Bitcoiners often advise people to withdraw their Bitcoin from exchanges, thinking that Layer 2 solutions will scale to handle everyone's self-custody. But running the numbers shows a different story. In reality, only a small percentage of the world's population will hold the keys to their own Bitcoin.
Here's Why:
In Bitcoin, there is a fundamental tradeoff between the cost to transact and validate. Bitcoin's block size expresses this tradeoff. Increasing the block size to decrease transaction costs will increase the cost to validate since the blocks will be larger. Decreasing the block size to reduce the validation cost will increase the cost to transact since each transaction will take up more of the available block space. Bitcoin was designed with these tradeoffs in mind. Tradeoffs that have been consciously decided upon to make globally decentralized money work effectively. Either way, the network economically prices people out of transacting or validating. Hence, the fundamental problem: Bitcoin doesn't scale.
Starting in July 2010, the Bitcoin protocol enforced a block size, but after the activation of Segregated Witness in August 2017, the protocol set the block size to 4 million "weight units." Each transaction is assigned a weight unit based on the number of inputs and outputs it has. There is also some transaction weight overhead, so combining more inputs and outputs into a single transaction is economically beneficial. To save on fees using the Bitcoin network, participants will reduce their on-chain footprint by reducing the number of transactions or the size of their transactions.
Layer-2 scaling solutions, like the Lightning Network, focus on reducing the number of transactions by allowing two participants to transact frequently with each other without needing to use Bitcoin's blockchain to settle the transactions. The success of the Lightning Network has increased the transaction density of Bitcoin; however, there is still a fundamental limit to the number of people who can own channels on the Lightning Network. The number of people operating the Lightning Network will remain low because each Lightning Network user needs to make at least one transaction to open a channel and has to be able to close that channel by broadcasting a transaction without losing a significant fee.
To determine how many individuals can participate in the Lightning Network directly, we first need to break down how institutions use the Bitcoin network to see how much block space is left over for the less economically efficient individual users. To simplify, if 25 Large Exchanges/Banks batch send to many destinations once per minute, 2,500 Small Exchanges/Banks send to fewer destinations once every couple of hours, and 25,000 other organizations like companies and countries transact once per day, that leaves only 1,000,000 individuals able to make one transaction per week. The complete analysis of how much block space these transactions will use can be found here.
The math is clear: to scale the user density of the Lightning Network, trust must be introduced; either people will use "Bitcoin Banks" as custodial Lightning solutions, or families and communities will collaboratively take custody of their Bitcoin.
To help these families and communities, sovereign.app now supports the Cashu e-cash protocol, and we have released an open-source mint: Chamberlain.
E-cash allows Bitcoin to scale through verifiable off-chain transactions. An e-cash mint operator can now form a Clan on sovereign.app to facilitate secure, private, and instant Bitcoin transactions within your network of friends and family. Transactions outside of your Clan are settled over the Lightning Network. This approach enables more people to use Bitcoin without depending on centralized custodians. If you can manage a Lightning Network node, you should issue Bitcoin-backed e-cash to support Bitcoin's decentralization for those who need help from a trusted "Uncle Jim."
Download sovereign.app today on iOS or Android and create a Clan to join forces with your friends and family to reclaim your financial sovereignty together.