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Bitcoin, Lightning, Channel Factories: Will It Really Work?

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Bitcoin, Lightning, Channel Factories: Will It Really Work?

Channel factories are an optimization feature for the Lightning Network, a popular scaling solution for Bitcoin which is currently still in beta with no exact launch date but is expected to be rolled out in 2018. The Lightning Network could allow Bitcoin to scale to 500 million users by using the blockchain’s built-in scripting language to create off-chain payment channels which can be confirmed instantly. This could potentially clear up network congestion, allow for micropayments, and reduce transaction fees dramatically.

In the Lightning Network, a channel is created which is actually a sort-of complicated bitcoin address. It’s a multisig bitcoin address that is owned and funded by two people. Any number of updates can be made within that one address, or channel, slicing the funds up into different quantities among the two channel partners, before it gets closed out and broadcasted, to be recorded on the Bitcoin blockchain. This works well for micropayments and reduces on-chain transactions and should help Bitcoin scale. However, one argument against Lightning is that it will take a very large amount of on-chain transactions to create enough payment channels for all the Lightning Network users. Channel factories claim to be a scaling solution for the Lightning Network which hopes to solve that problem.

In short, channel factories are just like regular payment channels, except that they have an extra feature. When a channel factory is closed, instead of broadcasting its balance to the Bitcoin (or Litecoin) blockchain, there is the option to open “child” payment channels between the members of the original channel without broadcasting anything to the blockchain. When the child channels are closed, they could be broadcasted to the Bitcoin blockchain, or they could simply update the original channel (channel factory) balance without broadcasting anything to the blockchain.

The obvious advantage of channel factories is that it allows numerous Lightning Network payment channels to be opened among many users without requiring on-chain transactions, reducing congestion on the main Bitcoin blockchain network. Or, to use the ever-popular (among crypto-enthusiasts) Lewis Carrol analogy; you tumble down deeper into the rabbit hole and do transactions two levels apart from the Bitcoin blockchain. It’s like taking a back road to avoid traffic and then turning onto another back road from there.

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The Lightning Network has been in development for about two years, the whitepaper was written in January 2016, and in December 2017, the first real lightning payment was completed when Alex Bosworth used Bitrefill to pay his phone bill. Despite evidence of a working product, there are too many critics to count. Ironically, one of the main criticisms of Lightning is the same “it will centralize Bitcoin” accusations that big blockers always get. An interesting article here claims to provide a mathematical proof that the Lightning Network will evolve into a centralized system of bank-like hubs that everyone will be forced to use in order to transact with each other.

One thing is certain, the complexity of Lightning Network including the channel factory optimization is far from a minimalist’s ideal of what a P2P cash system should be, and in every complexity is another opportunity for a bug to be exploited by a bad actor. It also changes completely how most people will use bitcoin, processing transactions on a separate network stacked on top of Bitcoin and using its own nodes/hubs, transforming Bitcoin into a settlement layer. It additionally has the potential, if successful, to dramatically change our entire economic system, specifically the buyer-seller relationship. Buyers and sellers will maintain payment channels with each other which will enforce brand loyalty and could gradually shift the economy towards subscription-based consumption.

Yet another point to consider is that Lightning users cannot go offline before the channel is closed or expired or they can lose all the funds they committed to the channel:

“These transactions require both parties to be actively participating in updating the smart contracts that keep the channel alive. If one party fails to respond, they are essentially in violation of the smart contract and are forfeiting their claim to any of the funds in the channel. Non-responsive clients are a liability to anyone opening up a channel. It means that their bitcoin may be tied up in the channel until the timeout period. That bitcoin was typically put there either to make a payment (which now is delayed) or to earn network fees for being a hub of other people’s transactions. An unresponsive node means the channel is wasted. It’s similar to a denial of service attack, except it’s tying up bitcoin rather than bandwidth.”

It is safe to say that Lightning, along with the channel factories optimization, are a force to be reckoned with, and most certainly something that should be examined closely by as many neutral parties as possible before we start mentally equating the Lightning Network with Bitcoin. It really is an entirely independent network in which cash grabs and power plays will have a new platform to try to take hold.

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