Why becoming a Lightning Network user is not a good idea in the long term.

In another Medium article, I laid out my case for why the Lightning Network (LN) (or any second tier network) is bad for the future of Bitcoin. In this article, I dive a bit deeper on why becoming a LN user is a bad idea given you are no longer able to use the Bitcoin main chain.

I going to assume your are tangentially familiar with Bitcoin and second tier networks that are being built to be clients of the Bitcoin main chain. No technical knowledge is required.

Let’s fast-forward a few years and assume that a second tier network such as the LN has gained the a plurality of Bitcoin’s user base. The vast majority of all Bitcoin transactions happen on this network, both in number and transaction value.

What is the value proposition of the LN itself. LN liquidity nodes open perennial payment channels so that their clients can make fast, easy and cheap Bitcoin transactions with any other party also willing to use the same payment channel. Sounds great, except that this is 180° out of phase of the main reason Bitcoin was invented in the first place. Instead of peer-to-peer exchange of value, we now have peer-to-middleman-to-peer money. Since we are so close to Bitcoin’s genesis, most of us still remember why we are all here. I would dare say that the original intent was not to reintroduce gatekeepers into Bitcoin. If you want gatekeepers and middlemen, you might want to stick to the legacy banking system, they have hundreds of years of experience.

Now, we will move on network topology. The LN, and all other second tier networks that have been proposed, have a functional hub and spoke configuration. I say a “functional” hub and spoke because the natural evolution of networks that start out looking like mesh networks must optimize into functionally hub and spoke. This means lots and lots of clients compared to relatively few servers or routers. What was once a router becomes a gateway and then a server. Hub and spoke networks have pretty big drawbacks, the kind of drawbacks Bitcoin was developed to avoid in the first place.

But you may be thinking, “doesn’t the Bitcoin network, itself, have centralized miners and mining pools?” Yes, it does but the downsides to this are greatly mitigated by:

1. one degree of separation between consensus voting mechanism and the network itself
2. as the rate of semiconductor innovation slows prior to the next breakthrough, this puts a great deal of pressure on the centralization of mining to proliferate.

Point 1 explained: Since Bitcoin mining has reached the stage where, to compete, a prospector must make a substantial investment in specific mining equipment. This is entirely a capital investment to serve a single purpose. The miner has significant skin in the game -and- this capital investment is quickly depreciating. The original investment of hardware has almost no utility outside the service of securing the Bitcoin Blockchain. All of this, applies much better motivation to miners than it would, say, a staked node on a proof of work chain. In the latter, the staked operator could liquidate his stake much easier than a miner could tear down his operation and hope to re-coup even a fraction of his original investment.

Point 2: I borrowed this idea from Andreas Antonopolous who outlined how the decentralization of mining would take place. It is very likely that as SHA256 ASIC mining chips become more and more energy efficient, the rate at which new chips replace the old chips must slow. Eventually, the span of time between new hardware releases will exceed the lifespan of the current chips. If manufacturing rates also rise, which is logical, chip making firms will have no choice but to sell their ever-growing surplus to the general public. This puts the cutting edge hardware in reach of anyone willing to buy it. If the chip market remains fairly open and free (governments don’t heavily regulate), we will also have healthy price deflation and plenty of competitors.

So, we have two serious, show-stopping, problems with the LN. The removal of peer-to-peer exchange of value and the move client-server architecture as the defacto consensus mechanism. But given that the LN is an open-source protocol and that there are few barriers to becoming a LN liquidity partner (LP), can’t we take the good with bad? Yes, but my thesis is that the bad far outweighs the good, especially as time progresses.

As new LP’s start competing there will be a logical consolidation of these services. More efficient LP’s will out-compete and otherwise take their competitors out of the market. Users will logically gravitate to the LP’s with the most liquidity and the lowest fees. There will be a better chance that larger, more well connected LP’s will have a pre-established connection with the party the user wishes to transaction with. We see all this even now on the LN. Further, the larger the LP, the more money the LP will get from the data brokers regarding all of the transactions that pass through its servers. Conversely, the larger the LP, the more attention it will get from government goons. But this is a feature and not a bug because the LP’s will demand that the government regulate them. Since the LP’s are the only ones who really understand their industry, they will write their own regulations, for a small fee paid to the government in the form of taxation. Regulation is another name for “government-sponsored incumbent protection under the guise of consumer protection”.

The LP’s will first require “Know Your Customer” regulations. This does 3 things. First, it allows the LP to know who is transacting with them, exponentially increasing the money they get from their data brokers. Second, it crushes the ability for new LP’s to enter the market. It might even kill existing LP’s who can’t afford to provide these services to the government. And third, it gives all LP’s an official brute squad to crack skulls of the LP’s that don’t get in line (FINCEN, etc.).

I hope I’ve made the case that there is A LOT of voltage behind the consolidation of LP’s. Eventually, there will be a small contingent of LP’s able to facilitate your Bitcoin transaction, each too big to fail. But, the joke is on them because they still have this pesky connection to Bitcoin mining network. The LP’s have significant power, but they are shelling out huge fees to the miners. Plus, they have the risk that the Bitcoin or LN protocol could be changed out from underneath them by the core developers. Clearly the goal of the independent LP would be to disconnect as quickly as possible from both parties. It turns out that it is much much easier to do the former than the latter. Disconnecting from the miners is relatively easy because the core developers are in league with the LP’s with respect to this goal.

The only problem with disconnecting from the Bitcoin mining chain are the users on the LN. It takes about a generation for people to acclimate to radical new approaches to core technology like money. It would be best to make a deal with the core developers in the short term.

However, this deal making is not among equal parties. The deal will be horribly one-sided. The LP’s will quickly learn that they are clients of the LN. They hold no equity. If an LP expresses the wrong opinion, they can be summarily evicted from the network. The relationship is analogous to YouTube creators and Google/YouTube. So, of course, no LP will step out of line. There is way too much money at stake.

But, you may be asking: “what if ALL the LP’s band together (like in a cartel) and bend the network to their will”? Well, we already have precedent for this. During the Scaling Wars of 2017, this is exactly what happened, except on the Bitcoin main chain. The miners themselves banded together to throw off the shackles of the core developers and their backers. After a protracted and costly war, it was the miners that lost. This was a war of attrition combined with a game of chicken. The core developers held firm to no block size increase while at the same time bleeding users off to alt coins. Implicitly, each side knew the main goal was to move users off the main chain and on to a new network. This tactic will repeat itself again and again if the need arises.

You may also ask, “what if the LP’s all leave the LN, wouldn’t this be bad for the core developers?” Yes, but the LP’s really have no place to go, especially if they are used to making the kind of revenue that the LN affords them. The users are on the LN and they go where the users go. It is demand that drives this market.

In conclusion, I’ve made two non-technical arguments for why becoming a LN user (or LP) is not in your best interest. The tracks laid by the Bitcoin development roadmap have set the stage for the recreation of our current banking system. To add insult to injury, things will be worse the next time around because there won’t be any possibility of privacy nor fungibility.