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Federal Reserve Bank of Cleveland Says Lightning Network Is Turning Bitcoin Into Money

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Going unnoticed for about a month, the Federal Reserve Bank of Cleveland released a paper on June 21st, 2022 discussing the Bitcoin Lightning Network and its uses.

The working paper focuses on the transactions per second compared to today’s solutions of Visa and Mastercard. The paper claims that if Bitcoin will one day become a successful medium of exchange, the throughput for transactions cannot be constrained by the main on-chain seven transactions (on average) per second for confirmations. 

The Fed recognizes that Lightning may be the solution for the scalability problem and might “help Bitcoin achieve its potential as a large-scale payments system.”

The Cleveland Fed describes the technical features of Lightning and explains how many transactions can be settled on a sidechain while only making two on-chain transactions: one to open the smart contract and one to settle or close the balance. 

The Cleveland Fed authors explain the development areas of Bitcoin today and what needs to change for Bitcoin to make the next step in its evolution into an everyday monetary system. There is even a breakdown for Segregated Witness (SegWit) and how Lightning relies on it to work.

While the Cleveland Fed does not think that Lightning is a “panacea” for Bitcoin, the tone of the paper overall is rather positive. 

The Fed authors also highlight that Lightning allows for less energy consumption.

“Second, since fewer transactions need to be recorded on the blockchain, less memory and energy are needed to run a Bitcoin node. …Third, by reducing fees, the LN reduces the incentive for Bitcoin miners to use large amounts of computing power, meaning less energy use and positive consequences for the environment.” (page 2)

Cleveland Fed’s Results on Mempool Test and Conclusion

Overall, the working paper introduces the Lightning Network in its current state and even mentions the Chivo wallet solution in El Salvador.

“Our findings suggest that the off-chain netting benefits of the Lightning Network can help Bitcoin to scale and function better as a means of payment.” (p. 13)

They then provide a brief description of what the Lightning Network is, run an experiment to figure out the Lightning effect on the mempool, and then give their results and conclusions.

“If, during 2017, the LN had existed and been the size it was at the end of our sample, by how much would Bitcoin congestion have been lowered? Our results suggest that the mempool count would have been 93 percent lower, mempool fees 96 percent lower, and the proportion of low fee transactions 197 percent higher.” (p. 13)

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