The quest for Bitcoin scalability through layer two protocols


As the largest cryptocurrency by market capitalization, the effectiveness of Bitcoin (BTC) as a medium of exchange is still controversial. Unlike fiat money, the supply of which is inherently infinite and which must be managed by a central bank, Bitcoin is similar to gold in that it is commodity money with a limited supply of 21 million.

However, the upper supply limit is not the biggest stumbling block for BTC as a medium of exchange, but rather the transaction throughput. While Satoshi Nakamoto introduced Bitcoin as a peer-to-peer e-cash system that can enable online payments without a central counterparty, an average of seven transactions per second is hardly the standard for scalability.

In fact, scalability is just one of three main metrics required for a currency system to be successful as a medium of exchange alongside acceptance and liquidity. There is an argument in favor of the growing global acceptance of Bitcoin in multiple layers of the global economy.

Price volatility, with Bitcoin peaking at $ 58,000 in the first two months of 2021 and then briefly falling below the $ 30,000 mark, likely indicates ongoing liquidity issues. It is important to note, however, that the current period has been marked by bullish progress that began in October 2020. Ultimately, some analysts expect Bitcoin’s volatility to weaken as more institutions take positions in the market.

What do the critics say?

Bitcoin’s scalability problem is even older than the network itself. When James A. Donald first proposed the system back in 2008, he responded to Satoshi Nakamoto by saying, “As I understand your proposal, it does not seem to be of the required size scale. “

This astute observation has been at the center of some of the more controversial and controversial debates within the Bitcoin ecosystem. Disagreements about how to solve the problem have even resulted in several hard forks.

In these days when Bitcoin critics can’t definitely deny BTC’s value proposition, scalability seems like a low hanging fruit to make an anti-Bitcoin soundbite with. During the Daily Journal’s 2021 annual general meeting, Berkshire Hathaway Vice Chairman Charlie Munger noted that Bitcoin will never become a global medium of exchange due to its price volatility.

The 97-year-old billionaire is no stranger to advocating anti-Bitcoin sentiments. Along with Warren Buffett, the two heads of Berkshire Hathaway were responsible for some of the more colorful negative comments under Bitcoin. Munger once beat up BTC investors for celebrating the life and work of Judas Iscariot.

Munger, like Buffett, belongs to a class of Bitcoin critics on Wall Street who have often claimed that Bitcoin has no intrinsic value. With the price of BTC continuing its unstoppable upward trend over the past decade while attracting considerable institutional interest, critics seem to have only the argument of scalability left.

Even among popular crypto users, Bitcoin’s inability to scale at the basic protocol level appears to be a significant problem. Speaking at the Future of Money conference in February, Ann Cairns, Vice-Chair of Mastercard, stated that BTC was not suitable for its crypto payment plans.

Cairns: “Bitcoin doesn’t behave like a payment instrument […] It’s too volatile and it takes too long to complete transactions. “As previously reported by Cointelegraph, Mastercard recently announced plans to offer support for cryptocurrency payments on its network.

The number of Lightning Network nodes is slowly increasing

Together with the 10 minute block creation time, the one megabyte block size acts as an actual transaction throughput limit for the Bitcoin network. The 2017 block size debate that ultimately led to the hard fork of Bitcoin Cash proved the intransigence of Bitcoin purists towards the 1MB block size ethos.

With the “big blockers” now firmly on their own Bitcoin forks like BCH and Bitcoin SV, the question of how BTC can be scaled without changing anything at the protocol level still remains open. From Bitcoin banks to sidechain protocols to deferred settlement infrastructure layers like the Lightning Network, several development projects are currently underway to make Bitcoin more suitable for microtransactions like paying for coffee.

At a high level, these scaling solutions include creating trusted, centralized (excuse the oxymoron) entities or layer two networks that manage lightweight versions of the BTC ledger to handle the actual “coin” transfers without the full bitcoin ledger having to manage. These sidechain implementations then transmit the transaction data for final settlement in the actual Bitcoin network.

LN is one of the key Bitcoin scaling solutions currently being developed by several organizations including Blockstream and Elizabeth Stark’s Lightning Labs. The Lightning Network is perhaps the most popular deferral and reconciliation scaling implementation that allows users to create payment channels that enable instant coin transfers with minimal fees.

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

While the introduction of LN hasn’t made any significant progress yet, the implementation of the second tier with Zap – a Visa-backed startup for payments on the Lightning Network – could get a boost. In February, the company launched Strike – a payment and transfer app that uses the Lightning network for payments.

Strike has also partnered with crypto exchange platform Bittrex to deliver LN-based payments to over 200 countries around the world. The company plans to issue Strike Visa cards to users in the US, Europe and the UK before the end of the year.

What about statechains?

There is a school of thought that argues that Bitcoin’s scalability is only possible through layer two solutions. Ruben Somsen, Bitcoin developer, crypto podcaster and founder of the Seoul Bitcoin Meetup, is one of the proponents of this argument.

Somsen is an advocate of Statechains, another implementation of the second level, but with a certain twist: Transaction participants send private keys instead of the actually unspent transaction output or UTXO. The process involves charging a Statechain compatible wallet with the exact amount of BTC required to trade, followed by transferring the private keys from the sender to the recipient.

Since the transfer of private keys via the blockchain is free and immediate, the idea of ​​the statechain seems to have gained in importance in the discussion about the scalability of Bitcoin. However, exposing private keys has significant security implications.

Recently, the Statechain concept has been changed to include a third unit that acts as an intermediary between the parties to the transaction. Somsen explained how this counterparty association works within the Statechain matrix and told Cointelegraph:

“With statechains, you can take your coins off the chain (which means cheap transactions) in such a way that you only place a minimum of trust in others. You have to trust an association, but the association will not know that it has partial control of your coins and it cannot refuse peg-outs (back to the bitcoin blockchain). “

Blockchain infrastructure company CommerceBlock is one of the companies actively developing Statechains as a viable scalability solution for Bitcoin. The company is credited with introducing the counterparty association or the “Statechain unit” to improve the security of the system. In an interview with Cointelegraph, Nicholas Gregory, CEO of CommerceBlock, explained how statechains work:

“At a high level, statechains are simply a way to transfer your private key to another user. To make this easier, you need to work with a statechain entity. However, the user has full control over his money at all times. You can take your Bitcoin into your own custody at any time. Therefore, the transfer is instant and private. “

While Statechains is a standalone scalability solution, some proponents agree that the system could be integrated with the Lightning network. When statechains run at the UTXO level, it is theoretically possible to implement another layer two protocol like the Lightning network over statechains.

Such a hybrid integration could solve the Lightning Network’s limited node capacity problem while ensuring the ability to accommodate multiple microtransactions across statechains. Since the exact transaction amount is loaded into Statechain wallets, it is impossible to split UTXOs, making Statechain unsuitable for microtransactions in its current iteration.

According to Somsen, the statechains can work independently of each other and work together with the Lightning network: “Statechains complement the Lightning network perfectly, as the opening and closing of channels can take place outside the chain. This removes a lot of the friction that exists in the current Lightning Network design. “

For Gregory, the integration of statechains into the Lightning network is one of the future development plans for CommerceBlock: “Statechains are immediately available and do not require a liquidity lock. However, you send the private key so you can’t do small or specific denominations. This is where LN excels. “

With these developments and more, the search for a workable Bitcoin scalability solution is far from over. While critics like Munger, who were consistently mistaken about BTC, continue to drop soundbites, developers are working hard to solve one of the longest running problems with the usability of Bitcoin.