Dear friends and strangers of the web, I regret to inform you that I’ve failed you all. Through my 49-page ebook, 22 pages of bonus content, and 5 months of newsletters, I have barely even mentioned—let alone explained—one of the most important aspects of Bitcoin’s future and perhaps the BIGGEST reason to be bullish on global adoption in the coming years: the Lightning Network. Today, I’m going to deliver that long overdue explanation.
First, why should you care?
Well, simply put, the Lightning Network can grow to process more transactions per second than Visa and Mastercard, and it can do so at a faster speed and lower cost, with greatly enhanced user privacy and no trusted intermediaries or restrictions on who can use it. While my ebook was focused on the case for bitcoin as a store of value and inflation hedge in these times of unprecedented central bank money printing, this newsletter issue will be about how the technology of bitcoin can out-compete existing financial infrastructure while also being accessible to billions of people who currently don’t have bank accounts or other financial services.
The Lightning Network is also a big part of the reason that perhaps the most cited metric by bitcoin critics—“energy consumption per transaction”—is completely bogus. (I’ll explain more later in this issue.)
But before I discuss what the Lightning Network is or how it works, I suppose some people will be interested in a wee bit of market analysis.
Bitcoin Market Update
Here’s how I would summarize the sequence of events in the past half year or so of price action for bitcoin:
- Long-term HODLers (HODL is a drunken misspelling of “hold” from 2013 that stuck), wealthy individuals, corporations, and institutions accumulate a lot of BTC
- Price starts to go up rapidly and bitcoin gets mainstream attention
- Many new investors enter the market, pushing prices up even higher
- Altcoins (e.g. DOGE) start reaching absolutely insane overvaluations and the market in general becomes very overleveraged
- Institutions and whales (large investors) start to take profits on their significant short-term gains
- Elon Musk tweets some (misinformed) negative stuff about bitcoin mining
- General market sentiment instantly shifts from euphoric to bearish and all the leveraged traders (e.g. trading 5 BTC with only 1 BTC of collateral) get wiped out, crashing price
- Many of the new investors from (3) sell at a loss and think bitcoin / cryptocurrencies are a scam now
- Long-term holders begin accumulating again in the 30-40k range
And, in case you were wondering, here is a summary of what I’ve done throughout this time period as each of the events above has taken place:
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
- Buy & HODL
Now, obviously if I had a magical crystal ball to see the future, I would have sold everything at $63k and bought it all back at $30k. Since I don’t have a crystal ball nor do I have the time to really analyze the market on a daily basis and try to trade short-term, the only thing I really care about is fundamentals — the stuff that I talked about in my ebook. Bitcoin’s fundamentals (monetary properties, technology development, and adoption) have continued to improve during events 1 - 9. For example, peer-to-peer trade volume in Sub Saharan Africa is sitting at all-time highs in USD terms, meaning that it has essentially doubled in BTC terms since price is down by ~50%.
This is led by Nigeria (orange), where high inflation and lack of accessibility to the financial system has been limiting the potential and growth of Africa’s largest economy and, by all accounts, a very skilled young population.
Then there’s El Salvador making bitcoin legal tender, and spurring politicians all over Latin America to voice their support for bitcoin as well.
Finally, there’s this: the supply of bitcoins being held on exchanges (orange line on the chart below).
This is the best evidence we have that #9, long-term holders begin accumulating again in the 30-40k range, is accurate. The supply on exchanges briefly increased during the sell off from $64k, but in a matter of weeks it reversed in earnest and began decreasing faster than at any point in recent history.
I’ve done my best to make sure that everybody who gets into bitcoin through me understands that this is a long-term game with a lot of short-term volatility. If you buy just for quick gains and you might panic sell if price starts dropping, then you should probably invest your money elsewhere until you’ve done more research on bitcoin and developed some conviction in it (or not).
That said, the amount of people (and capital) with deep conviction in bitcoin is continuing to grow. And what really makes bitcoin’s success almost inevitable in my mind is the fact that it is an OPEN network for anybody to participate in from anywhere in the world. That doesn’t just mean investing and using bitcoin, but also BUILDING on it. All the banks and other fintech companies of the world simply cannot compete with tens of thousands of passionate builders all working on solutions that add utility to the Bitcoin network. Nobody is working on Bitcoin and wishing they had a job at a corporate bank. Meanwhile, thousands of people are working unfulfilling “normal” jobs and wishing they could work in this industry instead. That is a huge part of the long-term fundamentals that should not be discounted.
And that also leads me back to the bigger topic of this issue, the Lightning Network.
Scaling Bitcoin without sacrificing decentralization
The innovative thing about the Bitcoin network is that it’s decentralized. It’s a system built with open-source computer code running on thousands of independent nodes (computers) all over the world — an open monetary network that nobody can control and nobody can stop. If Bitcoin could be stopped, there are plenty of powerful parties that would love to do so, such as many of the politicians and bankers of the world. That’s why it’s important that Bitcoin remains decentralized enough that it can’t fall into the control of any parties that would prefer to see it fail.
One of the key ingredients in achieving this robust decentralization is the cheapness and ease of running a node (i.e. to store a complete history of all transactions ever added to the Bitcoin blockchain and to enforce the rules to ensure that new transactions being added are valid).
Incidentally, this is why I don’t write a newsletter about Ethereum or any other cryptocurrency besides Bitcoin. Sure, the technology can still be really interesting, but none of those altcoins are really meaningfully decentralized compared to Bitcoin. In fact, the go-to marketing strategy of almost every altcoin promoter in existence is to criticize something about Bitcoin like its transaction throughput or its energy-intensive mining, and then to claim that ABCXYZ coin is better than Bitcoin because it can process more transactions or it doesn’t use as much energy. The part they don't usually say is that they made a trade off and sacrificed decentralization to do so. If you are new to the market or not very technical, it’s easy to fall for some of this disingenuous marketing, as I did in 2017.
So, how can the Bitcoin network serve billions of people without significantly increasing the cost of running a node? Well, the same way that the current financial system serves billions of people: layers of services optimized for specific use cases. For example, the Lightning Network is a second layer built on top of Bitcoin which doesn’t achieve final settlement on the blockchain, but which is optimized for smaller transactions so that they can be faster, cheaper, and more private. Somehow, it seems our pal Elon Musk didn’t know about the Lightning Network when Tesla invested $1.5B into BTC, nor afterwards when he started tweeting about Bitcoin’s supposed shortcomings.
If you’re interested in a slightly more technical explanation of how the Lightning Network works, I wrote about it when it was still hypothetical back in 2017: How the Lightning Network Can Resolve Bitcoin’s Scaling Issues.
To summarize more briefly here, the Lightning Network uses a concept called payment channels to take bitcoin transactions off of the blockchain. I can use the Lightning Network by opening and funding one of these payment channels with a single transaction on the blockchain where I lock the coins in my channel. Once the channel is open, I can use it to transact with others on the Lightning Network an unlimited number of times. These transactions are routed privately using the same technology as is used in the Tor network, called onion routing. The only limitation on transaction throughput is bandwidth speeds, so transactions are nearly instantaneous and practically free (fees are fractions of a cent). When I want to gain final settlement on all of those Lightning Network transactions, I simply close my payment channel with another transaction on the blockchain.
Now, if we go back to that “energy consumption per transaction” metric, can you see why it’s so dumb?
With just two transactions on-chain, I can enable and achieve final settlement on hundreds, thousands, or even millions of transactions off-chain. That's not to mention the amount of value that can transferred and settled more efficiently than in the legacy system, even if it's just a simple transaction not involving any Lightning activity off-chain. In the legacy financial system, the Bitcoin blockchain is like central banks settling balances with each other, while the Lightning Network is more like Visa, Mastercard, Venmo, and PayPal. But unlike all those companies, the Lightning Network is permissionless, global, private, and built on an open-source foundation. And it uses bitcoin.
This is a visual of what the Lightning Network looks like today.
Zooming in on any part of the graph shows all of the channels between nodes, with some nodes appearing to be service providers having hundreds of connections, while others are users with just 1 or a few connections.
The Lightning Network is not as decentralized as the base layer of the Bitcoin network itself (i.e. the blockchain), but it’s far more decentralized than our traditional payment processors today. Most importantly, it enables us to scale up the Bitcoin network to eventually serve billions of users and process trillions of transactions without making it cost-prohibitive for regular people to run a full node and be financially sovereign.
If you’re interested in trying out the Lightning Network for yourself, let me know and I’ll tell you about some choices for mobile wallets to use (or finally write an article on it). Then we can send a few sats (i.e. satoshis or units of 0.000000001 BTC) back and forth for you to see the future in action.