Lightning as a Retail Payment System

Research - Nicolas Burtey and Chris Hunter - July 22, 2020

Fundamental insight: when walled gardens and closed networks encountered open networks that were accessible to everyone, the open networks won. Locus of control shifted from the center to the edges.

This has happened throughout history:

• Email won because it was open. Proprietary email systems became irrelevant
• TCP/IP won because it was open. Proprietary networks became irrelevant
• The web won because it was open. Proprietary services became irrelevant
• Bitcoin is winning because it's open. Proprietary digital money becomes increasingly irrelevant

The same is true for Lightning. Lightning could replace dozens of closed, proprietary payment networks including:

• ACH (Automated Clearing House)
• SWIFT
• Mastercard
• Visa
• PayPal
• ApplePay
• Venmo
• Google Pay
• Stripe
• Square

Why? Because Lightning is an open, permissionless alternative to all of these systems.

The Current Digital Dollar System

The USD payment infrastructure is hierarchical. It looks like this:

Base Layer – Fedwire: A real-time gross settlement (RTGS) system operated by the Federal Reserve. Only licensed banking entities can access Fedwire. It's not accessible to individuals or companies directly.

Layer 2 Networks – Numerous incompatible systems:

• Credit cards: Visa, Mastercard, Amex, Discover
• ATM networks
• ACH: Automated Clearing House (for sending money between banks)
• Wire transfer systems
• Proprietary systems: PayPal, Venmo, Square Cash, ApplePay, Google Pay, etc.

All of these Layer 2 networks ultimately settle on Fedwire. This is the critical characteristic of the current system.

Why Do Multiple Payment Networks Exist?

If Fedwire is the settlement layer, why do we need so many other networks?

Because Fedwire doesn't scale. You can't send $5 over Fedwire. You can't send $50. The Fedwire minimum transaction is effectively thousands of dollars. Fedwire is designed for banks to settle large transactions with each other, not for individuals to send small amounts of money.

Also, only licensed banking entities can access Fedwire. Individuals and companies cannot access it directly.

So what happened? Because individuals and companies needed to transfer money, alternative networks emerged. Visa emerged. Mastercard emerged. PayPal emerged. Etc.

Each of these networks provides a different user experience, different security model, different fee structure, and different technological foundation. But they all exist for the same reason: to provide a mechanism for transferring value in cases where Fedwire is not accessible or practical.

Lightning as an Open Layer 2 for Bitcoin

Bitcoin is the base settlement layer. Similar to Fedwire, the main Bitcoin blockchain can't scale to handle every transaction everyone makes instantly.

Lightning is the Layer 2 that solves this problem. Unlike the dozens of incompatible payment networks built on top of Fedwire, Lightning is:

• Open: Anyone can operate a Lightning node
• Permissionless: No company or government needs to approve it
• Trustless: You don't have to trust a third party
• A single standard: Not dozens of incompatible systems
• Programmable: The protocol enables innovation at the edges

This is fundamentally different from the current dollar system. The current system has a central settlement layer (Fedwire) surrounded by many incompatible Layer 2 systems. Bitcoin + Lightning has a base layer and a single open Layer 2 protocol that enables all kinds of innovation.

Privacy at the Core

Here's an interesting characteristic of Lightning: throughput is unmeasurable and unknowable.

This is sometimes presented as a limitation. "Lightning doesn't give you transparent throughput metrics like Visa does." That's true. But it's actually a feature.

Why? Because Lightning prioritizes privacy. You don't need to (and shouldn't have to) tell everyone how much money you're sending or when you're sending it. Privacy is at the core of Lightning.

This is a critical requirement for a retail payment network to succeed. Nobody wants their financial transactions broadcast to a public ledger for anyone to analyze (aka: "blockchain analysis").

Lightning enables private payments between parties without requiring trust in a third party. This is a historic first for digital transactions.

Conclusion

Bitcoin won because it was an open, permissionless alternative to centralized digital currencies. Lightning will win because it's an open, permissionless, privacy-preserving alternative to centralized payment systems.

We predict that the pace of innovation and adoption will be staggering during the next decade.