8 minute read

Bitcoin Lightning as a payment rail Accept bitcoin without accepting bitcoin

By Timothy Lamb

The Bitcoin Lightning Network has broken down many of the barriers to using bitcoin for small payments. Accepting Lightning payments alongside traditional payment channels can offer advantages for merchants, and some businesses in the UK are getting on board.

The Bitcoin network (layer 1) is suited for moving larger sums of money securely, with no intermediaries and across borders – it is not suitable for buying a cup of coffee. The Lightning Network is a second layer technology designed to fix this.

The base layer: unsuitable for micro-payments

Until recently, the use case for crypto asset bitcoin has predominantly been as a store of value: a ‘digital gold’. In fact, the Bitcoin protocol has several features that make the network completely unsuitable for micro-payments.

Firstly, the block size is limited to only four megabytes of data. A low amount of data helps with the objective of decentralisation, with anyone able to run the Bitcoin protocol on a laptop. However, it means the network cannot be scaled to take on all the world’s transactions.

Fees vary widely over time, depending on the congestion of the network. At the time of printing, the transaction fee is around $1.30 (US) per transaction, but has been far higher in the past and is likely to be so again. Therefore, if using the Bitcoin network to buy a cup of coffee, the transaction fee could easily cost more than the item itself.

The other major constraint is the

► transaction time – it can take an hour or more for a Bitcoin network transaction to be confirmed.

The Lightning Network in action

The Lightning Network is a secondary layer on top of the Bitcoin network, designed to take on instant payments and remittances. Lightning is capable of processing a million transactions per second (TPS) versus the Bitcoin network’s seven TPS and Visa’s tens of thousands of TPS.

Lightning transactions work both online and with a customer physically coming into a store; the customer simply opens the Lightning-enabled app on their phone and scans the QR code on the merchant’s screen. The transactions settle instantly (within milliseconds to seconds) and are final, unlike Visa or Mastercard transactions that settle days later. The fees are incredibly small: a fraction of a penny compared to fees of around 1.5% to 3.5% for the traditional card payment networks.

“This is a superior payment network that humanity has really longed for,” says Jack Mallers, founder and CEO of Strike. “An ability to move value at the speed of light, digitally.”

Accept bitcoin without accepting bitcoin

With the use of some apps – like CoinCorner in the UK or Strike in the US – merchants can accept Bitcoin Lightning payments without actually taking ownership of any bitcoin.

For a 1% fee, in the case of CoinCorner, merchants can instantly have the bitcoin converted to local currency. They can invoice in sterling (GBP) and receive in sterling.

The merchant then doesn’t need to deal with the accounting and tax consequences – or the volatility – of having bitcoin on their balance sheet; Bitcoin Lightning is being used purely as a payment rail.

How does Lightning work?

The Lightning Network was first proposed in a draft whitepaper by developers Joseph Poon and Thaddeus Dryja in 2015, based on previous discussions of payment channels made by Satoshi Nakamoto – the anonymous creator of Bitcoin.

In 2016, Poon and Dryja, together with other developers, founded Lightning Labs, a company which is dedicated to developing the Lightning Network. In 2018, Lightning Labs launched a beta version of the network, and some public figures, including Twitter co-founder and former CEO Jack Dorsey, got involved – Dorsey later building use of the network into Twitter.

Lightning works by using payment channels between two parties where only the first and last transaction are recorded on the blockchain. Once a payment channel is established, the participants can transact an unlimited number of times off-chain, much faster and for virtually no cost, using smart contracts that are enforceable on-chain.

When a party wishes to close the channel, a final transaction is recorded on the blockchain with the updated balances of the two parties.

What is the Bitcoin network?

The Bitcoin network (layer 1) is a decentralised, peer-to-peer network of computers (or nodes).

This network of computers runs the software that records all Bitcoin network transactions on a publicly available ledger (the blockchain).

For transactions to be valid, the full network has to agree by verifying a ‘block’ of transactions. Blocks are generated roughly every 10 minutes by an operation called mining.

Miners are computers that compete to solve cryptographic tasks in order to package the transactions into blocks. They receive a pre-determined amount of bitcoin as a reward.

In the case that two participants don’t have a direct channel to each another, payments can still be sent; the Lightning Network leverages both participants’ connections to route the transaction through a web of open channels. The intermediaries can take a fee for routing the transaction.

For example, if John wants to send Mary $10, and John is connected to David, who is connected to Mary, the transaction can be routed through David – and it scales up through an unlimited number of intermediary channels. This all happens in the background in order to make a transaction near-instant.

The Lightning Network is a separate protocol from the Bitcoin network, and a different type of wallet is required for use, including the creation of off-chain payment channels. There are many types of Lightning-compatible wallets for users to choose from.

Doors opening for UK businesses

Danny Scott, CEO and co-founder of CoinCorner, says he knows of between 500 and 1,000 UK businesses using bitcoin and some businesses are already accepting Bitcoin Lightning payments.

James Dewar and Christopher Gordon are founders of Bridge 2 Bitcoin, an organisation that helps to onboard UK merchants to accept Lightning payments. They say that, according to their map, around 120 retail businesses in the UK are so far accepting the payment network – and that the majority of these have come online just in the past few months.

“Businesses come to us to accept bitcoin payments,” says Gordon, “The starting point is: ‘Would you like additional revenue?’ This is what we say to business owners. We’re not trying to convert them into bitcoiners. We say: ‘We can open your business up to a new customer base, a base you’re not touching at the moment’.

“Who are those customers? As we know, they are bitcoiners. Bitcoiners are extremely loyal customers,” he adds.

“Bitcoiners will go out of their way to use a bitcoin-accepting business. They will travel a ridiculous distance to get to a coffee shop or a pub just to buy a pint and a sandwich – they will travel across county borders – so the catchment area is much larger for bitcoin customers.”

Not only that, but they tend to post pictures on social media of their bitcoin transaction at the premises, giving some free publicity.

Dewar and Gordon report that merchants typically start out by receiving bitcoin payments in sterling. Once they have reached this stage, however, apparently some businesses have seen such potential in the use of the network that they have opted to keep the bitcoin rather than exchanging it for local currency.

CoinCorner

Founded in 2014, CoinCorner is a bitcoin exchange based in the Isle of Man. It currently offers the only UK service that lets retailers receive local currency instantly for Lightning trans-

► actions, although more companies are expected to offer the solution in the near future.

The company’s products include an e-commerce app, a point-of-sale app and the Bolt Card, which works as a contactless debit card. CoinCorner charges the merchant a 1% fee for all transactions.

The Bolt Card was designed to support customers who are used to contactless payments, but for whom scanning a QR code might be unfamiliar. The card uses near-field communications (NFC) technology to connect to a wallet on the customer’s smartphone.

When tapped on the merchant’s contactless terminal, it initiates a Lightning transaction from the customer’s wallet to the merchant’s. The Bolt Card is also available to be used with other customer Lightning wallets besides CoinCorner’s offering.

Lightning vulnerabilities

By its nature, the Lightning Network is designed to be fast and low cost, at the expense of the level of security that is inherent in the Bitcoin network. It therefore has several security vulner-

Benefits for merchants

Benefits for merchants of accepting Lightning payments alongside traditional payment channels include:

• Lower fees, typically of around 1 Satoshi – the smallest unit of bitcoin, or £0.0002 per transaction for the Lightning Network, or 1% for CoinCorner’s services

• Near-instant final settlement

• No chargebacks

• Generate extra revenue from attracting bitcoiners abilities, and developers continue to work on fixes.

For example, when nodes in the network are offline, their channels can be left open to transaction scams. Protection services called ‘watchtowers’, made up of various specialised nodes, have been introduced to help protect the network from such malicious activity.

“We don’t want to pretend there are no problems,” says Scott, of CoinCorner. “The best way to fix them are to acknowledge and accept there are problems to fix.”

Scott explains that regulation could be a potential risk for scaling merchant adoption, while the flaws in the Lightning Network itself are often to do with routing and liquidity.

“As transactions are routed through peers, if wallet A can’t find a route to wallet D, or if the necessary liquidity isn’t in the route, the payment can fail,” he says.

However, the success rate is over 99% at the moment, and this is anticipated to rise over time as the size of the network and its liquidity improve.

For these reasons, and due to the relatively small number of people who want to pay with bitcoin, Scott likes to temper the most bullish expectations about the speed of Lightning merchant adoption. “I do believe it is the future of payments,” he adds, “but it will take a long time.” He suggests it could take the best part of a decade to really catch on.

Cross-border payments

Cross-border payments is an area where Bitcoin Lightning could potentially make strides much faster.

Strike CEO Jack Mallers’ presentation to the IMF, titled ‘Bitcoin: Disrupting Cross-Border Payments’, shows a demonstration of a Lightning transaction being sent over Twitter from the US to El Salvador.

In less than 60 seconds, $10 has been sent from the US to El Salvador – a final settlement that costs almost nothing – and the recipient has bought a drink at Starbucks with the money.

The Lightning Network has a particular advantage in this situation on speed and cost, compared to services like international bank transfers, Western Union and PayPal.

Bitcoin for financial inclusion

In developing countries in particular, many smartphone users are still unbanked – meaning they do not have a bank account. Bitcoin can open up possibilities for these people: all you need is a smartphone and a connection to the internet to use it.

In order to fund a wallet, it’s possible for an unbanked individual to either pay someone in physical cash, or to be paid for work directly in bitcoin.

Next steps for Lightning

Adoption is on the rise, with the Lightning Network’s payment capacity having grown by over 60% from January 2022 to February 2023, according to data from The Block Research. However, usage remains relatively low.

While there are many use cases for the network, the protocol is still young and faces several vulnerabilities and challenges.

As the network scales up, developers will continue to work on solutions to the flaws; time will tell how successful these efforts will be, and how mainstream Bitcoin Lightning will become as a global payment network.

This article is from: