Catalyzing Bitcoin: The Impact of the Lightning Network

The lightning network is a scaling solution built for the Bitcoin blockchain. It operates as a “Layer-2” or “second-layer” on top of Bitcoin. Developers, soon after Bitcoin began gaining popularity, began exploring solutions for scaling the network.

The Bitcoin and Blockchain trilemma

The Blockchain trilemma is the inevitable trade-off a blockchain has to make between scalability, decentralization, and security. An alternative consensus model from traditional proof-of-work is an option for a blockchain to optimize scalability and maintain higher throughputs with more users. These alternatives to proof-of-work, however, have security and decentralization that allow transactions to be processed more quickly.

To find ways around the trilemma, while not sacrificing Bitcoin’s core of strong decentralization and security, developers have had to find distinctive ways around the scalability challenge.

The Lightning network is a network on top of Bitcoin that works using “Payment Channels”. Payment channels can be created between two parties by making an initial ‘unique’ transaction.

This transaction opens the channels and locks in a certain amount of Bitcoin. Once the channels are open, however, the two parties can make an unlimited amount of transactions between themselves. These transactions occur off-chain and can occur instantaneously and at a significantly reduced cost.

Accessing Bitcoin through the lightning network is extremely lightweight and can be achieved with a tool as simple as a mobile phone. This is a key factor in why lightning has so much potential in a country like El Salvador. The Central American nation has recently adopted Bitcoin as a legal tender. Using base layer Bitcoin for payments can be a slow and expensive process compared to cash or traditional card payments. Lightning network transactions facilitated through mobile, have the potential to make Bitcoin payments accessible and viable for the wider population of El Salvador.

Lightning network adoption slows

After years of bullish growth following the initial release of the lightning network, it appears based on several metrics that he growth of the lightning network has stagnated.

Source: Lightning Network Statistics – Bitcoin Visuals

A variety of measures including the number of Lightning network nodes, the number of channels, and the network’s capacity indicate a similar trend. Strong growth since the inception of the network, before a slowdown that appears to begin around the end of 2022 and the beginning of 2023. An explanation for this has been the Bitcoin and crypto bear market of 2022.

Alongside the bear market, there may be some fundamental factors limiting the growth of the Lightning Network. This includes —

• The limited usage of Bitcoin as a medium of exchange – While the Bitcoin Network and its native asset possess powerful potential as a decentralized digital cash system, Bitcoin is more popular as a store of value and a gold alternative.
• Centralized exchanges are slow at integrating the Lightning Network – One of the most obvious use cases for the Bitcoin Lightning Network is fast, cheap transactions to move BTC on and off centralized crypto exchanges. Several major exchanges including OKX, Kraken, Binance, and the Cash App have Lightning deposits and withdrawals enabled. Some well-known exchanges including Coinbase, however, have not yet integrated Lightning.

An Alternative View

In October of this year, however, Bitcoin financial services provider River offered an alternative view to this trend. “Protocol development takes time, and Lightning is being held to high standards by critics. These critics primarily look at the publicly available metrics such as node count, channels, and capacity, which have plateaued over the past year and thus give the false

impression that Lightning adoption may be declining. We will show the opposite in this

report, as growth in the number of users, transactions, and volume has been accelerating.”

They primarily do this by looking at the Routed Transactions on Lightning Network. These are traceable transactions on the Lightning network, they involve more than two nodes. They appear on the transaction routing logs of multiple nodes.

River makes it important that a large chunk of the activity on the Lightning Network is untraceable because it is private. Additionally, a large chunk of transactions are between peers and we cannot derive metrics from these. They note that the only way to accurately gather this data is through “receiving direct or private transaction data from a significant amount of the

network, if not all of it.”

River notes that in the absence of direct and private transaction data, estimating an upper bound of transactions on Lightning Network is impossible.

River, however, does observe growth in Routed Transactions by comparing data they have recorded in 2023, with data collected by K33 research in 2021.

They find that there has been a 1212% increase in the number of Routed Lightning transactions over two short years. The lower bound of transactions on the lightning network is 6,599,553. They estimate that Lightning is processing at least 47% of Bitcoin’s transactions daily.

River also assesses the volume of the transactions routed through the Lightning Network. They note that around $78.2 million was publicly routed on the Lightning Network in August 2023. This is ~2,950 BTC. This represents a growth of 546% increase since August 2021 when K33 Research estimated this value.

River notes some of the key drivers of this growth in transactions and volume are:

● Gaming

● Social media tipping

● Commerce

● Micropayments for content

● Exchange withdrawals and deposits

● Remittance through exchanges

An example of a growing use case for the Lightning Network is Nostr, a decentralized social media app that is unique for its approach to content sharing and community interaction. Nostr is Open Source and is a protocol as opposed to an application. Developers can build their own ‘clients’ on top of Nostr, this is similar to email clients like Gmail and Outlook.

Nostr can connect a Lightning Network wallet enabled with Nostr and send Bitcoin tips to users who create content they appreciate.

Nostr is growing in popularity because of its decentralized and private nature. Nostr users can tip each other using the Lightning Network. According to data from Nostr, in the last 2 months, 2.1 million tips have been sent on Nostr via the Lightning Networks. The Tips amounted to 1,345,987,343 sats or 13.46BTC, in today’s prices, this is US$593,863.08.

Other factors in the growth of Lightning include the popularity of Bitcoin Lightning apps like Wallet of Satoshi and Alby. 25% of transactions are smaller transactions between 1-10 sats (US$0.00044-US$0.0044) and wallets like these facilitate payments.

Another growth factor is other platforms that facilitate Lightning tipping, including THNDR gaming. The Bitcoin game developer has released games including Bitcoin Blocks, that are play-to-earn powered by the Lightning network. Users earn Bitcoin-based rewards for their in-game scores and games are integrated with Nostr. Data from THNDR gaming shows that between February 2022 and August 2023, transactions on the platform grew by 226%, from 82,000 transactions in a month to 267,000 transactions.

The potential growth of Lightning Networks is boosted by the adoption of Bitcoin in countries like El Salvador. In September 2021, El Salvador became the first country in the world to make Bitcoin legal tender. The shift meant that legally, all businesses in the country had to accept payments in crypto. Mike Peterson, the director of Bitcoin Beach in El Zonte, El Salvador, explained that El Salvador’s Bitcoinization was a grassroots movement. It has been noted that Bitcoin adoption really gained momentum after the Bitcoin Beach operators spoke to a variety of major Economic Ministries.

While the adoption of Bitcoin as a medium of exchange has been slow because of the prevalence of US Dollar cash as a frictionless payment option, the Lightning Network holds the key to Bitcoin becoming the centerpiece of the Salvadoran economy.

Strike, a Bitcoin-Lightning network-powered version of personal finance apps like Venmo and the Cash App, was launched with great fanfare in September. The app was built by Jack Mallers, a Lightning developer and Pro-El Salvador evangelist.

“Our decision to enter El Salvador as our first non-U.S. market was intentional. One of the opportunities that interest us the most at Strike is our ability to deliver financial tools to emerging markets. El Salvador is the sixth-highest ranked country in inbound remittance from the United States,” Mallers told news agencies.

“They don’t have supportive financial regulations, they don’t have supportive fintech banking infrastructure, they don’t have peer-to-peer applications and so on. Through initiatives like the Bitcoin Beach project, they’ve looked to Bitcoin as an asset and network to improve financial access,” he continued.

Conclusion

Despite some roadblocks and challenges kicking on from initial growth, the Lightning Network has proven its resilience and potential to significantly enhance Bitcoin’s functionality.

The challenge of addressing the blockchain trilemma—achieving scalability without compromising on decentralization or security—is nigh impossible. The Lightning Network offers a solution that allows for instantaneous, low-cost transactions. While this solution involves periphery solutions it has been a crucial development, particularly for Bitcoin, which has traditionally been viewed more as a store of value rather than a medium of exchange.

The increasing use of the Lightning Network in diverse applications, from social media platforms like Nostr to gaming and remittances, to being core to the adoption of Bitcoin as legal tender in El Salvador highlights its versatility and growing acceptance.

The real-world impact of the Lightning Network is perhaps most vividly illustrated in El Salvador’s adoption of Bitcoin as a legal tender. Here, the network has been instrumental in transforming Bitcoin into a viable option for daily transactions, proving that cryptocurrencies can indeed play a significant role in the everyday financial lives of people. This is a major step towards fulfilling the promise of cryptocurrencies as not just investment vehicles but as practical, usable currencies.

The story of the Lightning Network showcases the potential of cryptocurrencies to evolve and meet the demands of a diverse user base. As it continues to grow and evolve, it will likely play a pivotal role in shaping the future of finance and digital transactions.

Introducing Volcan Capital – a LATAM Focused Fund Builder

Volcan Capital, a fund-builder for El Salvador and the LATAM region, is closely watching developments in Argentina. Milei’s focus on decentralizing the Argentine economy to awaken South America’s second-largest economy resonates with our own vision.

The motivation to build Volcan Capital has been El Salvador’s non-traditional growth plan and the radical steps it has taken to move away from a political and economic pattern of corruption, debt, and disappointing economic growth. Milei’s intention to change a broken status quo may be exactly what Argentina needs.

On the other hand, Milei’s dollarization plan may be a flawed escape route from constant inflation. This is evidenced by El Salvador, where dollarization has shoved public debt higher, led to a reliance on remittances, and left the economy with no room to maneuver.

In El Salvador, Bitcoin, a more private form of money than the USD, has been adopted as an alternative legal tender, to free the economy. Perhaps dollarization is the step before Bitcoinization for Milei.