The global payments infrastructure is undergoing a revolution
The Market that Bitcoin's Lightning Network can Capture
According to McKinsey, the global payments industry generated $2.1 trillion in revenue in 2021, with a projected 2026 outlook of $3 trillion. Yet this industry is about to be cannibalised by an open-source technology, which nobody is talking about.
The first bitcoin block, known as the ‘Genesis Block’ was mined by Satoshi Nakamoto on the 3rd January 2009. This monumental event passed unnoticed by most of the world’s population and unbeknownst to them a revolution in money had taken place that would change everything.
As bitcoin’s popularity grew, it evolved from a niche technology that allowed you to buy drugs online, to a novelty that captured the interest of the finance and investment world, eventually spawning thousands of imitation chains forked from the original open-source code.
The Bitcoin Trilemma
As thousands of these so-called ‘alt-coins’ proliferated, it became apparent that with the greater flexibility they provided came some troubling compromises. These compromises were coined by the founder of Ethereum, Vitalik Buterin as the ‘Bitcoin Trilemma’.
The Bitcoin Trilemma states that you cannot have a cryptocurrency that is simultaneously secure, decentralised, and scalable. To modify one of these characteristics, you must compromise the others, and so it was that the Ethereum DAO (Decentralised Autonomous Organisation) was hacked in 2016 due to a vulnerability in its code.
While there have been improvements made to the original bitcoin blockchain, the consensus mechanism that governs any changes has prevented Bitcoin from compromising on security in order to scale. This means that to this day, there is a cap on the number of transactions that can be included in each block, and a new block is only minted every ten minutes.
The Lightning Network
Critics have seized upon these limitations over the years, to claim that bitcoin cannot be used as a monetary system at scale, but an innovation proposed in the 2016 white paper The Bitcoin Lightning Network, is proving them wrong.
The Lightning Network is a layer-2 technology that sits above the Bitcoin blockchain. It allows participants to open private channels with each other in order to transact by temporarily locking-up some bitcoin. These channels can remain open indefinitely, and transactions can be routed via multiple user’s channels increasing the speed and resiliency of the transaction paths as more users join. When one, or both participants decide to close the channel, the first and last transactions plus the balance are recorded on the bitcoin blockchain. This innovation allows for instant, frictionless and extremely cheap payments to be executed across the bitcoin rails, without the need to record each transaction to the main chain every 10 minutes.
In addition, transactions can be executed globally with instant settlement and without the need for a trusted third-party, know-your-customer (KYC) checks, anti-money-laundering (AML) procedures, or even a bank account.
Usage of the Lightning Network is growing at an exponential rate with merchants offering Lightning payments now across the globe. For anyone who has tried to transfer money globally using the legacy system or has had a credit card declined erroneously by their card provider due to perceived ‘suspicious activity’, the experience of using the Lightning Network is breathtakingly seamless.
Why is this such a big deal and what are the potential applications of the Lightning Network?
Bitcoin as a technology has already demonstrated its humanitarian applications by banking the unbanked globally and proving that financial inclusion is achievable. The Lightning Network does this at scale and creates a world of borderless free-trade where anyone can pay anyone else instantaneously by simply scanning a QR code with a Lightning Invoice.
Content creators can look forward to a world where consumers of their content can stream micro-payments to them in real-time based on consumption without the need to onboard with payment providers. This breaks apart the subscription model and ensures that consistently engaging content is rewarded. Creators can also receive tips by simply posting a QR code or Lightning address, protecting their businesses from financial censorship and allowing them to monetise a global audience.
Risk Reduction and Capital flow
Companies such as Synota.io, co-founded by Lisa Scott, are supplying software to energy companies and their customers that facilitates real-time payments based on meter readings. This reduces counterparty risk, freeing up capital and lowering energy costs, and incentivises energy providers to supply power to companies with more volatile revenue streams.
The Smart Money
You may not have heard of the Lightning Network, but the smart money is already moving into this space. David Marcus, a former Paypal executive who was responsible for Meta’s Messenger and Libra businesses, has founded Lightspark, a company that is producing a Software Development Kit (SDK) that will allow non-technical businesses to easily onboard to the Lightning Network.
Velas Commerce co-founded by Hannah Rosenberg is providing businesses with on-ramps to Lighting and supporting website build-outs with Lightning integrations.
These developments enable an exponential number of businesses to integrate at speed and scale. It is reasonable to expect most businesses to accept payments via the Lightning Network by the end of this decade, to not do so would mean reduced cashflow, increased risk and a smaller customer base.
Preventing Financial Censorship
Users of the Lightning Network can charge for the use of their Lightning channel, monetising the bitcoin they have locked up. However, they cannot censor transactions. Therefore, the Lightning Network provides a utopian payment system, where users rather than centralised corporations, can monetise their support of the network, and all participants benefit from low-barriers to entry and the assurance that their transactions cannot be arbitrarily censored.
What next for existing payments providers?
So where does this leave traditional payment providers? It’s hard to know. When a decentralised competitor with instant settlement, low barriers to adoption, which rewards its users, prevents financial censorship, banks the unbanked and charges minimal fees, comes on the scene, how should they respond?
Time will tell, but in the meantime the Lightning Network continues to be the hottest innovation in FinTech.