Solving The Blockchain Trilemma — Part Two
The Intelligent Insurer #71: The Bitcoin Lightning Network is improving scalability
Despite being the first iteration of modern-day blockchain networks and cryptocurrencies, Bitcoin's popularity has not shielded it from the effects of the Blockchain Trilemma. The influx of new, scalable blockchain networks has highlighted one of the biggest flaws of the Bitcoin network — its scalability. While Ethereum is addressing this issue of scalability with several solutions, such as rollups, Bitcoin deals with it differently.
This edition of the Intelligent Insurer will analyze the effect of the Blockchain Trilemma on the Bitcoin network and how developers are working to improve it. We will also consider a solution currently being implemented and how users can utilize it while being aware of its downsides. However, we'll first share some exciting updates from our development team.
Insured Finance software development update
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How the Trilemma affects the Bitcoin network
Despite being highly secure, the Bitcoin network has been a victim of its success. Several industry critics have highlighted how the network is not decentralized due to the concentration of mining activities among a few major companies. Scalability is thus a major concern.
As Bitcoin's popularity grew, it drew hundreds of thousands of transactions into the network, exposing its problem with high traffic. Each Bitcoin block has a size of 1MB and since each transaction typically holds 250 bytes of data, one block includes a limited number of transactions. This results in queues of pending transactions and increased cost.
With competition rising among newer, faster blockchain networks, improving the scalability of the Bitcoin network is an urgent task. Researchers, developers, and the Bitcoin community have presented solutions to allow the network to accommodate more transactions.
One of the proposals was to increase Bitcoin's block size from 1MB to 32MB permanently. However, this failed to reach a consensus of the global community and resulted in the hard fork of Bitcoin Cash in 2017. Bitcoin then tried to improve scalability by indirectly altering the size of the blocks via Segregated Witness (SegWit). Although the upgrade increased the block size by removing signature data from the transactions recorded there, it did not solve the issue.
The Lightning Network — Solving Bitcoin's scalability issues
The Lightning Network appears to be the most effective among all the proposed solutions to improve Bitcoin's scalability. The network is a secondary layer or Layer-2 solution on the Bitcoin blockchain that allows users to process off-chain transactions.
The Lightning Network is built upon a system of smart contracts that create payment channels where Bitcoin transactions can occur between two parties outside the main blockchain. While these transactions are settled off-chain, they still benefit from the security and decentralization offered by the main Bitcoin network.
The Lightning Network is run by a network of nodes that process payments and transactions are generally made using QR codes, as opposed to complex public keys. These nodes are run and maintained by users running a program on their laptops and desktops.
To create a payment channel on the network, two parties must commit a certain amount of Bitcoin each. This amount is held in the channel and can not be released until both parties close the payment channel. To receive a Bitcoin payment, the recipient creates an invoice, an alphanumeric string of digits usually represented by QR codes.
The code is scanned by the sender and as soon as payment is made, the confirmation is sent across the network to the transaction initiator. Transactions are completed in a fraction of a second and at an extremely low cost since they are not made on the main Bitcoin blockchain, making it ideal for small-scale transactions. The Lightning Network can handle up to 1 million transactions per second (TPS).
Each payment channel has its ledger where the transactions are recorded away from the main Bitcoin blockchain. Once the two parties decide to close the payment channel, all of the transactions that occurred are consolidated and then broadcast to the main blockchain ledger.
The adoption of the Lightning Network rose dramatically over the past year. There are currently over 17,000 nodes and approximately 84,784 channels on the network. The network's capacity is around 3,949 BTC, equivalent to $80.6 million.
With opportunities come risks
While the Lightning Network has greatly improved Bitcoin's scalability, it is not without flaws and complications. For one, the processes involved in transferring Bitcoin from a traditional wallet to a Lightning Network-compatible one are complicated.
While finding a compatible wallet is easy, the processes involved in transferring Bitcoin and creating a channel are complex. They also cost money as users must pay fees for transferring their Bitcoin from the traditional wallet to a Lightning Network wallet. However, subsequent transactions do not require transaction fees as they are conducted off-chain.
Perhaps the biggest problem with this solution is the risk of offline transaction scams. Since a payment channel is created by two parties, it also requires both of them to close it. A problem arises when one user decides to close the channel when the other is offline. The user closing the channel might steal the remaining BTC and go offline without any means of contacting them.
Thus, investors must fully understand how these processes work to avoid losing money. Getting acquainted with how the system works will mitigate the risks users face.
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About Insured Finance
Insured Finance is a decentralized, peer-to-peer insurance marketplace. Users can request customized insurance on a wide variety of digital assets, thereby ensuring full protection. Those fulfilling requests can earn premiums and earn a competitive return on their capital. Claims are fully collateralized and settled instantly.