CURRENT STATE OF PLAY
Lightning Strikes, But Select Hubs Dominate Network Funds
Earlier this year Blockstream deployed a small test store with payments being settled on the Lightning Network. Soon after, Lightning Labs and Acinq, also working on the development of Bitcoin's second layer solution, went onto the Mainnet with their offerings. And growth has been remarkable. Nodes are up by 8600% and the Bitcoin funds on the network are up by 3600% from the start of the year. It’s less clear, however, whether the concentration of capacity amongst the largest nodes will improve with more adoption.
The Lightning Network (LN), the second layer payment protocol primed as the solution to Bitcoin’s scalability woes, has been growing in popularity - and quite rapidly. The LN, which leverages smart contracts built on top of Bitcoin, allows for near instant, low cost and scalable transactions between two parties.
The number of nodes as well as the fund capacity has been steadily increasing ever since Lightning Labs, one of the three development teams actively working on the LN, officially launched the beta version in March (see table). The LN currently has more than 2,500 nodes, 7,800 channels and a total network capacity north of $150,000. On average, each node has more than 4 channels open and each channel has an average capacity of $20.
But while the capacity and the number of nodes as well as channels are increasing steadily, the reliability of successfully routing a payment on the Lightning Network is still quite low, especially for larger amounts. The success rate for a payment for no more than a few dollars between random LN nodes is 70% (see chart).
A current woe facing the LN is that it's not ideal for sending large payments. If only the nodes that have at least one channel with sufficient capacity to route the payment are considered, the probability of successfully routing the payment of less than $200 between random LN nodes is a mere 1%. However, there is an effort underway for what developers have dubbed as the Atomic Multipath Payment (AMP), which would allow large LN transactions to be split into many smaller transactions and then would be automatically joined back together.
While LN is still in Beta, Individuals might become more willing to lock up more funds as the development teams iron out kinks, which would result in a higher probability of successfully routing a payment.
And an increase in merchants accepting Bitcoin for payment of goods and services would also be key to the growth of funds on the network. Acinq, which currently holds close to 5% of the total BTC capacity on the LN has already addressed this with their launch of Strike, a Lightning payment processor (Diar, 11 June).
|| START OF A TREND?
One of the criticisms of the LN is that transferring funds requires that the sender, receiver, and intermediaries through which the transaction is routed to be online at the time when the transaction occurs. Unlike sending the transaction on chain, it is impossible to send funds to someone who is offline. It is more convenient to open a channel with someone who is always online and has enough liquidity to route even larger transactions.
This leads to another criticism of encouraging the creation of large hubs. The lack of liquidity between nodes, and the online factor, has led to the concentration of capacity to only a few large nodes. Ten of the largest LN nodes (0.4% of total nodes) currently have 53% of the network’s capacity while the remaining 2,500 nodes have 47% (see table).
|| KYC REQURIMENTS TO BUCK TREND OF LARGE HUBS?
While these hubs exert no control over the network, they could, technically be considered money transmitters, should regulators see it as such.
Bitcoin expert Andreas Antonopoulos said in January “I don’t think Coinbase will run Lightning, and I think there are many reasons why we’re not going to see regulated exchanges run Lightning Hubs. They have a fully KYC/AML-ed customer on one end of their connection, but if they receive a payment that’s going to that customer over the Lightning Network, they have no idea whether that customer’s the final destination. If they receive one coming in from that customer, they have no idea if that customer’s the origin, which means their KYC just fell apart – completely fell apart.”
Top 10 Lightning Nodes Hold Over 50% of Current Funds
* Private Node - Data Reflects Network on June 23 2018
Probability To Successfully Route A Payment Between Nodes (% vs. USD)
Notes: Only takes into account the nodes that have enough funding to route the payment (channel funding > 2x payment size)
2018 Lightning Network Nodes & Channel Growth
Tether Hits $3Bn Outstanding Following Solvency Report
US Dollar pegged stablecoin Tether released a report last week in an attempt to calm markets down on its solvency after much scrutiny by the cryptocurrency community. And while the report by Freeh Sporkin & Sullivan does confirm corresponding funds, disclaimers in the memorandum hasn't steered Tether free and clear from questions. And possible conflicts of interest do arise from many of the parties involved.
Tether hired Freeh Sporkin & Sullivan (FSS), a law firm co-founded by former FBI director Louis Freeh, to confirm that the company has the corresponding reserves in their bank accounts. The memorandum released by FSS does not constitute an audit since it was not conducted by an accounting firm.
Stuart Hoegner, lead legal advisor to Tether, said that an audit cannot be obtained because “the barriers to getting audited are simply too big to overcome right now, and not just for us. The cryptocurrency market looks too nascent for large accounting firms to consider taking on clients who offer digital coins.”
On the flip-side of the argument however, TrueUSD, an alternative stablecoin, publishes independent attestation performed by accounting firm Cohen & Company on the bank accounts holding the collateral for TrueUSD.
|| CONFIRMED RESERVES, BUT LIABILITIES UNCLEAR
The memorandum does indeed confirm that Tether had the corresponding reserves in their bank accounts at one point in time - June 1. The date was reportedly picked without Tether’s knowledge. The memorandum concludes that: “FSS is confident that Tether's unencumbered assets exceed $2,538,090,823.52 as of June 1st, 2018."
The memorandum does not examine Tether’s liabilities however. A disclaimer in the memorandum states that “FSS procedures performed are not for the purpose of providing assurance.”
There also seems to be potential for conflict of interest (see chart). Eugene R. Sullivan, Senior Partner at Freeh Sporkin & Sullivan, is also on Board of Advisors of Noble Bank, which has been providing banking for both Bitfinex and Tether for some time. Mr Sullivan’s name has since been deleted from Noble Bank’s website but it’s worth noting that FSS disclosed this in the memorandum. Tether’s co-founder Brock Pierce also reportedly co-founded Noble Bank in 2014.
|| REMEMBER MT.GOX?
John Betts, founder and CEO of Noble Bank, and Brock Pierce were both part of Sunlot Holdings in 2014, which unsuccessfully offered to take over the assets of Mt. Gox and revive the bankrupt exchange. Louis Freeh, co-founder of Freeh Sporkin & Sullivan, had an advisory role for Sunlot Holdings in 2014.
Tether Connections Run Deep & Wide
25-June-18 $250Mn Add Brings USDT Outstanding to Over $3Bn
|| REMEMBER FRIEDMAN LLP?
A previous accounting document, which was also not a full audit but rather a public internal memo, was done by Friedman LLP in September 2017 and found that Tether also back then had the corresponding reserves.
However, the auditor noted that the money was stored in the account held in name of trustee and he couldn't attest whether Tether had an enforceable agreement with the trustee. The name of the bank where the reserves were stored was redacted from the document. Tether ended the partnership with Friedman LLP “given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet”.
The U.S. Commodity Futures Trading Commission (CFTC) subpoenaed Tether and Bitfinex in December 2017 however no further information has come to the fore. It was also confirmed last week that Phil Potter, Tether director as well as chief strategy officer for Bitfinex, has left both companies.
US Secret Service Calls on Congress for Privacy Coins Oversight
Robert Novy, Deputy Assistant Director of the Secret Service’s Office of Investigations, gave a testimony before the House of Representatives Financial Services Subcommittee on Terrorism and Illicit Finance where he expressed the agency’s concern regarding “digital currencies’ use in criminal schemes that undermine the integrity of financial and payment systems, their use in cases of fraud, and their general use as a means of money laundering.”
Mr Novy wrote in his written testimony: “While some digital currencies have operated lawfully, others have been used extensively for illicit activity. The growing illicit use of digital currencies risks undermining the effectiveness of existing U.S. laws and regulations, especially those intended to limit the ability of criminals to profit from their illicit activities.”
Mr Novy asked Congress for action against private cryptocurrencies the likes of Monero and Zcash. He wrote: “We should also consider additional legislative or regulatory actions to address potential challenges related to anonymity-enhanced cryptocurrencies, services intended to obscure transactions on blockchains (i.e. cryptocurrency tumblers or mixers) and cryptocurrency mining pools."
In April, Japan’s Financial Service Agency (FSA) pressured cryptocurrency exchanges to stop trading Monero, Zcash and Dash citing the risks of money laundering and other criminal activity. US-based Gemini, however, recently obtained approval from New York Department of Financial Services (NYDFS) to offer Zcash trading and custody services. And Grayscale, Digital Currency Group's investment arm also offer a trust for the cryptocurrency.
As opposed to Monero, all Zcash transactions are transparent by default and only optionally private. In a press release, NYDFS explicitly stated that they are approving public T-addresses as well as fully private Z-addresses. Currently, most of the transactions on Zcash are not private, which makes it easier to identify the private ones through traffic analysis.
As Diar wrote in January, since most of the truly private coins are nearly impossible to track by the government and their awareness has been growing, regulatory pressure on fiat off-ramps was expected (Diar, 15 January). If Congress decides to go ahead with the legislative or regulatory action, one of the possible regulatory interventions would be to make it mandatory to declare the possession of private cryptocurrencies. If a person failed to do so and it was discovered, they would be legally or criminally liable. The most drastic solution would be to ban the possession of private cryptocurrencies altogether under the pretext of hiding assets.
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