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28 September 2021

Why The Bitcoin Lightning Network Doesn’t Work (Yet)

Why The Bitcoin Lightning Network Doesn’t Work (Yet)

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So I guess I should start this off with a disclaimer: I actually love the Lightning Network.

A Lightning channel really is just a set of pre-signed transactions — what I didn’t get into is the incentive model that allows this to work.

It’s out there and will always be a valid Bitcoin transaction unless you spend that bitcoin with a different transaction (you can’t spend bitcoin twice; once a transaction spends some bitcoin, any other transactions that try to act on those coins will be invalid).

This means that you cannot invalidate all the other pre-signed transactions you have made on chain without the cooperation of the other party.

Each time the parties exchange funds in their Lightning channel — Bob sends Alice 1000 sats — they generate a new pre-signed transaction that reflects their updated balances.

What if Bob spent his share of the funds by sending them to Alice but now wants to cash out using an earlier pre-signed transaction that still showed all the funds on his side of their channel.

The idea is that once both parties have replaced the older pre-signed transaction with a new one that updates the balances, they also exchange penalty keys.

Crucially, the pre-signed transactions have a built-in timelock so there’s always a window of opportunity for the other party to use the penalty key before the transaction can be confirmed in a Bitcoin block.

But you still have to keep some information about every old transaction — as well as the penalty key associated with that specific transaction — in case you ever have to use it to punish a dishonest channel counterparty.

There is no way to escape this, because if a channel counterparty is going to try to close the channel with an old transaction, you need that exact transaction’s penalty key in order to stop and punish them.

This means you have to keep all the relevant data for every transaction you ever made with them.

Eventually, this will come into conflict with other things you want to store on your phone and, after that, eventually start bumping into the upper storage limits for your phone.

And remember, you absolutely have to keep 100% of this data or your Lightning channel might not be safe to keep open.

This would be a kind of hidden fee users would have to pay that could grow to absurd levels.

For the skeptics still thinking this isn’t really a substantial scaling issue at all, in a world where Lightning is used solely for modest everyday transactions like coffee and dinner I’d agree with you, but in a world where major use cases for Lightning are things like microtransactions and streaming payments done in real time through an entire interaction (e.g.

Thankfully this issue would be solved with a proposed Bitcoin protocol upgrade called ANYPREVOUT and Lightning channels based on eltoo which would allow a single constant-sized piece of data to accomplish the same disincentive mechanism that penalty keys currently do.

But until that feature makes it into Bitcoin, current Lightning channels have this scaling issue.

A Lightning channel can only forward so many HTLCs at once because each one has to be represented by an actual output in the most recent pre-signed transaction.

This isn’t a credit system and we don’t do rehypothecation in Bitcoin or in Lightning; you can only forward payments that are ultimately backed by specific on-chain outputs that your channel has provable claims to.

If a transaction had more HTLCs than that, it would not be a valid Bitcoin transaction and therefore would leave the channel in a weird state where every pre-signed transaction that was valid (those constructed before the 483 limit had been reached) would allow the other person to steal your money and none of the current pre-signed transactions (those constructed after the 483 limit) could be used to close the channel honestly.

Fees are likely to keep increasing in the long term, so this will affect the value that can rationally be routed over the Lightning Network with HTLCs.

Let’s say that you want to open a Lightning channel with a capacity of $10 of BTC, but the on-chain fee for that transaction will cost $1.

This creates a very real market floor for people trying to directly interact with the Lightning Network.

If you only have $10 instead of $100 and don’t want to pay a 10% fee, then you submit your channel-opening transaction with a lower fee.

In times of extreme transaction demand, the mempool can even purge the lowest-fee transactions, guaranteeing that your channel open never occurs.

With the current way that Lightning channels work, this waiting game is really the only solution to this problem.

High effective fee rates have another implication: the timelocks used to guarantee that someone can penalize an old pre-signed transaction would have to be much longer for low-value channels that don’t want to pay a high effective fee rate.

But if you’re not willing or able to pay the potentially high fee for your claim to execute quickly, you need to code extra wait time for your slow low-fee transaction into your pre-signed transactions.

These entities’ trustworthiness is the foundation that allows you to route through Tor nodes that do not have knowledge of the entire path your information is taking through the network.

And the sad part about this is that the places where it would be most likely to happen are authoritarian countries where it would be most needed to protect your privacy.

Bitcoin existed for 9 years before the Lightning Network went live on mainnet with all kinds of existential problems and scaling issues that were open ended or unsolved.

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