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Chain News ChainNews (ID: chainnewscom)

Chain News ChainNews (ID: chainnewscom)

, Author: Mohamed Fouda, cryptocurrency researcher and investor, TokenDaily research team member, Ph.D., Northwestern University, Compiler: Perry Wang, published with authorization.

In 2017, the cryptocurrency bull market sparked a surge in transaction volume that overwhelmed the bitcoin and ethereum networks. Both networks suffer from congestion, transaction delays and high fees. In response to these issues, multiple scaling solutions have been proposed, or attention has once again been turned to off-chain and Layer 2 implementations.

Entrepreneurs, researchers, and investors mostly believe that the Layer 2 (L2) scheme has few disadvantages: only fine-tuning of the consensus layer is required, and the centralization of the underlying protocol can also be avoided. At the same time, the advantages of these programs seem to be quite a lot. These schemes include Bitcoin’s Lightning Network, Ethereum’s Raiden, which may be called a true L2 scheme, and sidechain schemes like Bitcoin’s RSK and Ethereum’s Plasma Chains.

In terms of Bitcoin, the Lightning Network (LN) mainnet was launched in March 2018. On the Ethereum side, multiple L2 variants, including state channels, such as SpankChain, Plasma/Plasma Cash, and Loom Network have also come online.

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lightning network

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lightning network

The Lightning Network (LN) is by far the most important and most discussed off-chain scaling solution. The project has been hotly discussed and debated since the release of the LN white paper in 2015. Since launch, LN has grown impressively in terms of channel count, network capacity, and use cases. However, entrepreneurs and investors are still thinking about what kind of business opportunities are most valuable in the LN ecosystem. The directions they explored include: building a liquidity hub to collect routing fees, providing integration and user services on LN, payment channels implemented with LN, and investing in LN infrastructure.

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Provide liquidity in LN

Opponents of this view are quick to point out the technical risk involved and the capital inefficiency inherent in LN, namely that so-called risk-free profits can only be achieved if fees are high or transaction volume is high. The past two years have shown that doubters have been proven right so far. At present, it is impossible to build a profitable business only by charging LN routing fees.

In theory, running nodes and routing payments on LN should be just one part of a larger profitable business, similar to running a Bitcoin full node. Teams like LNBIG, the operators of the largest liquidity provider in LN, are banking on this line of thinking. LNBIG currently operates 25 public nodes, controlling approximately 50% of the LN's total capacity.

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Annualized ROI for providing liquidity to LN in 2018, source: BitMEX Research

Regarding the economic mechanism of providing liquidity in LN, if you are interested in more rigorous data, you can take a look at the detailed analysis published by BitMEX Research in March 2019, the report is based on their own experience with LN fees. The main conclusion of the report is that in the first year of LN’s launch, under optimal conditions, such as channel rates, the annualized return on investment from routing fees is only about 1%, and this return does not include the opening On-chain fees required by the channel.

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• LN User Services

• The second type of investment in the LN ecosystem, and probably the most numerous, is in user services. The scope of this field is broad and includes all services that directly interact with customers. We can divide this field into three main sectors:

Micropayments powered by LN

Financial Services on LN

Services to improve user experience and integration with LN

1. In the first category of LN services, "micropayment services" first appeared, which is actually the story that LN originally told. Publishing platform Y'alls and cryptocurrency gift card provider Bitrefill are the first merchants in the LN network to offer such services.

2. With the growth of LN, there are more and more tools to facilitate access to LN, including wallets that support Lightning Network, such as Zap, Eclair and BLW. Bitrefill also began to provide services, opening channels to users, such as Thor channels. These products have made the LN ecosystem more mature, and have further contributed to the rise of financial-focused LN user services, such as merchant services/Bitcoin cashback services (Fold), and LN-based Bitcoin "boarding" services (River Financial and current Suspended Sparkswap), and LN-integrated exchanges (Bitfinex, LN markets).

The number of enterprises in the LN user service field is more than that of the other two vertical fields. Statistically, more investment opportunities mean that these projects are more likely to obtain financing.

Winners who emerge in this vertical also have the potential to capture markets outside of crypto.

For example, Fold mainly provides bitcoin-based cashback (cashback) services, but it has stepped out of the regular encryption community and aimed at a wider range of mainstream people. Therefore, LN is used as a tool with better user experience to deliver Bitcoin rewards. With this market direction, Fold raised $2.5 million in September last year. Similarly, Bitrefill has also successfully raised close to $2 million in VC funding for using LN to expand its Bitcoin merchant services. While this is an exciting area of ​​LN-based user services in general, the road has not been easy. Some companies, such as Sparkswap, have successfully obtained VC financing, but later found that their business was too advanced. In the entrepreneurial world, it is also a mistake to be too far ahead.

Some financial channels using LN as a tool

Although this is a relatively new direction in the LN ecosystem, it is likely that it will become a major trend in the not-too-distant future. The goal of this direction is to take advantage of various features of LN, such as global coverage, instant settlement, and low fees, to target users outside the encryption field. In other words, companies in this direction often regard LN as a payment channel running on the back end, and users do not need to know whether they are using BTC or LN. We can compare this to companies like Cash App or Venmo, who use protocols such as ACH and Swift under the hood to enable the flow of user funds.

One of the first projects to emerge in this vertical was Zap. Zap plans to leverage LN for the settlement of everyday dollar payments, such as merchant payments or personal cash transfers. Using LN as a settlement layer, with the benefits of instant settlement and low fees, has the potential to replace traditional payment channels, which charge based on the size of the funds, possibly up to 15%. For example, the Strike product launched by Zap achieves this goal without users or merchants needing to use Bitcoin at all. This approach also solves the main barriers to the adoption of Bitcoin in payment systems, such as price volatility and unfriendly tax policies for Bitcoin payments.

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• LN infrastructure

• Investing in crypto infrastructure with venture capital, such as buying stakes in businesses that develop protocols, has been a controversial topic in the crypto space. However, the use case for this is actually quite clear. In the case of LN, this means investing in the team that builds and advances the LN protocol. There are three main startups in this vertical, Lightning Labs, ACINQ, and Blockstream. Since key parts of the LN have already been built, these companies are committed to improving the experience of users and developers using the LN. For example, Lightning Labs developed tools such as Loop and Faraday to help node operators easily manage their channels. Similarly, ACINQ is developing a Stripe-like API tool to allow enterprises to easily integrate LN.

Leverage their existing Bitcoin position by backing LN, which promises to bring users and merchants to scale.

Bitcoin sidechain

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Liquid

LN initially focuses on supporting micropayments without any trusted middlemen. This focus precludes many exciting and much-desired features, such as fast settlement of large-scale Bitcoin transactions, confidential transactions, and the programmability of Bitcoin transactions. In turn, this creates opportunities for other off-chain scaling solutions, so-called sidechains. Sidechains also offer many exciting investment opportunities for the Bitcoin ecosystem.

secondary titlehttps://liquid.net/

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RSK

Blockstream currently lists 44 entities as members of Liquid, with some of the better-known names joining recently. Liquid does not currently have much traction among Bitcoin users. According to the Liquid block explorer, most sidechain blocks are empty, or have only a few transactions in the single digits. While Liquid's main focus has shifted to tokenized securities, the liquid market capitalization of tokenized assets on Liquid is minimal. Tether (USDT) is currently the most issued security on Liquid, with a market cap of just $16.5 million. Liquid's shift to asset (token) issuance has not received much response from the Bitcoin community, with many seeing the development as an attempt to replicate Ethereum's ERC-20 model. Such a low adoption rate should not be what its investors hoped to see, after all, Blockstream raised $55 million in Series A funding.

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There is a Federation to ensure a two-way peg between Bitcoin and RSK

So far, RSK has underperformed investors' expectations. RSK Labs, the company behind the RSK project, has raised $7.3 million in venture capital, according to Crunchbase data. In addition, RIF Labs also raised 22,000 bitcoins during the token private placement stage. RIF Labs and RSK Labs have merged to create IOV Labs. To make matters worse, there are now more and more projects building interoperability between Bitcoin and various smart contract blockchains, which means that RSK has more and more competitors.

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Interoperable Bitcoin sidechains

At one time, many investors in the crypto space believed that all functions, whether privacy or programmability, would be built at some level on top of Bitcoin. So Liquid and RSK sidechains sound like good investment targets. Recently, however, this view has changed. For investors considering adding programmability to Bitcoin, teams building bridges between Bitcoin and Ethereum or other smart contract platforms have proven to be better investment targets. Just look at the recent rise of TBTC. The Keep/TBTC team announced a few weeks ago that it had raised $7.7 million in funding to accelerate the development of the project.

TBTC is not an exception. In fact, almost all emerging smart contract platforms are considering how to build a Bitcoin sidechain/bridge to the platform. In the Cosmos ecosystem, Nomic Bitcoin Sidechain is a project worthy of attention. The project utilizes the Tendermint technology stack to implement a Bitcoin sidechain. Once the Inter-Blockchain (IBC) protocol is live, Nomic BTC (NBTC) will be interoperable with other Tendermint assets. Similarly, Tezos fans have started the tzBTC project, minting BTC tokens on the Tezos blockchain.