Last time, I spoke about how the bread and butter use case of Ethereum was going to be soon challenged by Bitcoin Cash, when the missing op-codes are re-enabled in the upcoming May 16th upgrade. Today, I will discuss more about the other use cases which BCH is going to challenge, as a payment system and the biggest challengers in that space. Yes, many expert bitcoiners will recognize that Bitcoin Cash is aiming to be CASH first and foremost, but that doesn’t preclude its use as a payment rail as a secondary use case.
Firstly, it will be good to explore exactly what is the difference between a payment network and cash. Most simply, cash is an asset. It is something that cannot be taken away from you without force, because you solely have the ownership of it, and you solely decide when to keep it or when to give it away. A payment network is simply a system by which transfers of ownership rights can be tracked, requested, processed, and settled. SWIFT is the most popular payment system among first world banks today, and among consumers VISA is a payment network that allows you to pay for things with credit extended to you by a credit issuer. It is important to note that while Bitcoin can be thought of as a payment network, (given the nature that all the assets are publicly visible and moved on the blockchain) it is first and foremost an asset ownership ledger. And Bitcoin (the coin) is an asset, not just a utility token.**
The biggest players in the digital payment network space these days are Lightning Network (built on top of the Bitcoin asset blockchain), and Ripple. Both have a ‘usage token’ that you have to buy to use it, BTC and XRP respectively, but these networks have a very different approach to solving the same problems. And, I will argue, these problems don’t exist in the Bitcoin Cash blockchain.
Lightning in a Bottle
First off Lightning Networks. I first spoke about it back in Oct 2016, when the developers first said that they were ready to deploy the network real soon. The problems I saw were not so much the technical issues (because there were so many technical issues that it wasn’t worth getting too deep into the details at that early stage) but more the economic problems –IF the network were to be adopted at scale. Those issues have not changed, and we will re-iterate on them later in this post. Let’s first discuss the matter of trying to “Fix something that isn’t broken”. The best way to think about LN technically is through an analogy in the physical world. In the world of motorcycles, there are many types of experimental steering mechanisms.
This is what Lightning developers think they are building:
For those not into bikes, the way a motorcycle steers is very different from how a car does. Basically, you have to move the handlebars in a direction which is opposite to the direction that you want to turn. This is called counter-steering. In addition, the front wheel due to its role in steering has been traditionally mounted using a fork system. This means that the wheel is held between 2 shock absorbers, which joins the main frame of the bike at the headstock, or the pivot point of the steering system. This wheel mounting configuration, while most common and simple, combines the steering system, with the braking system, and the suspension system. This has some disadvantages however, which I won’t get into here, as this is a financial technology blog, and not a motorcycle one (though I’m happy to go into for the riders out there). Very much like Bitcoin, the LN developers and many of those who support the legacy version of Bitcoin (the one disabled with 1mb maximum blocks and segwit) they see these self imposed issues needing to be fixed and LN seems to be the solution. The bizarre bike in the following figure is how they see the LN network becoming:
Keep in mind: this is IF the dream of LN can be realized without any complications or fundamental bugs. In the best case scenario, we will get something like the Bimota Tesi, a beautifully engineered, overly complicated, and expensive motorcycle that looks bizarre and exotic, sure to turn heads, but is very rarely seen on the road as a performance bike because the complicated steering removes all the ‘feel’ and control out of the steering. Needless to say, for all its purported benefits, no rider of MotoGP has ever taken a Tesi to the track in a serious race. That pretty much says it all. However, this was in the best case. In reality, the LN technology at present looks more like the following bike experiment:
An overly engineered experiment that suffers from having to solve engineering problems that it introduced itself due to its overly complex fundamental design. The world doesn’t really need a hub-steering, 2-wheel drive, diesel powered motorcycle. Well, not presently anyhow. The other critical point is the matter of ownership. Recall that I mentioned that Bitcoins are assets. And that having total and complete control of your assets (or having the option for complete control) is part of the rights of the owner of an asset. In LN, you are forced to put your asset (Bitcoins) into what is effectively a bank account. This bank account is a weird jointly owned bank account that you have opened with another peer, which LN folks call a payment channel. Your Bitcoins locked in such a channel can only go to or from the peer that you opened the channel with, so in order to fix that problem LN network is developing a massive IOU balancing/routing system to make sure that if you need to pay somebody or get paid that it can be done through one of your existing payment channels if possible. Even if this were all to work, the fact of the matter is that your Bitcoins are still locked in channels, and even though you can technically remove them all if you wanted to that would require many transactions to do so in practice for any decent sized wallet, which would be costly. In addition, there are also new attack vectors that are introduced where a thief can try to steal your locked coins in the hope that you aren’t watching the channel. Don’t take my word for it (though I DID warn about all these things back in 2016, but you probably don’t remember) read it from the LN Dev blog yourself! If you manage to get through the post without being totally confused, then at least you will have an impression of all the extra complications that using LN coins will involve. I would rather not peg my Bitcoins into the LN network if I could just use bitcoins directly.
In practice, LN is exactly like the existing banking system. Yes, you put your money in the bank and it is ‘technically’ still yours, and yes, you CAN take your money out when you wish, and 99.9% of the time that is fine. But just like in a banking system, the 0.01% the ownership of your property can be violated, as those who had money in Cyprus Banks found out in 2013, when the banks basically bailed in themselves with their own customers money. LN seems very similar to this system.
Ripple: The network that tried to bootstrap itself with its own tokens
With Ripple, the situation is slightly different. They were originally a IOU passing network, which wanted to have everyone issue their own IOU tokens on the network, and to manage the transfer of these IOUs on a standard platform.
That standard platform would be a shared ledger with a common consensus protocol, which is what most people call the Ripple network today. The token XRP was created from nothing, and was originally intended as a spam prevention measure, as to send increasingly more transactions to a node would mean that it would cost more and more XRPs. Also the intent was that every transaction would destroy a small amount of XRPs so that increased use of the network would slowly appreciate the value of XRP, due to fixed number of them in existence. It may surprise most people to learn that Ripple actually existed before Bitcoin was released, though it should be mentioned that the Ripple network today looks very different from the original one. Ripple didn’t like the concept of doing work to earn the inflation of the coin, and thus it had a distribution problem. Where PoW in Bitcoin made the distribution of the coins very simple (you spend time and energy to mine, you earn coins, whoever you are), Ripple created all 100,000,000,000 XRPs and granted it to themselves a non-profit foundation, early investors, and struggled to figure out how to get them distributed down the pyramid to regular people. The way XRP was distributed harkens back to how money in a central banking system is distributed. It is printed by the central bank, then it is sold to large investment banks, which then pass it onto regional banks, and finally to the regular people through loans.
Their approach brought about it some self-induced problems that they then had to solve. How do prevent some of the large early holders of XRP from hoarding their distribution? How much should be kept aside to pay for development? How much XRP should be burned on each transaction? And most importantly, if all the tools and applications look like they are useful, what is to prevent a rival network from just forking the code and running their own version of XRP with a NEW distribution of funds? These are big issues with the Ripple business model, which requires that they sell the technology to large banks first, which ostensibly want a payment system that costs less than the existing SWIFT payment systems. To this strategy Ripple is developing trading interfaces and applications to make exchanging IOUs (which may represent fiat currencies or other tokens) to/from XRP easier. The strategy that they are now pursuing is to position XRP as a bridge currency for FX speculators to hold in order to reduce the volatility of marking markets in low liquidity currencies such as Venezuelan Bolivars or Israeli Shekels.
The issue with the strategy is that many times in economic history people attempted to create a stable bridge currency for the banks of the world and have failed. The original attempt was proposed by Maynard Keynes, the bancor, and was a failure (no relation to the recent ICO called Bancor, which was also a colossal failure). The second more recent attempt in the last couple decades is the SDRs proposed by the IMF, which is based on a basket of the G8 currencies, also largely a failure. Something about having to use a complex instrument controlled by a 3rd party to hedge your own foreign currency risks didn’t appeal to the central banks of the world. After all, every central bank had a different unique set of problems they are faced with, which necessitates a different hedging strategy. For instance, a country in South America may do most of its trade with the US, which means it would want to hedge its balance of trade risk with a heavier weight put on USD instead of say, EUR. At the end of the day, hedging FX with a specific central bank non-negotiable instrument wasn’t as straightforward as just holding the foreign currencies yourself (and less useful). That is the problem with the “XRP as a bridge currency” strategy. Why hold XRPs when you can just hold the USD, JPY, EUR yourself? Which means XRP becomes nothing more than an necessary evil, in order to use the payment network, to put a cost to DDoS attacking the network with many transactions. But if the network is going to be a wall-gardened curated network and used only by registered banks, then the risk of attack is minimal. Leaving XRP’s only true value as a speculative instrument that is loosely and informally tied to the usefulness of the Ripple network itself, and the applications that Ripple Labs is creating for it. Astute readers will note that this is also the same base value proposition as Bitcoin. (that its value is related to the usefulness of the blockchain itself) but the difference is that Ripple created all the XRP out of thin air themselves, and they themselves decided how to distribute the tokens. Who knows if they played favourites. Also creating the tokens ex nihilo means that they may very likely be treated as a security by the SEC. As only securities are created in this way, (well currency is as well, but the central banks have the exclusive license to create those), so there may be complications for those that raised funds by granting XRP to investors. Furthermore, if XRP were to be considered a security that would severely limit its trade in US and other first world countries further limiting its use as a bridge currency for FX liquidity providers.
Lastly, the problem with XRP comes back to the beginning statement where I posited that Bitcoin is an asset, which means you own it, and nobody else. This is achieved in Bitcoin through both asymmetric key cryptography (you own the knowledge of your private keys), and the decentralization of the mining ecosystem itself. Mining is its own business, and the business of the miners isn’t to run a payment system. The unique fusion between a commodity extraction business that is concerned more about cheaper greener power generation and the processing of a financial payment system is what gives Bitcoin its power, and Satoshi’s true innovation. If you build a token market on top of BCH, trying to steal peoples assets, or to freeze their BCH would be very costly and not guaranteed to work. In comparison, if Ripple at its hypothetical apex, when all central banks were to use it for its inter-bank transfers, and you were a liquidity provider who have been stockpiling XRPs in order to make profit from the imbalance of flows between North Korean Won to the US dollar, you could be denied access to your XRP if all the central banks of the world just refused to listen to the nodes that broadcast your transactions. Where Ripple uses similar cryptographic security to enforce proper signing of transactions, unlike Bitcoin, a Ripple that banks will use will only trust transactions from each other. You will not be able to submit a transaction that the banking consortium disapproved of***. And the banking consortium would not allow a trusted validator into their cartel without ensuring that they were going to play by their rules. So the difference between Ripple’s decentralization strategy vs Bitcoin’s is that Ripple has a trusted server list (called the UNL) and transactions received from the list are assumed ‘blessed’ (assuming they are valid). Transactions received from outside the list are not treated the same. Basically in Ripple, anyone can connect to the network and send transactions, but unless your txn is acknowledged somewhere down the line by the main validators, it won’t make it into their ledger. And membership to the main validator pool is similar to a cartel formation. “I’ll put you on my trusted list if you put me on yours”. Every bank using Ripple will certainly guard its UNL list and ensure that only other licensed banks are on their lists. Contrast this to Bitcoin, where nobody can stop anyone else from participating in mining, — that is the true key to decentralization.
It is going to be an exciting next few months, as more and more features of ‘speciality Altcoins’ stand to be usurped by BCH as the true power of the original Bitcoin design starts to come to fruition.
For the industry to grow and expand in order to reach the maximum number of humans on the planet, therefore ensuring its survival through future regulatory and political pressures, it needs to be simple, elegant, and functional. So despite the above experiments in technology being very cool for bike geeks like myself, I would much rather just have the original and best:
** this stems from the fact that Bitcoins require energy to be burned on creation. Which means they are at least worth the value of the cost of mining them when they are granted. Utility tokens, on the other hand, like all tokens, have no intrinsic value, and are created ex nihilo.
*** well, you could submit it, but it will never make it into their ledger. It may make it into yours if you reduced your UNL list to only have validators which were not part of the banking cartel, but in that case, you have effectively forked off into a parallel ledger.