitcoin operates in a decentralized, not distributed network.

. Image result for network topology distributed

The Lightning Network or (LN) is simply a protocol that enables off-chain channels to exist only between two parties. Once the channel is established the two entities involved can make as many transactions as they want without having to pass through the chain. However, this protocol does not enable the interaction between multiple parties. Meaning that a torrent-like, peer-to-peer, endlessly scalable network is impossible. If you want to refresh your memory on LN, read this article.

There are two main issues that prevent the establishment of a distributed network for payment processing – Network Efficiency and User Capital Availability. Network Efficiency is the number of operations the network needs to perform to execute a transaction. User Capital Availability is the amount of BTC each user needs to have to perform a transaction. For the math behind this argument check this article out.

An Example

Let’s assume that Greg and Mary have a private off-chain channel and they are doing business with Josh. Greg and Mary owe Josh 5BTC each. Since it is impossible for a third party to enter their channel Greg and Mary have a couple of options:

Both Mary and Greg send on-chain 5BTC to Josh.
One of them makes an on-chain transaction with Josh, paying 10BTC. Then they settle the difference of 5BTC on their private channel.
Either of them makes a separate private channel with Josh (Mary-Josh or Greg-Josh) with the LN protocol, sending 10BTC to Josh and then settle in the Greg-Mary channel.

Network Efficiency

Option 1:

The first option does not require the LN protocol. This is how, currently, the Bitcoin network operates. Choosing (1) would settle the balance with two, on-chain transactions.

Option 2:

If Greg and Mary choose option (2) it would result in one on-chain transaction, sending the 10BTC to Josh, and one off-chain to settle the 5BTC difference. Option (2) is more efficient than Option (1) as it requires only one on-chain transaction.

However, if there is no pre-existing private channel between Greg and Mary this transaction would necessitate two on-chain transactions: repaying Josh and setting up the private channel and an additional off-chain transaction. In this case, option (1) would be more viable.

Option 3:

In case Greg and Mary have an already-established private channel, and one of them has a pre-existing channel with Josh. Option (3) would result in 2 off-chain transactions, sending 10BTC to Josh and settling the 5BTC balance; making it the most efficient choice of all.

If the private channels have not been pre-established for the transaction, option (3) will result in 2 on-chain transactions, opening the two private channels, and two off-chain transactions, to send the BTC. In this case Option (3) would be the most inefficient.

Doing a case by case analysis for the best payment method would be impossible for any user who will execute a large number of transactions.

Capital Availability

Option 1:

For the repayment of 10 BTC with two on-chain transactions, Greg and Mary must have only the amount each owes Josh, 5BTC, available in their account.

Option 2:

Let’s assume that Josh would initiate the on-chain transaction to pay Josh the 10 BTC. He then has to have 10 BTC available in his account (his 5BTC and Mary’s 5BTC debt) and trust Mary that she will repay him in the private channel. The balance cannot be settled without either Mary or Josh becoming a lender to the other.

Option 3:

In this option, again, we face the same issue. If Greg pays in his private channel to Josh, he has to pay 10 BTC, and then get reimbursed in the Greg-Mary channel.

Both options (2) and (3) show the biggest impediment to the Lightning Network Dream – a gigantic network of debtors and lenders. If more than two parties participate in a transaction, each involved party has to have available in their wallet, the total amount owed by all parties.

Conclusion

Even though a purely peer-to-peer distributed network is impossible with current technology, a decentralized one will soon become reality. Whether the existence of centralized hubs is a stray away from the founding principles behind Bitcoin is yet to be seen.

Do not hesitate and share with us what do you think is the right path for Bitcoin in the comment section below!