The quest for Bitcoin scalability through layer two protocols

The quest for Bitcoin scalability through layer two protocols 1
The quest for Bitcoin scalability through layer two protocols 2

The quest for Bitcoin scalability through layer two protocols 3

As the largest cryptocurrency by market capitalization, Bitcoin’s (BTC) effectiveness as a medium of exchange is still a matter of debate. Unlike fiat money, which is intrinsically infinite and must be managed by a central bank, bitcoin is linked to gold in that it is a base currency whose supply is limited to 21 million.

However, supply constraints are not a major stumbling block for BTC as a medium of exchange, but rather for the flow of transactions. Although Satoshi Nakamoto designed Bitcoin as a peer-to-peer electronic payment system that enables online payments without a central counterparty, an average of seven transactions per second is hardly the norm in terms of scalability.

In fact, scalability is only one of the three key criteria, along with acceptance and liquidity, that a monetary system needs to be successful as a medium of exchange. There is something to be said for the growing acceptance of Bitcoin worldwide in many layers of the global economy.

The price volatility where Bitcoin peaked at $58,000 in the first two months of 2021 and then briefly fell below $30,000 likely indicates ongoing liquidity problems. However, it is important to note that the current period is characterized by an upward trend that began in October 2020. Ultimately, some analysts expect Bitcoin’s volatility to level off as more and more institutions take positions in the market.

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What do the critics say?

Bitcoin’s scalability problem is even older than the network itself. After James A. Donald first proposed this system in 2008, he responded to Satoshi Nakamoto : If I understand your suggestion correctly, it doesn’t seem to be on the right scale.

This insightful observation is at the heart of some of the most controversial debates in the Bitcoin ecosystem. Disagreement over how to solve the problem has even led to some strenuous efforts.

While Bitcoin’s critics cannot definitively reject BTC’s value proposition, scalability seems to be the easiest fruit to obtain these days to create some sort of anti-Bitcoin. Speaking at the Daily Journal’s annual shareholder meeting in 2021, Charlie Munger, vice president of Berkshire Hathaway, said bitcoin will never become a global exchange because of its price volatility.

The 97-year-old billionaire investor is no stranger to anti-Bitcoin sentiment. Besides Warren Buffett, even two CEOs of Berkshire Hathaway have been responsible for some of Bitcoin’s most brilliant negative statements. From rat poison squared to the shit trade: Munger once chastised BTC investors for celebrating the life and work of Judas Iscariot.

Munger, like Buffett, belongs to a class of Wall Street critics of Bitcoin who often argue that Bitcoin has no intrinsic value. But as the price of BTC has continued its unstoppable upward trend over the past decade and attracted significant institutional interest, opponents now seem to be stuck with the scalability argument.

Even among prominent cryptocurrency propagandists, Bitcoin’s inability to scale up to the level of the underlying protocol seems to be a significant problem. Speaking at the Future of Money conference in February, Ann Cairns, Executive Vice President of Mastercard, said that BTC is not suitable for their cryptocurrency payment plans.

According to Cairns: Bitcoin does not behave like a payment method […] It is too volatile and takes too long to complete transactions. As Cointelegraph has pointed out, Mastercard recently announced its intention to offer cryptocurrency payment support on its network.

Lightning conductor network counter increases, but slowly

With the block creation time of 10 minutes, the block size of one megabyte acts as a de facto limit on transaction throughput on the Bitcoin network. The 2017 block size debate, which ultimately led to a brutal bifurcation of Bitcoin Cash, proved that Bitcoin purists cling to the 1MB block size.

With the major blockers sitting firmly on their own bitcoin fork, such as BCH and Bitcoin SV, the question of how to evolve BTC without changing the protocol is still unanswered. From Bitcoin banks to side-chain protocols to delayed layers of settlement infrastructure such as the Lightning Network, there are several development projects underway to make Bitcoin more suitable for microtransactions such as coffee payments.

At a high level, these scale-up solutions include the establishment of robust, centralized (pardon the oxymoron) Tier 2 facilities or networks that support lightweight versions of the BTC ledger to handle real parts transfers without having to support a full parts ledger. These parallel implementations then send the transaction data to the actual Bitcoin network for final settlement.

LN is a key solution for scaling bitcoin that is being actively developed by several organizations, including Blockstream and Elizabeth Stark’s Lightning Laboratories. The Lightning Network is perhaps the most popular implementation of time-shifted consistent scale, allowing users to create payment channels that transfer money instantly for a minimal amount.

According to the LN 1ML data aggregator, there are over 17,300 Lightning Network public network nodes and over 38,400 channels. LN’s capacity is currently more than 1,100 BTC.

The quest for Bitcoin scalability through layer two protocols 4

While LN adoption has yet to reach significant peaks, Layer 2 adoption may be on the verge of rising with Zap, a start-up of payments over the Visa Lightning network. In February, the company launched Strike, a payment and money transfer application that uses the Lightning Network for payments.

Strike also partners with cryptocurrency exchange platform Bittrex to offer LAN-based payments in more than 200 countries around the world. The company plans to distribute Strike Visa cards to users in the United States, as well as in Europe and the United Kingdom, by the end of the year.

What about the State Channel?

There is a movement that claims Bitcoin’s scalability is only possible with Layer 2 solutions. Reuben Somsen, Bitcoin developer, crypto-podcaster and founder of the Bitcoin meeting in Seoul, is one of the proponents of this argument.

Somsen favors state strings, another implementation of layer 2, but with a special feature: participants in transactions send private keys instead of actual unused transaction data (UTXO). The process involves loading a state-chain compatible wallet with the exact amount of BTC required for the transaction, followed by the transfer of private keys from the sender to the receiver.

Since the transfer of private keys through the blockchain has no cost and is instantaneous, the idea of the state chain seems to have gained ground in the debate over the scalability of bitcoin. However, the disclosure of private keys has serious security implications.

As a result, the concept of state chain has recently been amended to include a third party acting as an intermediary between the parties involved in the transaction. In detailing the work of this federation of counterparties within the Statechain matrix, Somsen told Cointelegraph :

State channels allow you to remove your coins from the chain (i.e. cheap transactions) in a way that gives others a minimum of credibility. You have to trust the federation, but she won’t know that she gets partial control over your coins, and she can’t take advantage of it (go back to the blockchain of coins).

The company CommerceBlock, which specializes in infrastructure for state chains, is one of the companies actively developing state chains as a viable solution for Bitcoin scalability. The company is credited with introducing a network of counterparties or a chain of statistics to improve the security of the system. Speaking to the Cointelegraph, CommerceBlock CEO Nicholas Gregory talked about how state channels work:

At a high level, status strings are just a way to transfer your private key to another user. To make that happen, you need to work with Statechain. However, the user has full control of their money at all times; they can move their Bitcoin to their own storage at any time. Therefore, the transfer is immediate and private.

While Statechains is a standalone solution for scalability, some proponents agree that it could be integrated into the Lightning Network. Since the Statechains operate on the UTXO layer, it is theoretically possible that another layer 2 protocol, such as Lightning Network, could be overlaid on top of the Statechains.

This hybrid integration could overcome the limited bandwidth of Lightning network nodes while enabling multiple microtransactions via state strings. Because the exact amount of the transaction is loaded into Statechain’s portfolios, it is not possible to split UTXOs, making Statechain in its current iteration unsuitable for microtransactions.

Statechains can work independently or in conjunction with the Lightning Network, Sommsen said: The Statechains are the perfect complement to the Lightning Chain, because the opening and closing of the channels can take place outside the chain. This removes many of the frictions that exist in the current lightning network design.

For Gregory, integrating the state channels with the Lightning Network is one of CommerceBlock’s future development plans: State channels are ready to use and do not require a cash lock; however, you send a private key that allows you to not make specific small bills. That’s what sets LN apart.

With these and other developments, the search for a viable solution to Bitcoin’s scalability continues. While critics like Munger, who continually misjudge BTC, continue to spout slogans, developers are working hard to fix one of Bitcoin’s oldest performance problems.

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