Trustless Banknotes: A Neoclassical Solution for Blocksize Debate


Bitcoin’s blocksize debate is about the technical contradiction between the speed of transactions and the network’s centralization. One of the parties, which we may conventionally dub “entrepreneurs”, is interested in the network’s scaling, while the other party, the so called “idealists”, is resisting further centralization. Each of these parties has its arguments, but is there a solution that both of them would find acceptable?

Gold to Solve the Blocksize Debate

Continuing the commonplace analogy of bitcoin and gold, blocksize debate may be extrapolated to the question of what should gold be like. It’s obvious that such a debate would look ridiculous: gold has certain natural physical properties. However, the history of money still may hint how to resolve the dispute, and, moreover, make us see that the solution may already be there.

At a certain stage, gold trade has reached such amounts that expenses of using gold coins became too obvious. First of all, coins were wearing off as they circulated, and society-wide implications of that were expensive. For instance, out of 380 million pound sterling circulating Europe in 1809, 19 million simply disappeared by 1829. Transportation and storage of big amounts of gold coins also required serious expenses, while speed of such transactions was limited by the speed of their transportation.

Thus, further development of trade was limited by natural properties of a precious metal. There was a need to resolve a technical contradiction between “money shall not move” and “money shall move”.

The eventual resolution wasn’t in changing natural properties of gold, but in creating a “doppelganger”, or a representative for gold money – which was a classic banknote. While lightweight, compact and inexpensive representative of money may move, the money itself is stored safely at a bank. Can bitcoin use this idea? Sure, it can. The real question is – how.

Bitcoins Move Not Going Anywhere

Bitcion’s evolution has to go through the resolution of technical contradiction between “bitcoins move” and “bitcoins don’t move”. They have to service transactions without moving in the blockchain. This task is solved with various off-chain solutions. I have already discussed this issue earlier, and generally the currency notes can be subdivided into two groups: non-trustless and trustless.

Non-trustless solutions, like crypto-exchange accounts or centralized wallets, are related to the third party’s risks. The third party may restrict customers’ access to their money, be attacked, or just shut down following the administration’s scam. On the other hand, trustless solutions like physical carriers or sidechains, have nothing to do with the third party risks.

Basically, bitcoin address keys are not monetary obligations, but means of access. The problem of “physical” bitcoins is their indivisibility. It’s hard to use “physical” bitcoins to pay for something cheaper, as those coins don’t have all the denominations. Therefore, microtransactions for such coins are not an option as yet.

Sidechain are not truly an off-chain solution, as in this case transactions are only transferred from a blockchain to a sidechain. Still, the technology is quite interesting as it allows for creating exchange means we may call “trustless banknotes”.

Trustless Banknotes

As opposed to transfer of keys with physical bitcoins, sidechains allow for transferring cryptocurrency representatives. While such representatives move in the sidechain, the cryptocurrency itself remains immovable in the blockchain at a designated address. Such banknotes are redeemed with destruction, and then, using Proof-of-Burn, blockchain publishes a transaction of transferring cryptocurrency from the designated address to the redeemer’s address.

Trustless banknotes are a “neoclassical” solution for the blocksize debate. It merges classical notes with trustless principles of cryptocurrencies.

At the first glance, trustless banknote is a senseless notion. Firstly, because bitcoin itself can’t exist without trust. Secondly, it lacks any warrants, any issuer’s promises to pay, or any creditors or debtors. There is no debt, indeed, but there still is an obligation to pay. But it is not an obligation of some person, it is an obligation of the protocol. Trust is rendered not to the issuer, but to the protocol specifying the rules of issuance, circulation and redemption; and the nodes that input transactions into the blockchain or the sidechain. Indeed, in some way money just can’t do without trust. The term “trustless banknotes” just highlights that there is no third party risk involved.

Lightning Network

Lightning Network proposes a non-classical solution for “bitcoins move vs bitcoins don’t move”. Similar to the sidechain solution, Lightning Network lacks any third party storing the money. The network’s payment channels transfer rights for bitcoins, while the coins themselves remain immovable. However, the project didn’t implement the trustless principle with blockchainizing classical banknotes.

In Lightning Network’s case, the term “banknote” does not reflect the essence of what is going on in the payment channels. Classical banknotes are a termless monetary obligation of the issuer that it redeems with money upon request. Lightning Network’s payment channels are not for termless obligations of the issuer, but for terminable transfer orders of the cryptocurrency’s owner.

In other words, node A, while opening a payment channel with node B, deposits some amount in bitcoins, and uses the channel to transfer the timelock-limited right to publish the transaction of the deposited bitcoins’ remittance instead of a promise to pay with the bitcoins.

There are no IOU’s moving in channels of Lightning Network. Transactions within a channel register the change within the mutual transfer order of both parties, not the change of their mutual obligations. This transfer order records the number of coins to be transferred to the creators’ addresses, not the number of coins one party owes the other. As opposed to banknotes, such orders do not circulate, as the parties don’t assign them to third parties.

High cost factor of gold limited what is now known as “microtransactions”. In this light, bitcoin does resemble gold, even though it has other difficulties. Its divisibility is much better than that of gold, yet bitcoin microtransactions are limited by fees and the network’s throughput.

Lightning Network seeks to overcome this limitation as well. Miner fees are logically set to become the upper limit of Lightning fees, while the network’s scalability would have no limits whatsoever. On the other hand, higher cost of transactions may justify fees higher than those of miners.

Lightning Network’s Limitations

Lightning Network’s channels may process only those cryptocurrencies where the off-chain solution had been implemented. In sidechains, it’s also just cryptocurrency tokens that are moving. Similar to sidechains, Lightning Network is applicable beyond bitcoin, yet, as opposed to sidechains, its implementation requires a softfork.

In terms of trustless principles, there are two kinds of LN limitations. The first is mostly technical, and has nothing to do with abandoning the trustless principle. The second is mostly ideological, as the limitation cannot be overcome without abandoning the trustless principles. Presence of such limitations isn’t the technology’s disadvantage; it’s more of its functional limits.

The first kind of limitation may be represented by cross-currency transactions. Say, node A opens a payment channel with node B in X-Coins, while node B opens a channel with node C in Y-Coins. Then, if node A has to pay node C with Y-Coins, it may send X-Coins to node B via AB channel, and node B would send Y-Coins via BC channel. The limitation is about using the same hash function across the entire AC chain.

The second kind of limitation is about freezing coins in the payment channel. A classical banknote implies there is gold at a bank’s vaults. The right to publish a transaction that moves within LN’s payment channel implies there are bitcoins in the channel. The same is true for trustless banknotes: you have to freeze the coins in the blockchain to use their representatives in the sidechain.

However, the freezing wasn’t as harsh in classical banknotes. Banks could lend a part of their gold backing by using their right of partial redundancy. Banks could issue banknotes to excess the actual gold redundancy if entrepreneurs required additional means of exchange. There is 100% redundancy in the LN and trustless banknotes. Bitcoins will not move. That’s the price for trustless.

by Dmitri Bondar

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