Will Lightning Network be the answer to Bitcoin’s problems?

Bitcoin may have been in existence since 2009, but the search for a solution to its scaling problems continues. If Bitcoin is to become a reliable payment option, then it needs to enable faster payments option without sacrificing security, privacy and availability. The answer, many believe, is the Lightning Network.

When Bitcoin arrived, it was introduced as a “purely peer-to-peer version of electronic cash” that “would allow online payments to be sent directly from one party to another without going through a financial institution.” But that idea is largely dead, unless there is a means to scale Bitcoin and thus resurrect it.

The Lightning Network is an overlay network powered by Bitcoin smart contracts that enable instantaneous Bitcoin payments. It was launched in 2018 and has been growing steadily since, with the node count and network capacity steadily increasing. Without a tool like Lightning, Bitcoin is too slow and expensive to be used for everyday spending, which is exactly what it is supposed to be used for. Furthermore, as more users join the Bitcoin ecosystem, the more expensive using Bitcoin becomes. This is a scalability problem that needs to be overcome.

What a Coindesk Research Study says

A recently published Coindesk Research Study provides an in-depth view of the Lightning Network and its capabilities. It looks at the Lightning technology, the node capacity, and especially its weaknesses, including the different forms of attack it may be vulnerable to, as explained by developers interviewed for the report. It also asked developers about their prime concerns for the network and what needs to happen in order for Lightning to be adopted going forward. Although many had different answers, there were some common themes, such as methodical and careful development of the network, the need for more users to test the network and a need to consider the fact that in the end, Lightning may not end up working at very large scale, because in its present form, it may not scale to billions of users.

UK financial regulator warns again regulatory overreach

Charles Randall, the Chair of the United Kingdom’s Financial Conduct Authority (FCA) has warned that whilst regulators should increase consumer protection for consumers investing in crypto tokens, they should also be wary of going too far.

Randall made his comments during a speech for the Cambridge International Symposium on Economic Crime, when talking about the risks for consumers who dive into the crypto world without really knowing how to manage these risks.

Tackling crypto promotions a priority

Significantly for those crypto projects that might be considering hiring a high profile influencer to help promote their tokens, Randall tackled this head on. In particular he mentioned Kim Kardashian’s recent Instagram promotion of EthereumMax (EMAX); a brand-new token issued by “unknown developers.” He commented that this “may have been the financial promotion with the single biggest audience reach in history.” 

Whilst Randall didn’t say that EthereumMax was fraudulent, he said that he had used it as an example of the issues around influencers and paid-for advertising, pointing out that using a celebrity like Kim Kardashian meant the campaign had a massive reach and that it had the potential to mislead under-informed consumers. He emphasised that this is the kind of marketing activity that regulators should be taking greater notice of in the interest of consumers, because “many consumers remain blind to the financial risks they are courting by trusting influencer endorsements and savvy online token campaigns.”

Randall went on to tell the audience that 2.3 million UK citizens own crypto and that 14% of them had bought it using a credit card, which in his view was a worrying scenario. Moreover, 12% of the UK’s crypto holders mistakenly believe the FCA, or the Financial Services Compensation Scheme, would protect them should things go wrong, according to the FCA’s research.

Don’t strangle crypto with excessive regulation

However, Randall appeared to be wary of too much regulation in the case of cryptocurrencies. As he said, the British consumer had multiple opportunities to invest in other unregulated speculative activities — from gold and foreign currencies to Pokemon cards — despite there being “no shortage of consumer harm in many of those markets.” He said:

“So why should we regulate purely speculative digital tokens? And if we do regulate these tokens, will this lead people to think that they are bona fide investments? That is, will the involvement of the FCA give them a ’halo effect’ that raises unrealistic expectations of consumer protection?”

Stablecoins and security tokens offer useful ideas

The FCA currently regulates cryptocurrency exchanges in the UK, and has banned the sale of crypto derivatives to retail customers. Going forward, Randall proposed that its measures should focus on stablecoins and security tokens, which would be a limited intervention. He said that both of these forms of digital asset offered, “encouraging useful new ideas” for cross-border payments, financial infrastructures and financial inclusion, and should not be hampered by “overbearing red tape.” Instead, he argued for a moderate approach, in line with existing rules for other FCA-regulated entities, to ensure that token issuers and blockchain firms are solvent and transparent.

Crypto could play a vital role in Afghanistan’s future

Most of us have watched the events of August in Afghanistan with dismay. For those of us with an eye on the country’s precarious financial position, the long lines of people queuing outside banks to withdraw limited amounts of money reminds us of just how difficult life is for Afghanis right now, and there is little reason to for optimism about the future. Charles Hoskinson, the CEO of IOHK and Cardano, believes that cryptocurrencies offer a solution to the Afghan people.

In an interview with CNBC on 1st September, Hoskinson said, “ “cryptocurrencies will play a larger role in Afghanistan […] in the war for and against the Taliban forces,” not least because there is a massive need for financial privacy-preserving technologies.

Frozen assets

Let’s not forget that the bulk of Afghanistan’s reserves –around $9 billion – are actually stored in the Federal Reserve Bank of New York, and access to them has been frozen, a fact the Taliban only recently discovered. The World Bank and IMF have also halted access to significant sums earmarked for the country. Ajmal Ahmady, former acting governor of the Afghan central bank, Da Afghanistan Bank (DAB) reportedly had to explain to Taliban leaders that the country’s assets were not in the country, and that DAB was “reliant on obtaining physical shipments of cash every few weeks,” the Biden administration had cancelled shipments as the Taliban approached Kabul. Meanwhile a Biden administration said, “Any central-bank assets the Afghan government have in the United States will not be made available to the Taliban.”

Taliban funding

So where will the Taliban get money from? To date, the organisation is largely funded by drug money from Afghanistan’s opium poppy crops, but whilst this might have sustained them, it’s not enough money to run a government, which means there will soon be a financial crisis in a country that already depended on foreign aid to support so much of its infrastructure. Furthermore, analysts predict that the economy will collapse, with prices exploding into hyperinflation. 

The rise of crypto adoption

Which brings us back to crypto for the Afghan citizen who wishes to evade the Taliban’s attempts to track personal spending or seize their crypto assets. For example, Western Union has suspended its services in the country until further notice last week — limiting the means available to Afghani citizens seeking to transfer their assets internationally. However, there are already many organizations that have shifted to accept cryptocurrencies in an effort to facilitate funding of basic needs and medical care for the Afghan people arriving as refugees in western countries. This does not answer the needs of those left behind.

Crypto adoption appears to have been rising in Afghanistan over recent years, with the country currently ranking 20th according to Chainalysis’ 2021 Global Crypto Adoption Index. It is notable that other countries with poor financial infrastructures, such as Pakistan, Venezuela, Vietnam and the Philippines also rank high on the index.

Cryptocurrency exchanges  in Afghanistan

There are a number of cryptocurrency exchanges operating in Afghanistan, including Binance. CNBC suggests the current situation is “a perfect test case for the usefulness of bitcoin and other cryptocurrencies.” One young Afghan crypto trader interviewed by CNBC said he has been keeping a very close eye on his crypto portfolio on Binance, as the local currency touches record lows and nationwide bank closures make it next to impossible to withdraw cash. It doesn’t give him access to cash, in a majority cash economy, but it does give him peace of mind that some of his wealth is safeguarded against economic instability at home. It also offers him and other crypto holders access to the global economy from inside Afghanistan, as well as certain protections against spiralling inflation.

Another young trader in Kabul said he sees crypto as the safest place to park his cash. “If a government isn’t formed quickly, we might see a Venezuela-type situation here.” He isn’t alone in his thinking. Google trends data shows that web searches in Afghanistan for “bitcoin” and “crypto” rose sharply in July just before the coup in Kabul. 

It is difficult to be definitive about how crypto could help Afghanistan, and the current number of crypto owners there is well concealed by the use of VPNs, plus nobody there is talking about it loudly, because most digital currency supporters inside Afghanistan often don’t want others to know they exist. There are also multiple barriers to entry for citizens: complex on-ramping processes, low Internet access and unreliable electricity leading to daily outages. Another factor is that 85% of the country is unbanked. So people wishing to deal in crypto have to get creative, usually through international contacts. One trader said, “It’s very easy in Pakistan,” he said. “Most people have relatives in Dubai, who buy crypto for them using their credit cards.”  This situation requires a great deal of trust, because when the person wants to liquidate their crypto stake, relatives will sell it for them and use the hawala system, an honour-based system of credit common in Asia and the Middle East, to transfer the funds across the border to Afghanistan. 

At the moment the situation is so unstable that crypto traders are unable to operate, and are resigned to HODLing until a government is formed. But many of the enthusiasts are determined to teach fellow Afghans about the benefits of owning crypto, with grassroots adoption coming down to one Afghan teaching another about how cryptocurrencies like Bitcoin work. It may be some time before we see much movement in crypto in the country, but it is going to be something to watch out for and see what happens.

The U.S. government mood on crypto is shifting

Senator Elizabeth Warren, who sits on the Senate’s banking and finance committee, is not known for her love of crypto, and indeed is better known for her push for tighter regulations on cryptocurrencies. So, it was something of a surprise when she made a statement on Wednesday of this week, saying that digital currencies, and in particular those issued by central banks, could assist unbanked, low-income Americans. She pointed out that this group has long been denied access to bank accounts in the mainstream banking system.

So, is this a signal that support for cryptocurrencies is picking up in Washington D.C.?

When Warren spoke to CNBC’s Squawk Box, she said, cryptocurrencies and central bank digital currencies “may be an answer” to the “enormous failure by the big banks to reach consumers.”

She also pointed out that digital currencies have “extremely low transaction costs,” and that this could make them an ideal way to include the 15 million Americans without bank accounts in the financial system. Warren also highlighted a fact that is well known to those working with the financially underserved: they have to pay intermediaries to cash their pay cheques or to pay bills. Access to a digital currency could change all that for these people and give them back full control of their money.

When asked about her objections to crypto, Warren replied that her concerns focused on “bad actors” rather than cryptocurrencies per se, saying that in her view a “wholly unregulated market” has allowed “big guys to take advantage . . . of small investors and taxpayers.”

The sentiments Warren expressed this week are significantly different to her thoughts expressed in a letter to Janet Yellen, the Treasury Secretary, in which she urged Yellen to lead “a coordinated and cohesive regulatory strategy” to help mitigate the “growing risks” cryptocurrencies pose to the financial market.

Before we get too excited about what appears to be a change of direction on Warren’s part, it is probably best to reserve judgement until we see the Fed’s highly anticipated report on central bank digital currencies, which is due to be released in early September. Fed Chair Jerome Powell has already insisted the Fed isn’t rushing into the space, but he has suggested that a digital US currency could make all other cryptocurrencies obsolete. He said, “You wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency. I think that’s one of the stronger arguments in its favour.” That’s quite a big claim that smacks just a bit of American exceptionalism.

Meanwhile the Bank of America is reconciled to digital currencies, and sent out a note to its clients this week saying:

“Digital currencies—either issued by central banks or privately issued with safe, liquid backing—seem inevitable.” It added that central banks in particular “have the power and the will to prevent a very bad outcome in terms of collateral damage in the financial system.”

In the end, that is their real concern. Make of it what you will.