The big idea and why it matters: Crypto and blockchain have substantially evolved since we published an intro series in 2022. Solutions like Bitcoin’s Lightning Network are being developed to increase capacity and reduce costs, but many challenges remain.
“Times and conditions change so rapidly that we must keep our aim constantly on the future.” -Walt Disney
Since the nine-part Crypto Dip-Toe series that ran from April through July of 2022, “crypto” has evolved significantly. As was the case then, my interest in the crypto/blockchain space centers on the utility of the technology. Whatever your opinion about FTX and SBF’s demise, the latest spike or crash of Bitcoin’s price, or cryptocurrency as a medium of exchange, today I’ll encourage you to separate that from the genuine utility blockchain technology is already starting to offer. Early indications are promising, but the ability for blockchain to fully realize its potential comes down to one word: scale. Here we go!
Baby and the bathwater
This whole conversation is similar to David Bahnsen’s recent Capital Record podcast with Larry Kudlow (aptly named Principles before Personalities), in which they stress the importance of objectivity and integrity and how that has served them well over the years. Someone having different beliefs than you doesn’t mean the two of you can’t have a meaningful relationship or even friendship; this is not the currently prevailing media mindset, and, unfortunately, I expect even more divisiveness as we approach the election and its aftermath.
Let this serve as a reminder: there is value in understanding a diverse range of opinions from a diverse range of people. Embrace complexity and the gray areas, as it’s difficult to characterize most things in life simply as “good” or “bad” (as we’ve discussed, hot Italian hoagies in Pittsburgh qualify for the “good” list). Cryptocurrencies and blockchain technology are no different. It doesn’t matter if any of these become reliable future currencies, as the underlying distributed ledger technology (DLT) is vital for our ability to maintain digital integrity. Let’s focus on what’s important.
The Merge!
First, some Friends trivia: Making the list of the “10 Most Annoying Things Chandler Ever Did” was when he thought hanging a “merge” sign in his and Monica’s bedroom would be funny. Monica quickly squashed that idea, and apparently, the ScreenRant article writer (linked above) didn’t like his joke.
In crypto, “the merge” wasn’t about people getting closer together. Instead, it’s specific to Ethereum (“the Ethereum Merge”) and describes a transition of that platform from proof-of-work (PoW) to proof-of-stake (PoS) validation (if you need a refresher on those, we covered it in Crypto Dip-Toe – Part 5). The merge was officially completed on September 15, 2022 (thanks, Investopedia) and has been a game-changer. Feel free to read more about it at the above link. The goal of moving to PoS validation was to create a “99%+ reduction in energy consumption,” along with other significant changes, like better security and setting the stage for greater scalability.
Express Lane
When I think about “express lanes,” Washington DC immediately comes to mind. There have been numerous occasions of driving the I-95 corridor from New Jersey to/from the Carolinas, leaving me with deep gratitude for the multiple miles of express lanes near DC. Those lanes allow you to leave the standard “local” I-95 roadway onto a parallel roadway (for a very worthwhile toll). As the name implies, the express route often allows you to avoid copious amounts of slow-moving traffic to save precious time, as long as you don’t need to access local exits.
What does this have to do with the topic at hand? The express-lane concept is similar to “layer-2 scaling,” a critical innovation in the blockchain world. Historically, the major blockchain technologies – especially Bitcoin – have been challenged with a scaling problem. They cannot handle/process enough transactions to be a feasible contender for some use cases you may have heard about, such as payment processing. As this overview from Fidelity Digital Assets touches on, Bitcoin can only process 7 transactions per second vs. “Visa at about 1700 transactions per second on average.” Yikes!
A shift that has seen much greater adoption and use, with already impressive results, is the idea of Layer-2 processing. With regard to Bitcoin, the Lightning Network (aka “LN”) is one such solution. It doesn’t change the processing of Bitcoin itself. Instead – very much like our express lane – we can think of Lighting running in parallel to the main Bitcoin chain, doing a lot of faster, cheaper processing, and then eventually logging that information back in the main blockchain/ledger at a later point – avoiding the additional transactions (traffic) along the way. My express-lane example falls short because the layer-2 protocol is more like taking all of the cars in the express lane and bundling them into a single vehicle that merges back onto I-95, thus truly reducing congestion.
As the above article goes on to say (as of July 2023), this technology “has made payment in Bitcoin possible for over 400,000 merchants…and is 1,000 times cheaper than that of Visa or Mastercard”!
Not so fast!
Don’t mistake the above for implying that the Bitcoin scaling problem is resolved. In its latest update, Native Bitcoin’s Scaling Problem, the Fidelity Digital Assets team dives deeper into the challenges and potential solutions on the horizon. Even the Lightning Network faces some efficiency and cost issues, which can be summed up as “channel capacity constraints.” Without getting too in the weeds, the current lightning network still has to tap back into the main Bitcoin chain too often or at inopportune times. Using our express lane example, fewer merge points into the main I-95 roadway or staying on the express lane until traffic dies down completely (not feasible for cars, but could work for data) could help to reduce congestion and related costs further (Bitcoin processing costs spike during times of peak demand).
These concerns can partially be addressed via “channel splicing” – a way of cutting the number of on-chain transactions in half while adding some pragmatic efficiencies for end users. Separately, we also need to discuss what’s happening on Ethereum, which is already far ahead of Bitcoin in terms of developing scale and efficiency. However, this edition is already too long, so that excitement must be parlayed into a “Part 2” 😊.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
