Letter #232: Exchanges Go Lightning - Boom Or Bust?
Read now to learn how the integration of the Lightning Network into your cryptocurrency exchange of choice may not be as clear cut as you might think.
News has recently come up that some of the largest cryptocurrency exchanges in the world have integrated or are looking to integrate the Lightning Network with their platforms. In all honesty, the news is, or perhaps at least should be, unsurprising, since long wait times for transaction confirmations and high deposit and withdrawal fees are two of the most common complaints users levy against their exchange of choice. Both issues can be somewhat addressed by the Lightning Network; although the exchanges’ own policies still obviously play a major role in the level of impact the Lightning Network can have.
While this is welcome news in many corners of the Bitcoin space (including here) it may be appropriate to somewhat temper our expectations of the impact exchanges integrating the Lightning Network might truly have.
The Good And The Bad
The Lightning Network is a layer-2 protocol that sits on top of the Bitcoin blockchain and allows users to open bidirectional payment channels. The channel participants can then send essentially limitless numbers of Bitcoin transactions back and forth quickly and cheaply. Those benefits have led to the Lightning Network being hailed by many commentators as a major driver, now and in the future, of the scalability of Bitcoin as a monetary network.
I admit that I’m a believer in that vision. That said, there are somewhat challenging characteristics that can’t be ignored, and that we’ll see later on may have some bearing on how much exchanges truly integrate the Lightning Network into their platforms:
Firstly, opening up a channel on the Lightning Network is not as simple as new initiates may think. Even the most straightforward Lightning Network software requires some technical understanding of networking principles. An exchange certainly has or can easily employ people with that expertise, but the exchange’s everyday customers may find the task of managing a Lightning node more daunting.
Secondly, channels on the Lightning Network are limited primarily by two factors: the channel’s size (i.e., how many Bitcoin are committed to the channel by both participants) and how many connections (i.e., other channels) each participant, and to quite an extent, the Lightning Network as a whole, has. In other words, everyday customers may find it difficult to use the Lightning Network for transactions with their exchange of choice unless they decide to commit non-inconsequential amounts of Bitcoin to a channel opened directly with the exchange itself.
The Truth About Customers, Exchanges, And The Lightning Network
The truth is that relatively few people may be sufficiently interested in shaving off a few minutes of transaction time and a few dollars’ worth of transaction fees by managing the rigors of Lightning node setup and operation and by committing some of their Bitcoin holdings to the channel. Instead, if anything, they’ll tend to gravitate towards custodial Lightning Network solutions and providers who take on the effort of maintaining the channel, but also hold the keys to your Bitcoin. In short, I expect that most of the Lightning Network integrations we’ll see from major exchanges will center around opening channels with other exchanges, as well as with major Lightning Network wallet providers and other Bitcoin service providers — direct withdrawals and deposits to and from self-custodied wallets on the Lightning Network may be few and far between.
Don’t get me wrong: any level of integration with the Lightning Network can drive positive benefits for exchanges and their users. But I’m a firm believer in the power of self-custody, and my preference for platforms and solutions that prioritize it is absolute.
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This is not financial or business advice. This newsletter and related content are for informational purposes only. Cryptocurrencies and digital assets can be risky. Always do your own research before making any sort of investment.