Bye-bye, bitcoin: It’s time to ban cryptocurrencies

I’ve never quite understood why cryptocurrencies are worth anything. [footnote] Do you also question why gold has historically been worth so much more than its industrial and ornamental value?[/footnote] [footnote] Gold has 6 important attributes that make it suitable for use as money:

  1. scarcity
  2. durability
  3. portability
  4. uniformity
  5. divisibility
  6. fungibility (interchangability)

[/footnote] [footnote]Not all “cryptocurrencies” or crypto-assets are created equal, but Bitcoin has the advantage that it is:

  1. much more portable (able to transfer a billion dollars worth of bitcoin electronically at low cost anywhere in the world that has internet),
  2. more divisible
  3. more verifiable (you can verify that you have authentic bitcoin and audit the supply)
  4. decentralized: to prevent power from being concentrated
  5. harder to steal, through the optional requirement that multiple signatures be used to  unlock it

[/footnote]

Of course, the untraceable [footnote]It’s not untraceable.  The FBI has know for a long time that Bitcoin can be traced.  That’s how the FBI caught their own agents stealing money from the Silk Road[/footnote] [footnote]The next thing you’re going to do is reverse yourself and argue is that, because it is traceable, that there is no privacy!  The truth is somewhere in between. [/footnote] [footnote]Cash is untraceable-ish.  Cash is more useful to money launderers than Bitcoin.  Do you want to ban cash?[/footnote] payments are worth a lot to ransomware hackers, cyber criminals and money launderers. But dollars, euros and yen are backed by nations’ respective treasuries.[footnote]How do government treasuries “back” currencies and create value?  The Zimbabwean dollar was backed by the “full faith and credit” of the Zimbabwean government and how much was that worth?[/footnote] [footnote]Most people believe the “full faith and credit” of the US government is on the decline and doesn’t inspire confidence. (just ask the Kurds and Afghanis about American credibility)[/footnote] [footnote]Some people would prefer a currency that is backed by math and game theory rather than politicians and technocrats.[/footnote] If someone invents a cryptocurrency, any value is based solely on convincing others it has value. But is it a usable means of exchange? International banking officials say cryptocurrencies [footnote]Why should we believe International banking officials.  The reason Bitcoin was created was out of disillusionment with these sort of people.[/footnote] such as bitcoin are speculative assets, not sustainable, usable money [footnote]To say that bitcoin is a “cryptocurrency” is a misnomer.  Bitcoin is too small to compete with the US dollar — only $1 trillion in market cap compared with $100 trillion +.  Just as micro cap stocks are more volatile than large cap stocks, Bitcoin is more volatile than the dollar. [/footnote] [footnote]It is better to call Bitcoin a “crypto asset” rather than “crypo currency”.  Right now Bitcoin functions as an emerging store of value like gold. Perhaps someday it will be large enough to stabilize, but until then its only competition to the dollar is with those who do not have access to banks and who value its comparable ease of use via the Lightning Network which runs on top of Bitcoin using products such as Strike.[/footnote].

Yet the epidemic of hugely disruptive ransomware attacks in recent months — on JBS Foods, a major meat processor; on Colonial Pipelines, our critical infrastructure, causing gasoline shortages for weeks; and on 1,000 or more U.S. businesses on July 4 — highlights the enormous risks. Moreover, hundreds of small towns, hospitals, school districts and small businesses have been hit by the ransomware epidemic — all enabled by cryptocurrencies.

How should governments respond? Besieged with cyberattacks, the Biden administration has been struggling with this question of cybersecurity with few clear answers. Cyber offense still seems to beat cyber defense.

As the eminent economic analyst Martin Wolf outlined in a recent Financial Times essay, the risks and chaos of a wild world of unstable private money is a libertarian fantasy. According to a recent Federal Reserve paper, there are already some 8,000 cryptocurrencies. It’s a new mom-and-pop cottage industry.[footnote]If in 1998 I told you there were some 8,000 dot-com companies, would you be justified in dismissing the sector?  Sure, many of them failed, which is a cautionary tale against concentrated investment in the sector, but a select group of those companies were innovative and are now powerhouses.[/footnote]

How should governments respond? Wolf argues that central banks (e.g., the U.S. Federal Reserve) should create their own official digital currencies — central bank digital currencies (CBDC) and make cryptocurrencies illegal. [footnote]If the government’s new digital currency is so good and crypto currencies currencies not worth anything then the government currency should be able to easily win on the merits, without criminalizing the competition[/footnote] [footnote]If you criminilize the competition that suggest to me that you fear the the public will oppose the new digital dollar or at least prefer a private alternative.[/footnote]

I’ve been asking the same question: Who needs cryptocurrencies? Apart from the nasty uses and wild speculative value swings, data mining to produce bitcoin is a serious environmental hazard, using huge amounts of electricity [footnote]YouTube uses more energy that Bitcoin.  It just depends on whether you think Bitcoin provides something useful and whether Bitcoin uses more energy that the current banking system.[/footnote]  [footnote]The unspoken truth that the Bankers and Political Establishment fail to acknowledge is that the creation and support for cryptocurrencies is directly attributable to the establishment’s failure and the public’s distrust of them. [/footnote] [footnote]How can you get an establishment technocrat or politician to see the value of something whose creation was inspired by their failure?  It is like getting a man to understand something when his salary depends upon his not understanding it. [/footnote] by rows and rows of computers.

Governments should guarantee safe, stable and usable money.[footnote]The whole reason why Bitcoin was created was because the creator thought the government couldn’t be relied upon to maintain the value of money.  The government may keep CPI low, but CPI is not a very good measure monetary debasement.[/footnote] Already, according to the Atlantic Council GeoEconomics Center’s CBDC Tracker, 81 countries representing 90 percent of world gross domestic product are at various stages of researching and exploring the adoption of digital currencies.

The four largest central banks — the European Central Bank, the Bank of England, the Bank of Japan and the U.S. Federal Reserve — are all exploring CBDCs, though the U.S. lags behind. Meanwhile, China is already digitizing its currency, the RMB, and allowing foreign visitors to use it for payments. Though China is still a long way from having an international reserve currency to rival the dollar, its digitized RMB is a step in that direction.

Nonetheless, caution is well advised, as there are important, complex issues that must be sorted out before launching an official digital currency. These issues include equity: Should the digital dollar be available to all or just used for certain business transactions? I would argue it must be for all.[footnote]I didn’t even know that people were considering not making it available for all.[/footnote] Should a U.S. CBDC augment cash or totally replace it, and would there be a transition period? Then there is the impact on private banks: Should individuals have bank accounts with the Fed rather than private banks? What should be the relation between private banks and the Fed with regard to currency? Should businesses have “digital wallets”? How would international payments work?

And not least, there is the question of privacy and surveillance. A digitized dollar would likely make it hard to dodge taxes with untraceable cash. But just how traceable would the public and Congress accept a CBDC to become? Would the fact of a CBDC making transactions safer, faster and cheaper be worth some trade-off? [footnote]He doesn’t say it directly, but what I hear is: “Would the fact of a CBDC making transactions safer, faster and cheaper be worth less privacy and more surveillance“.[/footnote]

Then there is the question of whether the world’s major powers would cooperate in outlawing cryptocurrencies — and reach agreement on rules and regulations of CBDCs. China, always with an eye on control, has indicated skepticism, if not disdain, toward cryptocurrencies. [footnote]Why does China have disdain for “cryptocurrencies”?  Is it because they “waste electricity” or does crypto have the potential to check China’s power over their population, including the ability to surveil, debase, and “cancel” individuals’ money.[/footnote] Indeed, that was one driver in Beijing’s swift move to digitize the RMB. This could be an area of U.S.-China cooperation worth exploring. [footnote]Maybe the US should be more like China?  Who thought this is a good idea?  If China is jealously guarding its power over its people, the US should not use this as an opportunity to collude to gain additional power over its people.[/footnote]

If China were on board, the possibility of a U.N. Security Council resolution to ban cryptocurrencies could be in the cards. That would be a foundation for taking the issue to the Group of 20 to make it a global norm. [footnote]If you think people distrust you now, wait until you attempt to gain power over the entire world’s money supply and to prevent the people from making a free choice.[/footnote]

For now, there are a whole lot more questions than answers. But the insidious new industry of cyber hacking and ransomware is an unacceptable disruptive threat to American economic security[footnote]Mexican drug cartels use American dollars.  That doesn’t prove that dollars should be outlawed. [/footnote]. It is a problem that is growing, not subsiding. And the proliferation of do-it-yourself digital currencies is a serious and bad omen for global financial stability.[footnote]It is the current financial system that has required bailouts, not the crypo financial industry.  It is obscene to hear the financial elites complain about Bitcoin — a system which was designed as an alternative to their system. It was their system whose corruption threatened world stability and  required trillions of bailouts with zero accountability.  If people want to put some of their money in an alternative system, can they make an appealing counter-argument or do they have to rule the whole world by force?[/footnote]

Yet amid an international order that is fraying and fragmenting, it’s an open question whether such threats are enough to catalyze sufficient international cooperation. I suspect that with a little U.S. leadership[footnote]Will this “leadership” involve bribes and threats or are people persuaded the more knowledge they gain?[/footnote], jump-starting financial diplomacy would go a long way. Certainly, it’s a good test for President Biden’s efforts to align democracies.

Robert A. Manning is a senior fellow of the Brent Scowcroft Center for Strategy and Security at the Atlantic Council. He was a senior counselor to the undersecretary of State for global affairs from 2001 to 2004, a member of the U.S. Department of State policy planning staff from 2004 to 2008 and on the National Intelligence Council strategic futures group from 2008 to 2012. Follow him on Twitter @Rmanning4.

Lightning Network Explained

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A Beginner’s Guide to Bitcoin’s Lightning Network

A Beginner’s Guide to Bitcoin’s Lightning Network

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Introduction

Cryptocurrencies have some pretty unique properties. They can’t be hacked or shut down easily, and anyone can use them to transmit value around the globe without a third party’s intervention.
To ensure that these features remain, significant trade-offs must be made. Since many nodes are responsible for running a cryptocurrency network, throughput is limited. As a result, the number of transactions per second (TPS) a blockchain network can process is relatively low for a technology that aims to be adopted by the masses.
To overcome the inherent limitations of blockchain technology, a number of scalability solutions have been proposed to increase the number of transactions that a network can handle. In this article, we’ll take a deep dive into the Lightning Network, one such extension of the Bitcoin protocol.

What is the Lightning Network?

The Lightning Network is a network that sits on top of a blockchain to facilitate fast peer-to-peer transactions. It’s not exclusive to Bitcoin – other cryptocurrencies such as Litecoin have integrated it.
You might be wondering what we mean by “sits on top of a blockchain.” The Lightning Network is what’s called an off-chain or layer two solution. It allows individuals to transact without having to record every transaction on the blockchain.
The Lightning Network is separate from the Bitcoin network – it has its own nodes and software, but it nonetheless communicates with the main chain. To enter or exit the Lightning Network, you need to create special transactions on the blockchain.

What you’re actually doing with your first transaction is building a sort of smart contract with another user. We’ll get into the details shortly – for now, just think of the smart contract holding a private ledger with the other user. You can write many transactions to this ledger. They’re only visible to you and your counterparty, but neither of you can cheat due to some peculiar features of the setup.

This mini-ledger is called a channel. Say Alice and Bob put 5 BTC each into the smart contract. In their channel – they’d now both have a balance of 5 BTC. Alice could then write to the ledger pay 1 BTC to Bob. Now, Bob has 6 BTC on his side, and Alice has 4. Then, Bob could send 2 BTC back to Alice at a later date, updating the balances to 6 BTC on Alice’s side and 4 BTC on Bob’s. They can continue to do this for a while.

At any time, either can publish the current state of the channel to the blockchain. At that point, the balances on each side of the channel are allocated to their respective parties on-chain.

True to the name, Lightning transactions are lightning fast. There’s no block confirmations to wait for – payments can be made as fast as your internet connection will permit.

Why is the Lightning Network necessary?

So far, the Lightning Network (or simply, LN) appears to be the most sensible approach to scaling the Bitcoin blockchain. Coordinating changes in such a vast ecosystem is tricky –  there’s a risk of hard forks and potentially catastrophic bugs. With so much value at stake, experimentation is incredibly dangerous.

When you move that experimentation away from the blockchain, you have a lot more flexibility. If something goes wrong, it’ll have no impact on the actual Bitcoin network. Layer two solutions don’t undermine any of the security assumptions that have kept the protocol going for 10+ years.

There’s no obligation to switch from the old way of doing things, either. On-chain transactions continue to work as normal for the end-user, but they now have the option of transacting off-chain, too.

There are several benefits to using the Lightning Network. We’ll look at some of the main ones below.

Scalability

Bitcoin blocks are created approximately every ten minutes, and can only hold so many transactions. Block space is a scarce resource, so you must bid against other users to have yours included in a timely manner. Miners care, first and foremost, about getting paid, so they’ll include transactions with higher fees first.
When there aren’t many users trying to send funds at the same time, this isn’t really an issue. You can set a low fee, and you’re likely to have the transaction included in the next block. But when everyone’s broadcasting transactions at the same time, the average fee can rise significantly. On a few occasions, it has exceeded $5. At the height of the 2017 bull market, it exceeded $50.

Average Bitcoin Transaction Fee (in USD)

That might seem insignificant for transactions moving thousands of dollars worth of Bitcoin, but for smaller payments, it’s not sustainable. Who wants to pay for a $3 coffee with a $5 fee attached?

With the Lightning Network, you still pay two fees – one to open your channel, and another to close it. But yourself and your counterparty can make thousands of transactions for free once the channel is open. Once you’re finished, you just need to publish the final state to the blockchain.

In the grand scheme, if more users rely on off-chain solutions like the Lightning Network, block space will be used more efficiently. Low-value, high-frequency transfers could be carried out in payment channels, while block space is used for larger transactions and channel opening/closing. This would make the system accessible to a vastly wider user base, allowing it to scale in the long run.

Micropayments

There’s a minimum amount of Bitcoin you can send in a transaction – approximately 0.00000546 BTC. At the time of writing, that’s equal to about four cents. It’s a small amount, but the Lightning Network allows you to push the limits to transact the smallest unit currently available – 0.00000001 BTC, or one satoshi.

Lightning is a lot more appealing for micropayments. The fees on regular transactions make it impractical to send tiny amounts on the main chain. Within a channel, however, you’re free to send a fraction of a fraction of a Bitcoin for free.

Micropayments are suited to plenty of use cases. Some speculate that they could be a viable replacement for subscription-based models, where users instead pay tiny amounts each time they use a service.

Privacy

A secondary benefit of the Lightning Network is that it can offer users a high degree of confidentiality. Parties do not need to make their channels known to the broader network. While you may be able to look at the blockchain and say this transaction opened a channel, you won’t necessarily be able to tell what’s going on inside it. If the participants choose to make their channel private, only they will know what transactions are taking place.

If Alice has a channel with Bob and Bob has a channel with Carol, Alice and Carol can send payments to each other via Bob. If Dan is connected to Carol, Alice can send payments to him. You can imagine this expanding into a sprawling network of interconnected payment channels. In such a setup, you couldn’t be sure who Alice has sent funds to once the channel is closed.

How does the Lightning Network work?

We’ve explained how the Lightning Network relies on channels between nodes at a high-level. Let’s now take a look under the hood.

Multisignature addresses

A multisignature (or multisig) address is one that multiple private keys can spend from. When creating one, you specify how many private keys can spend the funds, and how many of those keys are required to sign a transaction. For instance, a 1-of-5 scheme means that five keys can produce a valid signature and that only one is needed. A 2-of-3 scheme would indicate that, out of the three possible keys, any two are required to spend the funds.
To initialize a Lightning channel, the participants lock up funds in a 2-of-2 scheme. There are only two private keys capable of signing, and both are needed to move coins. Let’s bring back our friends Alice and Bob at this point. They’ll be making a lot of payments to each other in the coming months, so they decide to open a Lightning Network channel.

This starts with both of them depositing, say, 3 BTC each into the jointly-owned multisig address. It’s worth reiterating that Bob can’t move funds out of the address without Alice agreeing, or vice versa.

Now, they could just keep a sheet of paper that adjusts the balances on each side. Both have a starting balance of 3 BTC. If Alice wants to make a payment of 1 BTC to Bob, why not just make a note that Alice now owns 2 BTC and Bob owns 4 BTC? Balances could be tracked like this until they decided to move the funds out.

That’s possible, but where’s the fun in it? More importantly, doesn’t that make it incredibly easy for someone not to cooperate? If Alice ends up with 6 BTC and Bob with none, Bob loses nothing by refusing to release the funds (except, perhaps, his friendship with Alice).

Hash Timelock Contracts (HTLCs)

The system above is boring and doesn’t offer much over today’s trusted setups. It gets a lot more interesting when we introduce a mechanism that enforces the “contract” between Alice and Bob. If one of the parties decides not to play by the rules, then the other one still has a remedy to get their funds out of the channel.

That mechanism is a Hash Timelock Contract (or HTLC). The term may sound daunting, but it’s actually quite a straightforward concept to grasp. It marries two other technologies (hashlocks and timelocks) to remedy any uncooperative behavior in payment channels.
A hashlock is a condition placed on a transaction dictating that you can only spend funds by proving that you know a secret. The sender hashes a piece of data and includes the hash in the transaction to the receiver. The only way that the receiver can spend it is if they provide the original data (the secret) that matches the hash. And the only way they can provide that data is if the sender gives it to them.
A timelock is a condition that prevents you from spending funds before a certain time. It’s specified either as an actual time, or a specified block height.

HTLCs are created by combining hashlocks and timelocks. In practice, HTLCs can be used to create conditional payments – the receiver has to provide a secret before a certain time, or the sender can reclaim the funds. This next part is probably better explained with an example, so let’s get back to Alice and Bob.

Opening and closing channels

We gave the example of Alice and Bob having just created transactions that fund the multisignature address they’ll share. But those transactions aren’t published to the blockchain yet! We need to do one more thing first.

Three coins from Bob and three coins from Alice.

Remember, the only way those coins can move out of the multisig is if both Alice and Bob jointly sign a transaction. If Alice wanted to send all the six coins to an external address, she would need Bob’s approval. She’d first put together a transaction (six bitcoins to this address) and add her own signature.

She could try to broadcast the transaction right away, but it would be invalid because Bob hasn’t included his signature. Alice must give the incomplete transaction to him first. Once he adds his signature, it becomes valid.

We still haven’t put a mechanism in place to keep everyone playing honestly. As we said earlier, if your counterparty refuses to cooperate, your funds are effectively trapped. Let’s get into the mechanism that prevents this. There are a few different moving pieces, so bear with us.

Each party needs to come up with a secret – let’s just call those As and Bs. They’d be terrible secrets if Alice and Bob revealed them, so they’ll keep them hidden for now. The pair will generate the respective secrets’ hashes – h(As) and h(Bs). So instead of sharing their secrets, they share those hashes with each other.

Alice and Bob share the hashes of their secrets with each other.

Alice and Bob also need to create a set of commitment transactions before they publish their first transactions to the multisignature address. This will give them a remedy in case the other decides to keep funds hostage.

If you think about a channel like the mini-ledger we referenced earlier, then commitment transactions are the updates that you make to the ledger. Any time you create a new pair of commitment transactions, you’re rebalancing the funds between the two participants.

Alice’s one will have two outputs – one that pays an address she owns, and another that’s locked into a new multisig address. She signs it and gives it to Bob.

Alice’s transaction with two outputs – one to her own address, and one to a new multisig. She still needs Bob’s signature to make it valid.

Bob does the same – one output pays himself, the other pays another multisig address. He signs it and gives it to Alice.

We have two incomplete transactions that are very similar.

Normally, Alice could add a signature to Bob’s transaction to make it valid. But you’ll note that these funds are being spent from the 2-of-2 multisig that we haven’t funded yet. It’s a bit like trying to spend a cheque from an account that has zero balance for now. Therefore, these partially-signed transactions will only be usable once the multisig is up and running.

The new multisignature addresses (where the 3 BTC outputs are destined) have some peculiar properties. Let’s take a look at the incomplete transaction that Alice signed and gave to Bob. The multisig output can be spent under the following conditions:

  1. Both parties can cooperatively sign it.
  2. Bob can spend it by himself after a certain period of time (due to our timelock).
  3. Alice can spend it if she knows Bob’s secret Bs.

For the transaction Bob gave to Alice:

  1. Both parties can cooperatively sign it.
  2. Alice can spend it by herself after a certain period of time.
  3. Bob can spend it if he knows Alice’s secret As.

Bear in mind that neither party knows the other’s secret, so 3) isn’t a possibility yet. Another thing to note is that, if you sign a transaction, your counterparty can spend immediately because there’s no special conditions on their output. You can either wait for the timelock to expire to spend the funds by yourself, or you can cooperate with the other party to spend them outright.

Okay! Now you can publish the transactions into the original 2-of-2 multisignature address. It’s finally safe to do so, because you can retrieve your funds if your counterparty abandons the channel.

Once the transactions confirm, the channel is up and running. That first pair of transactions shows us the current state of the mini-ledger. Currently, it will pay out 3 BTC to Bob, and 3 BTC to Alice.

When Alice wants to make a new payment to Bob, the pair create two new transactions to replace the first set. The drill is the same – they’re only half-signed. However, Alice and Bob first give up their old secrets and trade new hashes for the next round of transactions.

 If Alice wanted to pay 1 BTC to Bob, for example, the two new transactions would credit 2 BTC to Alice, and 4 BTC to Bob. In this way, the balance is updated.

Either party can sign and broadcast one of the most recent transactions at any time to “settle” it on the blockchain. But whichever party does so will need to wait until the timelock has expired, while the other can spend immediately. Remember, if Bob signs and broadcasts Alice’s transaction, she now has an output with no conditions on it.

Both parties can agree to close the channel together (a cooperative close). This is probably the easiest and quickest way to get your funds back onto the chain. However, even if one party becomes unresponsive or refuses to cooperate, the other can still reclaim their funds by waiting out the timelock.

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How does the Lightning Network prevent cheating?

You might have identified an attack vector here. If Bob currently has a 1 BTC balance, what’s to stop him from broadcasting an older transaction where he had more? He’s already got the half-signed transaction from Alice, he just needs to add his signature and broadcast it, right?
Nothing’s stopping him from doing that – except for the fact that he could lose his entire balance. Let’s say he goes through with it and broadcasts an old transaction that pays one coin to Alice and five to that multisig address we mentioned earlier.

Alice receives her coin immediately. Bob, on the other hand, must wait until the timelock expires to spend from the multisig address. Remember the other condition we mentioned that would allow Alice to spend those same funds immediately? She needs a secret that she didn’t have then. She does now – as soon as the second round of transactions were created, Bob gave that secret away.

While Bob sits, unable to do anything as he waits for the timelock to expire, Alice can move those funds. This punishment-based mechanism means that participants are unlikely to even attempt to cheat because the peer will get access to their coins.

Routing payments

We touched on this earlier – channels can be connected. The Lightning Network wouldn’t be that useful for payments otherwise. Are you really going to lock up $500 in a channel with a coffee shop just so you can get your daily fix for the next few months?

You don’t have to do that. If Alice opens a channel with Bob and Bob already has one with Carol, Bob can route payments between the two. This can work across multiple “hops”, meaning  that Alice can effectively pay anyone to whom a path exists.

In this scenario, Alice can go through multiple routes to get to Frank. In practice, she’ll always take the easiest one.

For their role in routing, the intermediaries might take a small fee (though there’s no obligation to). The Lightning Network is still very new, so a fee market has yet to materialize. What many expect to see are fees based on liquidity provided.

On the base chain, your fee is based solely on the space your transaction takes up in a block – the value being transmitted doesn’t matter – $1 and $10,000,000 payments cost the same. In contrast, there’s no such a thing as block space within the Lightning Network.

Instead, there’s the idea of local and remote balances. The local balance is the amount that you can “push” to the other end of the channel, whereas the remote balance is that which your counterparty can push to you.
Time for another example. Let’s take a closer look at one of the above paths: Alice <> Carol <> Frank.

Users’ balance before and after a transfer of 0.3 BTC from Alice to Frank.

The Alice <> Carol and Carol <> Frank each have a total capacity of 1 BTC. Alice’s local balance is 0.7 BTC. If they settled on the blockchain now, she would receive 0.7 BTC, and Carol would receive the remote balance (i.e., 0.3 BTC).

If Alice wants to send 0.3 BTC to Frank, she pushes 0.3 BTC to Carol’s side of the channel. Then Carol pushes 0.3 BTC from her local balance in the channel with Frank. As a result, Carol’s balance remains the same: the +0.3 BTC from Alice and -0.3 BTC to Frank cancel each other out.

Carol isn’t losing value from acting as a connection between Frank, but she is making herself less flexible. You see, she can now spend 0.6 BTC in her channel with Alice, but only 0.1 BTC in the channel with Frank.

You can imagine a situation where Alice is only connected to Carol, whereas Frank is connected to a much wider network. Carol could previously send a total of 0.4 BTC to others via Frank, but now she can only push 0.1 BTC because that’s all she has on her end of the channel.

In this scenario, Alice is effectively eating into Carol’s liquidity. Without any kind of incentive, Carol may not want to weaken her own position. So, instead, she might just say I will route every 0.01 BTC at a fee of ten satoshis. In this way, the more of her local balances Carol sacrifices in “stronger” paths, the more she profits.

As mentioned previously, there’s no de facto requirement to charge a fee. Some might not be concerned with the reduction in liquidity. Others might just open channels directly to the receiver.

Limitations of the Lightning Network

It would be fantastic if the Lightning Network proved to be the solution to all of Bitcoin’s scalability troubles. Unfortunately, it has its own shortcomings that may get in the way.

Usability

Bitcoin isn’t the most intuitive system for beginners – addresses, fees, etc. can be confusing to familiarize yourself with. But wallets can abstract away the complicated stuff to give users something that vaguely resembles existing payment systems. You can get someone to download a smartphone wallet, send them coins, and they’re good to go.

For now, that isn’t possible with the Lightning Network. Options are limited when it comes to smartphone apps – generally, Lightning nodes require access to a Bitcoin node to be fully usable.

After a client has been set up, users also need to start opening channels before they can make payments. This can be a time-consuming process, and it could be overwhelming when a newcomer is introduced to concepts like inbound/outbound capacity.

That said, improvements are constantly being made to reduce the barriers to entry, and to provide users with a more streamlined experience.

Liquidity

One of the biggest criticisms of the Lightning Network is that your ability to transact is constrained. You can’t spend more than you have locked into a channel. If you spend all of your funds so that the remote balance has all of the channel’s funds, you’ll have to close the channel. Alternatively, you can wait until someone pays you through it, but that’s not ideal.

Your paths can also be limited by the channel’s total capacity. Take the Alice <> Carol <> Frank example from earlier. If Alice and Carol have a capacity of 5 BTC in their channel, but Carol and Frank only have a capacity of 1 BTC, Alice can never send more than 1 BTC. Even then, the entire balance would need to be on Carol’s side of the Carol <> Frank channel for that to work. This can severely limit the amount of funds that can be passed along LN channels, and thus has a knock-on effect on usability.

Centralized hubs

Because of the issue mentioned in the previous section, there’s some concern that the network will facilitate the creation of massive “hubs.” That is, large, heavily-connected entities with a lot of liquidity. Any significant payments would need to be routed through some of these entities.

Obviously, that wouldn’t be a great situation. It would weaken the system, as these entities going offline would majorly disrupt relationships between peers. There’s also an increased risk of censorship since there are only a few points through which transactions are flowing.

The current state of the Lightning Network

As of April 2020, the Lightning Network looks healthy. It boasts upwards of 12,000 online nodes, 30,000+ active channels, and just over 920 BTC in capacity.

Global distribution of Lightning Network nodes. Source: explorer.acinq.co

There are a handful of different node implementations – Blockstream’s c-lightning, Lightning Labs’ Lightning Network Daemon, and ACINQ’s Eclair are some of the most popular. For users that are less technically-inclined, many companies offer plug-and-play nodes. The only thing you have to do with these is power up the device and you’re ready to get started with the Lightning Network.

Closing thoughts

Since its mainnet launch in 2018, the Lightning Network has seen impressive growth, in spite of many considering it to still be in beta.

There are still some usability obstacles to overcome, as it currently requires some degree of technical proficiency to operate a Lightning node. But with the amount of development taking place, we may well see the barriers to entry reduced over time.

If the issues can be resolved, the Lightning Network could become an integral part of the Bitcoin ecosystem, greatly boosting scalability and transaction speeds.

Why Does Bitcoin Have Value?

TL;DR

Bitcoin derives its value from a variety of different attributes. Ultimately, both crypto and fiat currencies have value because of trust. As long as society believes in the fiat system, money will continue to have value. We can say the same for Bitcoin: it has value because users believe it does.

But unlike fiat, Bitcoin has no central bank, and its decentralized structure allowed for the creation of a unique financial system. Blockchain technology offers a great deal of security, utility, and other benefits. It also provided a revolutionary way of dealing with the transfer of value globally. In many ways, Bitcoin can also act as a store of value similar to gold.

Introduction

One of the biggest struggles for newcomers to crypto is grasping how and why a cryptocurrency like Bitcoin (BTC) can have value. The coin is digital, has no physical asset backing it up, and the concept of mining can be very confusing. In a sense, mining creates new bitcoins out of thin air. In practice, though, successful mining requires a very costly investment. But how can all of this make BTC valuable?

Think about the money we all use daily. There’s no longer gold or assets backing up our banknotes. Money that we borrow often exists only as numbers on a screen, thanks to fractional reserve banking. Governments and central banks like the Federal Reserve can create new money and increase its supply through economic mechanisms.

Although there are remarkable differences, BTC, as a digital form of money, shares some similarities with the fiat money we are all used to. So, let’s discuss first the value of fiat money before we dive into the cryptocurrency ecosystem.

Why does money have value?

In short, what gives money value is trust. Essentially, money is a tool used to exchange value. Any object could be used as money, as long as the local community accepts it as payment for goods and services. In the early days of human civilization, we had all kinds of objects being used as money – from rocks to seashells.

What is fiat money?

Fiat money is the one issued and officialized by a government. Today, our society exchanges value through the use of paper notes, coins, and digital numbers on our bank accounts (which also define how much credit or debt we have).

In the past, people could go to the bank to exchange their paper money for gold or other precious metals. Back then, this mechanism ensured that currencies like the U.S. dollar had their value tied to an equivalent amount in gold. However, the gold standard was abandoned by the majority of nations and is no longer the basis of our monetary systems.

After removing a currency’s ties to gold, we now use fiat money without any backing. This uncoupling gave governments and central banks more freedom to adopt monetary policies and affect the money supply. Some of the main characteristics of fiat are:
  1. It’s issued by a central authority or government.
  2. It has no inherent value. It’s not backed by gold nor any other commodity.
  3. It has an unlimited potential supply.

Why does fiat have value?

With the removal of the gold standard, we seemingly have a currency without value. Money does, however, still pay for our food, bills, rent, and other items. As we discussed, money derives its value from collective trust. Therefore, a government needs to firmly back and successfully manage a fiat currency to succeed and maintain a high level of trust. It’s easy to see how this breaks down when faith in a government or central bank is lost due to hyperinflation and inefficient monetary policies, as seen in Venezuela and Zimbabwe.

Why does crypto have value?

Cryptocurrencies have some things in common with our standard idea of money, but there are some remarkable differences. Although some crypto like PAXG are pegged to commodities like gold, most cryptocurrencies have no underlying asset. Instead, trust once again plays a significant role in the value of a cryptocurrency. For example, people see value in investing in Bitcoin, knowing that others also trust Bitcoin and accept BTC as a payment system and medium of exchange.
For some cryptocurrencies, utility is also an important factor. To access certain services or platforms, you may need to use a utility token. A service in high demand will therefore provide value to its utility token. Not all cryptocurrencies are the same, so their value really depends on the features of each coin, token, or project.

When it comes to Bitcoin, we can narrow it down to six features that we’ll discuss in more detail later: utility, decentralization, distribution, systems of trust, scarcity, and security.

What is intrinsic value?

A lot of the discussion regarding Bitcoin’s worth is whether it has any intrinsic value. But what does this mean? If we look at a commodity like oil, it has intrinsic value in producing energy, plastics, and other materials.

Stocks also have intrinsic value, as they represent equity in a company producing goods or services. In fact, many investors perform fundamental analysis in an attempt to calculate an asset’s intrinsic value. On the other hand, fiat money has no intrinsic value because it’s just a piece of paper. As we’ve seen, its value derives from trust.

The traditional financial system has many investment options that carry intrinsic value, from commodities to stocks. Forex markets are an exception as they deal with fiat currencies, and traders often profit from short or mid-term exchange rate swings. But what about Bitcoin?

Why is Bitcoin valuable?

The value of Bitcoin is a subjective topic with many differing opinions. Of course, one could say that the market price of Bitcoin is its value. However, that doesn’t exactly answer our question. What’s more important is why people judge it to have value in the first place. Let’s dig a bit deeper into some of the characteristics that make Bitcoin valuable.

Bitcoin’s value in utility

One of the major benefits of Bitcoin is its ability to quickly transfer large amounts of value worldwide without the need for intermediaries. While it can be relatively expensive to send a small amount of BTC due to fees, it’s also possible to send millions of dollars cheaply. Here, you can see a Bitcoin transaction worth around $45,000,000 (USD) sent with a fee of just under $50 (as of June 2021).
While Bitcoin isn’t the only network that makes this possible, it’s still the largest, safest, and most popular. The Lightning Network also makes small transactions possible as a layer two application. But regardless of the amount, being able to make borderless transactions is certainly valuable.

Bitcoin’s value in decentralization

Decentralization is one of the key features of cryptocurrencies. By cutting out central authorities, blockchains give more power and freedom to the community of users. Anyone can help improve the Bitcoin network due to its open-source nature.
Even the cryptocurrency’s monetary policy works in a decentralized manner. The work of miners, for example, involves verifying and validating transactions, but it also ensures that new bitcoins are added into the system at a predictable, steady rate.
Bitcoin’s decentralization gives it a very robust and secure system. No single node on the network can make decisions on everyone’s behalf. Transaction validation and protocol updates all need to have group consensus, protecting Bitcoin from mismanagement and abuse.

Bitcoin’s value in distribution

By allowing as many people as possible to participate, the Bitcoin network improves its overall security. The more nodes connected to Bitcoin’s distributed network, the more value it gets. In distributing the ledger of transactions across different users, there’s no need to rely on a single source of truth.

Without distribution, we can have multiple versions of the truth that are difficult to verify. Think about a document sent via email that a team is working on. As the team sends the document among themselves, they create different versions with different states that can be difficult to track.

Also, a centralized database is more susceptible to cyber-attacks and outages than a distributed one. It’s not uncommon to have issues using a credit card because of a server issue. A cloud-based system like the one of Bitcoin is maintained by thousands of users around the world, making it much more efficient and secure.

Bitcoin’s value in systems of trust

Bitcoin’s decentralization is a huge network benefit, but it still needs some safeguarding. Getting users to cooperate on any large, decentralized network is always a challenge. To solve this problem, known as the Byzantine General’s Problem, Satoshi Nakamoto implemented a Proof of Work consensus mechanism that rewards positive behavior.

Trust is an essential part of any valuable item or commodity. Losing trust in a central bank is disastrous for a nation’s currency. Likewise, to use international money transfers, we have to trust the financial institutions involved. There is more inbuilt trust in Bitcoin’s operations than other systems and assets we use daily.

Proof of Work is a transparent mechanism that anyone can verify and check themselves. It’s plain to see the value here in generating consensus that is highly robust and almost always error-free.

Bitcoin’s value in scarcity

Inbuilt within Bitcoin’s framework is a limited supply of 21,000,000 BTC. No more will be available once Bitcoin miners mine the last coin around 2140. While traditional commodities like gold, silver, and oil are limited, we find new reserves every year. These discoveries make it difficult to calculate their exact scarcity.
Once we have mined all BTC, Bitcoin should, in theory, be deflationary. As users lose or burn coins, the supply will decrease and likely cause an increase in price. For this reason, holders see a lot of value in Bitcoin’s scarcity.
Bitcoin’s scarcity has also led to the popular Stock to Flow model. The model attempts to predict BTC’s future value based upon Bitcoin mining per year and the overall stock. When back-tested, it quite accurately models the price curve that we have seen so far. According to this model, the main driving force in Bitcoin’s price is its scarcity. By having a possible relationship between price and scarcity, holders find value in using Bitcoin as a store of value. We’ll dive further into this concept at the end of the article.

Bitcoin’s value in security

In terms of keeping your invested funds safe, there aren’t many other options that provide as much security as Bitcoin. If you follow the best practices, then your funds are incredibly secure. In developed countries, you can easily take for granted the security offered by banks. But for many people, financial institutions cannot provide them the protection they need, and holding large amounts of cash can be very risky.

Malicious attacks to the Bitcoin network require owning more than 51% of current mining power, making coordination on this scale almost impossible. The probability of a successful attack on Bitcoin is extremely low, and even if it happens, it won’t last long.

The only real threats to the storage of your BTC are:

  1. Fraud and phishing attacks
  2. Losing your private key
  3. Storing your BTC in a compromised custodial wallet where you don’t own the private key
By following best practices to make sure the above doesn’t happen, you should have a level of security that exceeds even your bank. The best part is that you don’t even have to pay to keep your crypto safe. And unlike banks, there are no daily or monthly limits. Bitcoin allows you to have full control over your money.

Bitcoin as a store of value

Most of the characteristics already described also make Bitcoin a good fit as a store of value. Precious metals, U.S. dollars, and government bonds are more traditional options, but Bitcoin is gaining a reputation as a modern alternative and digital gold. For something to be a good store of value, it needs:
  1. Durability: So long as there are still computers maintaining the network, Bitcoin is 100% durable. BTC cannot be destroyed like physical cash and is, in fact, more durable than fiat currencies and precious metals.
  2. Portability: As a digital currency, Bitcoin is incredibly portable. All you need is an Internet connection and your private keys to access your BTC holdings from anywhere.
  3. Divisibility: Each BTC is divisible into 100,000,000 satoshis, allowing users to make transactions of all sizes.
  4. Fungibility: Each BTC or satoshi is interchangeable with another. This aspect allows the cryptocurrency to be used as an exchange of value with others globally.
  5. Scarcity: There will only ever be 21,000,000 BTC in existence, and millions are already lost forever. Bitcoin’s supply is much more limited than inflationary fiat currencies, where the supply increases over time.
  6. Acceptability: There’s been widespread adoption of BTC as a payment method for individuals and companies, and the blockchain industry just continues to grow every day.
If you want to explore the topic a bit more, check out Is Bitcoin a Store of Value?.

Closing thoughts

There is, unfortunately, no single and neat answer as to why Bitcoin has value. The cryptocurrency has the key aspects of many assets with worth, like precious metals and fiat, but doesn’t fit into an easily identifiable box. It acts like money without government backing and has scarcity like a commodity even though it’s digital.

A general lack of knowledge and misunderstanding has led some to question whether Bitcoin has any value at all. With words like “scam” and “Ponzi scheme” used, it’s easy to see that some people have unfounded fears. But, ultimately, Bitcoin runs on a very secure network and the cryptocurrency has a considerable amount of value placed on it by its community, investors, and traders.

Paul Krugman’s 10-Year History of Being Wrong About Bitcoin

Why is it so hard for him to just admit he was wrong?

Nobel Prize–winning economist Paul Krugman is one of the most influential individuals in his field, which means people listen when he talks about bitcoin. Unfortunately, most of what he has had to say about the cryptocurrency over the years has been misguided, uninformed, or just plain wrong.

It’s sometimes difficult for the average person to understand what economists and politicians are talking about when they debate policy, but the value proposition of bitcoin can be easily understood by anyone through its NgU technology (NgU is an abbreviation of Number Go Up and is a meme based around bitcoin’s deflationary monetary policy). While Krugman has stated that his 1998 prediction that “the Internet’s impact on the economy [would be] no greater than the fax machine’s” was supposed to be a fun and provocative thought experiment, it may be much more difficult to explain away his many confused and oftentimes arrogant takes on bitcoin over the past ten years.

Krugman first wrote about bitcoin in The New York Times back in September 2011. In this post, Krugman mainly compared bitcoin to gold in a rather negative light. “To the extent that the [bitcoin] experiment tells us anything about monetary regimes,” he wrote, “it reinforces the case against anything like a new gold standard—because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression.”

In other words, Krugman made a moral case against the adoption of bitcoin as money. In Krugman’s telling, a bitcoin standard would make the world much worse off because bitcoin has a fixed supply and central bankers would not be able to increase the money supply to stimulate the economy during economic recessions.

Even if you accept the idea that the world would be much better off under a more inflationary monetary system where central bankers have the power to stabilize the economy (I don’t), individuals tend to respond to incentives related to the betterment of their own lives, not necessarily the greater good of society. If holding bitcoin theoretically makes the world as a whole a bit worse off but acts as a better form of savings for an individual, is the average person going to choose to put his savings in fiat currencies that lose value over time out of the kindness of his own heart, or will he choose to just hold bitcoin? It’s also important to remember that the entire point of bitcoin is to persist in the face of governments that try to force their citizens into only using the government-approved form of money.

In April 2013, Krugman invoked Adam Smith to make another moral case against bitcoin, this time claiming that the use of gold, silver, or bitcoin as money was a waste of resources. “Smith actually wrote eloquently about the fundamental foolishness of relying on gold and silver currency, which— as he pointed out—serve only a symbolic function, yet absorbed real resources in their production, and why it would be smart to replace them with paper currency,” Krugman wrote. “And now here we are in a world of high information technology—and people think it’s smart, nay cutting-edge, to create a sort of virtual currency whose creation requires wasting real resources in a way Adam Smith considered foolish and outmoded in 1776.”

This was an early version of the energy and climate change–based arguments being made against bitcoin today. This is a faulty argument, however, because it assumes there is no difference between bitcoin and traditional bank accounts. The entire point of bitcoin as an asset is that, unlike Venmo or traditional bank accounts, users can retain full control over their digital money and are not simply holding IOUs. Claiming that this is a waste of resources is a subjective argument. It is no different from saying automobiles or YouTube are wasteful due to the amount of energy that is used to power them. People use bitcoin because it provides value for them, so the resources expended to make bitcoin possible aren’t a waste.

Later in 2013, Krugman simply declared that “Bitcoin Is Evil” because, as science-fiction writer Charlie Stross put it, “BitCoin looks like it was designed as a weapon intended to damage central banking and money issuing banks, with a Libertarian political agenda in mind—to damage states ability to collect tax and monitor their citizens financial transactions.” That said, Krugman did at least go into the argument that bitcoin lacked any sort of fundamental price floor and contrasted that characterization with gold’s use in jewelry and the U.S. dollar’s use for paying taxes.

Krugman would go on to use bitcoin’s lack of a price floor mechanism as his key argument against the cryptocurrency for many years to come. For example, as he argued in a 2015 interview, bitcoin “is a technically sweet solution to a problem, but it’s not clear that problem is one that has much economic relevance. It’s certainly not a reason to hold that currency.…If you’re looking for the idea that a currency doesn’t really have to be something physical, it can be something that is virtual, that’s the system we already have.”

But this misses the point of bitcoin, which is actually nothing like the monetary system we currently have. For one, bitcoin’s long-term monetary policy was “set in stone” when the network launched in January 2009, and it is not subject to changes by a trusted third party such as a central bank. Additionally, bitcoin solves the problem of centralization that is found in the digital equivalents of both the gold and fiat-based currency systems. Bitcoin users are able to retain full ownership over their coins with no counterparty risk; a bitcoin is not an IOU. Further, due to the censorship-resistant nature of the bitcoin network, a new financial system can be built on top of the bitcoin blockchain through the use of smart contracts to enable a greater degree of user privacy for a wide variety of activities, operating in a manner that contrasts the current surveillance state.

In addition to calling bitcoin evil, Krugman has also dismissed it as “libertarian derp” on multiple occasions. He even took pleasure in the crashing bitcoin price in early 2018. Notably, some of Krugman’s negative comments toward bitcoin popped up around the absolute bottoms of two consecutive cryptocurrency bear markets. In other words, it may be a good time to buy bitcoin whenever you see Krugman taking a victory lap.

Unfortunately for Krugman, the “libertarian derp” cryptocurrency hit a new all-time high once again in 2021, 10 years after his initial criticisms of the crypto asset were first published in The New York Times. Instead of acknowledging the reasons for bitcoin’s staying power, however, it appears that Krugman will continue to claim there is no utility for this technology and keep dismissing bitcoin as a cult that can survive indefinitely.

Fortunately for bitcoin, it can rebut Krugman by simply continuing to exist and thrive in the marketplace.