Handing over the keys: Bitcoin and side-chain networks, Liquid and Lightning
Bitcoin, when first created, was envisioned as a response to an age-old problem: the corruption of centrally-controlled money that could be fabricated and manipulated to the advantage of the few and to the detriment of many. The few in control had to be trusted to steer the ship in the right direction, to maintain honesty and accountability, despite the reality that it would often be in their best interests not to do so. The few would require permission from users who wished to transact or store value and would be entrusted to keep an honest account of said transactions.
Bitcoin attacked these problems with a collection of revolutionary solutions, made possible with mathematics and modern computer technology. It is trustless; not needing to trust anyone to complete transactions; only requiring verification via objective mathematics. It is permissionless; not requiring the go-ahead of a bank or financial body to move funds from one entity to another. It is transparent; with all transactions visible for anyone who cares to see them. It is scarce; impossible to be faked, counterfeited, or duplicated. And it is immutable; enabling transactions that can never be reversed by any central entity.
But a problem continues to persist: Scalability.
Let’s face it. Bitcoin is slow. Often taking ten or more minutes to confirm a transaction, it simply cannot be used right now as it stands for everyday transactions. We’re talking a blockchain that handles a mere 7 or so transactions per second. Globally. That. Is. Slow.
Blockstream’s proposed solution: Side-chains
Touted as the solution to the scaling limitations of the BTC network, side-chains offer the possibility of a network that simply offloads the majority of work to chains running alongside it, reporting back to the BTC network only when deemed necessary by the given situation. It seems like a pretty reasonable and clever solution, but it raises some concerns, particularly when it comes down to the characteristics that distinguished Bitcoin from its centralized counterparts.
Two of the most prominent side-chain offerings in the news lately are the Liquid and Lightning networks. These scaling solutions serve different purposes and offer different advantages, but also spark a few concerns. Let’s take a look at them more closely to gain a better understanding of the issue:
Designed by Blockstream for exchanges and large volume trades, Liquid is highly scalable due to its structure — a private chain that is non-transparent and allows for the rapid transaction of large quantities of a tokenized Bitcoin called Liquid-BTC, charging fees that are then collected for profit by Blockstream, operating on the side-chain instead of relying on public mining consensus. This allows for large quantities of BTC to be moved rapidly between exchanges via a pegged 1:1 Liquid-BTC to BTC exchange. Thus, miner Proof of Work influence is diminished, instead requiring trust in the private operators of the Liquid network.
In essence, Liquid-BTC is pegged to BTC much like Tether USDT is supposedly pegged to USD. The key word here? “Supposedly”. That’s not to say this is necessarily a malicious act, but it opens up the possibility for vulnerabilities that do not exist in on-chain BTC transactions, since the entire process is not resolved on the Bitcoin blockchain, instead relying on a 1:1 trade that has to be trusted, despite a lack of transparency and accountability. Just as Tether has continued to raise eyebrows of suspicious and cautious investors, a Liquid-BTC could potentially cause further doubt in regards to genuine volume and market value in BTC itself.
Designed, again by Blockstream, for small transactions like buying a coffee or drawing rude pictures on Satoshi’s Place for fractions of a penny, the Lightning Network is touted as the solution to making Bitcoin a truly peer-to-peer cash network. It is highly scalable, with nodes that can be freely set up by anyone, collecting minuscule fees across a series of nodes as transactions are transmitted. It is a peer-to-peer system where transactions are routed through a series of nodes, resolving back to the BTC network via smart contracts once a payment channel is closed.
Again, Proof of Work consensus loses some significance, but not to the same extent as the Liquid network, which really is in essence an exchange existing for the purpose of trading BTC for the Liquid-BTC token and back to BTC as needed. Since transactions are public, anonymous, peer-to-peer, and capable of being routed or rerouted as needed, Lightning does not exhibit the same accountability limitations as Liquid. Some have criticized Lightning because, in essence, the BTC transacted on the network is traded for a tokenized version of BTC and resumes its existence as true BTC currency upon returning to the main blockchain, only when the user decides to close the channel. This concept is highly debatable and can result in many arguments across the cryptosphere.
In fairness, neither side-chain requires traders to use them, and on-chain transactions could be used instead if you’re willing to wait and pay the BTC miner fees, which are now much cheaper than they were pre-SegWit. It’s possible that these side-chains could simply be a positive alternative route for Bitcoin users that may improve its efficiency and everyday utility, paving the way forward to broader adoption.
Side-chains are an inevitability, offering a range of capabilities to ride alongside the main BTC network. For example, another side-chain offering, dubbed Rootstock, or RSK, offers the possibility of smart contracts operating on Bitcoin via the side-chain. Tokenization of assets ranging from real estate to precious metals can also operate on Bitcoin side-chains. Is it possible that Bitcoin could become the central economic hub to a myriad of side-chains operating in conjunction with the BTC network? Will the vast range of altcoins currently offered on the market fade into irrelevance as more side-chain solutions develop, rendering alternatives redundant?
Blockstream is a business, trying to make money from the solutions it is busy developing. Who can blame them for the development of these potentially profitable innovations? And if they were not developing these side-chains for the BTC network specifically, who’s to stop them, or anyone else, from building the same solutions on another network? Ultimately, they offer a choice to users and can not stop other choices from being selected in their stead.