Let's consider the efficiency of the Lightning Network compared to traditional financial solutions such as Visa and Mastercard in the context of Bitcoin scalability.
Table of Contents:
- Bitcoin Network
- Lightning Network
- Low Transaction Costs
- Lightning Network vs Visa and Mastercard
- Conclusion
Bitcoin Network
The cryptocurrency Bitcoin, the most well-known and popular one these days, was launched back in 2009. After gaining widespread attention, Bitcoin was predicted to achieve grand success and potentially compete with traditional payment systems like Visa and Mastercard, and perhaps even replace them. However, these predictions did not come true. One of the main reasons for this outcome was the low transaction speed and high fees in the Bitcoin network. This characteristic of the network came to be known as the "Bitcoin scalability problem," which is associated with the block size limitation in the blockchain network and, as a result, the limited network throughput.
The Lightning Network technology was developed with the aim of overcoming the aforementioned shortcomings that previously existed. It significantly increased transaction processing speed and reduced transaction costs.
Lightning Network
The Lightning Network is a second-layer network protocol that operates on top of the underlying Bitcoin blockchain. It enables users to conduct fast and inexpensive transactions, addressing the issues of high fees and slow block confirmations by miners. The protocol utilizes onion routing technology, which breaks down data into multiple packets and sends them through various nodes in the network, ensuring end-to-end encryption.
One of the key advantages of the Lightning Network concept is the efficient facilitation of microtransactions for small amounts outside the main blockchain. This is achieved through the creation of payment channels between two or more parties. However, it's important to note that Lightning Network is not designed for transferring large sums of cryptocurrency, where Bitcoin remains unmatched. Instead, it represents a payment system that can be used in everyday life for regular transactions.
Therefore, Lightning Network was initially developed to directly compete with traditional international payment systems. It aimed to attract a large number of users by providing a more efficient and decentralized peer-to-peer network.
However, there are still several issues associated with blockchain technologies. One of them is known as the "scalability trilemma," which points to the challenge of simultaneously addressing three key problems:
- Speed,
- Decentralization,
- Security.
Within this problem, it becomes necessary to choose two out of the three aspects to improve. For example, the classic Bitcoin protocol focused on ensuring security and decentralization at the expense of transaction speed. Lightning Network was developed to enhance speed, but it introduces potential security trade-offs: Lightning Network nodes may be susceptible to attacks from malicious users. Additionally, there is a higher level of user readiness required, as blockchain service interfaces are less familiar and intuitive compared to banking applications (and this applies not only to cryptocurrencies).
If the Lightning Network manages to overcome these issues, it could pose competition for major payment systems like Visa and Mastercard. The support of public figures, such as Jack Dorsey, former CEO of Twitter, lends hope to the idea of the Lightning Network. In 2018, Dorsey conducted experiments using the Lightning Network on Twitter for a tipping system.
Low Transaction Costs
The Lightning Network has indeed made significant progress in reducing transaction costs. When moving a small amount of Bitcoin, it often requires paying nearly the same amount as a transaction fee. However, with the use of the Lightning Network, the cost of executing a transaction through a channel is significantly lower. When using this network, users need to take into account two types of fees.
First Aspect Relates to the base fee charged at a node to incentivize data transfer. Typically, this is a negligible fraction of a cent (e.g., a few satoshis) required to attract traffic to a specific node. Second Aspect Is associated with the fee based on the payment amount occurring within a node. In this case, the channel owner can set a fee as a percentage of the total number of satoshis being sent (e.g., 0.01 satoshi per each sent satoshi).
There can be situations where the fee for using the Lightning channel is practically insignificant, as well as cases where the fee is significantly inflated.
Lightning Network vs. Visa and Mastercard
If we compare the costs of using Lightning Network to those of Visa and Mastercard, we will find that the latter have significantly higher expenses. Major payment systems like Visa and Mastercard charge various fees to card-issuing banks based on:
- the type of merchant,
- the transaction amount,
- the location where the transaction takes place.
In the United States (since this market is considered one of the key players in the payment system), Visa typically charges an interchange fee ranging from 1.15% plus $0.05 to 2.40% plus $0.10 per exchange. Additionally, Visa imposes a transaction fee of 0.14% on each completed transaction.
Mastercard charges a fee for currency exchange based on the transaction amount. They charge from 1.15% + $0.05 to 2.50% + $0.10. Additionally, they have an additional surcharge. If the transaction amount is less than $1000, the additional surcharge is 0.1375%. For transactions of $1000 and above, the additional surcharge is 0.01%.
Currently, it is unlikely that traditional payment systems will face threats from technologies that are still under development. However, blockchain developers have achieved impressive successes that will likely attract attention in the near future.
Nevertheless, simply having a more efficient payment technology is not enough for full competition with Visa and Mastercard, which are already firmly entrenched in people's daily lives. Furthermore, excessively low transaction fee costs can slow down the widespread adoption of Lightning Network technology, as appropriate economic incentives are required for its successful expansion. Only in such a case will market participants be interested in supporting this solution. Additionally, there have been instances of unstable performance in second-layer networks, which raise certain concerns.
Conclusion
As mentioned earlier, the success of the Lightning Network depends on several factors, including the overall network capacity. In order to become a mass-scale and widely adopted solution, the Lightning Network needs to significantly increase its capacity. Currently, according to expert estimates, the network is capable of processing transactions up to 4828 BTC, which is roughly equivalent to $148 million. This is a relatively small amount compared to the volumes of funds moved through traditional payment systems, which are measured in billions. However, it is worth noting that the capacity of the Lightning Network continues to grow over time, indicating the right direction chosen.
