Table of Contents
Introduction
When people discuss scaling Bitcoin, they usually mean finding ways to increase the current transaction throughput beyond ~7 transactions per second. Lightning Network might not be a perfect solution, but it’s already available, and it can process an unlimited number of transactions, so I consider transaction throughput problem as largely solved.
While scaling transactions is the main goal, nothing stops us from scaling Bitcoin use cases beyond storing and moving sats. Some blockchains, such as Ethereum and Solana, can serve as platforms for issuing different kinds of assets, such as stocks, bonds, stablecoins, and so on. All those extra use cases create demand for their native tokens, and I’d like this demand to be redirected to Bitcoin.
It’s important to note that using Bitcoin for anything beyond storing and moving sats is considered controversial, and some bitcoiners don’t want to have anything to do with it. In my view, adding more use cases to Bitcoin network is good, as long as it doesn’t interfere with its “core” use case: saving and moving sats. As an example, I’m not against issuing Bitcoin-powered assets, but asset movements shouldn’t happen onchain and should not compete with normal transactions.
Scaling is Secondary
It doesn’t make much sense to scale something which fails to deliver on its core promises. The main value proposition of Bitcoin is the fact that it’s not controlled by any single entity, and we have many problems to solve in order to make sure Bitcoin will stay truly decentralized in the years to come. We need to geographically and geopolitically diversify the mining market, including mining chip manufacturing, so it’s important to make sure we’re making progress there before dedicating our efforts to something less critical.
Bitcoin Blockchain is for Savings
It’s beyond doubt that the primary use case of Bitcoin is savings, due to its inherent scarcity. Bitcoin blockchain was never suitable for retail transactions, since onchain transactions are slow and expensive. Those fundamental limitations aren’t going away anytime soon, if ever, which makes it impossible to spend bitcoins in the same way as we spend fiat currencies. Issuing assets onchain is possible, but those activities compete with normal transactions and therefore should be discouraged.
Political Risks of Savings-Only Narrative
Current bitcoiners are mostly happy with savings-only use case, but I think it’s a mistake to ignore other practical applications of Bitcoin. Most people aren’t saving that much, and we need to be aware of how Bitcoin is perceived outside our little social bubbles. Bitcoin should be viewed as an instrument of freedom, not a greed manifest. If we keep focusing on savings-only, politicians will eventually convince the public that Bitcoin is useless for anything but “hoarding”, which will allow them to launch a full-scale attack on Bitcoin, with silent (or not so silent) approval of the majority.
Onboarding as many people as possible is crucial to Bitcoin’s long-term survival, and different people have different needs. There are more folks who need truly neutral seizure-proof payment rails and financial instruments than hardcore maxis who only want to HODL, and we need to address all those needs in order for Bitcoin to survive an inevitable confrontation with an extremely powerful entities which don’t want people to enjoy those freedoms.
L2: Beyond Savings
As we figured out already, it’s not possible to scale Bitcoin onchain. Most spending and decentralized finance solutions are calling themselves L2, or Bitcoin Layer 2, which hints that they’re using separate systems and higher-level sets of abstractions in order to achieve their goals.
The general idea is to move most activity off-chain while preserving as much onchain guarantees as possible. L2 solutions cannot involve creation of new tokens, since those solutions would be immediately classified as shitcoins. If you aren’t dealing with bitcoins, it’s obviously not a Bitcoin scaling solution, and it has nothing to do with Bitcoin.
Current Solutions
In order to make bitcoins usable on L2, you usually need to somehow “freeze” or restrict them on the main blockchain, so they can be temporarily moved to a Layer 2 system with no risk of double-spending. Let’s follow the money and see how many bitcoins were moved to the most popular L2 implementations:
- Lightning Network - 5,090 BTC (per https://1ml.com/)
- Liquid Network - 3,850 BTC (per https://liquid.network/)
As you can see, ~9,000 BTC ($540,000,000) is enough to cover all the current non-saving needs, which suggests that using bitcoins for retail transactions is still a relatively niche, but growing, use case, and 0.05% of all mined bitcoins is enough to satisfy the retail demand. I did include lost bitcoins so the actual number can be a bit higher, depending on how many bitcoins were irrecoverably lost.
Lightning Network
Risks
Lightning Network nodes are supposed to be online all the time, so they’re basically hot wallets. Hot wallets are only suitable for small amounts of money which you can afford to lose in an unlikely, but not impossible case of a software defect being exposed to get access to your wallet.
Benefits
Lightning transactions are:
- Cheap
- Private
- Instantaneous
Let’s say you refilled your Lightning wallet with $500 in sats, and you intend to use your wallet at a local cafe. You can buy 100 $5 cups of coffee before you need to refill your wallet again, so you only need to make a single onchain transaction in order to make 100 real retail transactions, significantly lowering your overall fees.
Being able to hide your financial activity from the prying eyes is also one of the benefits which you can’t really get onchain, so Lightning Network serves as a kind of mixer, which is a nice side effect.
Summary
Lightning is perfect for spenders, since you can send an unlimited number of private and instant transactions at the fraction of a cost of onchain transactions. That said, Lightning wallets aren’t suitable for holding or moving large sums of money due to protocol design and interactivity requirements.
Liquid Network
Risks
All Liquid bitcoins are controlled by a Liquid Federation, which holds them on an 11 out of 15 multisig wallet, so Liquid it technically a custodial solution. It is an undeniable fact that all your Liquid bitcoins can be seized, and you’re not really in control of them as long as you stay within Liquid Network. In my view, that fact alone makes Liquid unsuitable for anything but small amount of bitcoins, where the benefits of cheap and fast transactions can outweigh the risks of asset freeze or seizure.
There are hardly any risks for people who use Liquid to hold regulated Issued Assets, since they’re highly regulated and require KYC. I’m not really interested in KYC assets, but I guess it comes with some strong investor protections.
Benefits: Trustless Swaps
A Liquid “swap” is a single transaction that finalizes a trustless exchange of assets between two or more parties. It is much safer than having to trust the other person to complete their part of a traditional two-step exchange after you have completed yours.
A swap on Liquid is done using the Partially Signed Elements Transaction (PSET) standard, whereby the parties involved sign an input and output each and pass around the transaction until all inputs and outputs are accounted for and signed, whereupon the transaction become fully signed and valid for broadcast.
This is a really nice feature, but it can only be used to swap a pair of assets within a Liquid ecosystem. Bitcoin is just a single example of a Liquid asset and there are many more, such as stocks, bonds and fiat-pegged stablecoins. Basically, Liquid users can trade with each other without trusting each other or trusting an intermediary such as an exchange.
Benefits: Non-Custodial Order Books
Being able to create and accept exchange orders without an exchange is cool, but people still need a place to discover all the available orders placed by other users, which is usually done by a trusted third party such as an exchange.
So, it looks like you’re going to need an exchange anyway, but Liquid Swap-based exchanges don’t hold your money, so they don’t have the ability to rug you, which is a significant improvement over the status quo.
It’s also technically possible to create an open-source public order book, which would allow us to minimize or completely remove trading fees.
Benefits: Confidential Transactions
All Bitcoin onchain transactions are public, but it’s not really a fundamental limitation. In fact, Bitcoin developers considered hiding transaction amounts, but it would be too costly due to the larger size of such transactions. The fact that we can’t have confidential transactions onchain does not mean we can’t add them in a L2 system, so Liquid developers decided to make all Liquid transactions confidential by default.
Confidential Liquid transactions also hide the types of transferred assets, so you can get a certain Liquid Asset without anyone knowing about it, including the Liquid Federation itself.
Liquid Federation
Liquid Federation is a complicated multi-layered organization which is supposed to maintain and improve the Liquid Network. There are a few governance boards, but the most important subgroup is “functionaries”, since they control the keys from all pegged-in bitcoins. There are 15 Liquid functionaries, and they also serve as miners, processing Liquid transactions and packing them into new blocks. Liquid needs an approval of 11 out of 15 functionaries in order to produce a block or move pegged-in bitcoins back to their rightful owners, and it’s critical to prevent those functionaries from colluding and doing something nasty.
Ideally, Liquid functionaries should be geographically and geopolitically distributed, and they should also target different and unrelated markets. In reality, many Liquid Federation members are funded by the same VC firms and most of them can be bullied by US, since they’re located in its sphere of influence. Hopefully, Liquid will be able to improve on that as more developing counties get their sovereignty back due to their increasing economic and military weight. I believe that federation model is sound, if done right.
AQUA
I’ve been using Liquid-powered AQUA wallet for the last few months, and my first impressions are mostly positive. It’s the most interesting Liquid wallet and is showcases all the main Liquid features such as peg-ins/outs, confidential transactions and asset swaps. It’s easy to use, and it can become very popular among Bitcoin merchants, since unlike Lightning, there is no need to worry about inbound liquidity when you receive money over Liquid.
Liquid Assets
Liquid blockchain can host many assets in addition to Bitcoin, which can be useful to many people. I don’t really like using USDT, but I often need to transfer USD back to Russia and Liquid USDT is an easiest and cheapest option.
Liquid also hosts Microstrategy stocks and EL Salvador government bonds, which allows them to be traded 24/7 without any broker. There are many interesting financial instruments which can be built on Liquid, although most of them would require KYC.
Summary
Liquid is similar to Lightning in a sense that it can offer cheaper and faster transactions, but unlike Lightning wallets, Liquid wallets don’t need to stay online all the time, allowing you to store your Liquid assets in a cold storage. The main downside of Liquid is the fact that you need to trust the Liquid federation, so Liquid is basically a custodial solution. It’s still much better than custodial Lightning wallets, but Liquid Federation can rug you any time, which makes Liquid unsuitable for anything but small amounts of money.
Conclusion
Both Liquid and Lightning allow us to spend bitcoins faster, cheaper and more privately, as well as to issue other assets, such as stocks and bonds, but every L2 system has a different set of trade-offs. I like to keep some pocket money in each system, but I don’t think that either can be trusted with medium or large sums of money.