Bitcoin needs latency independent second layers

Many Arguments can be made in favor of second layers to bitcoin. The most common ones are efficiency, privacy and speed. For a long time I too thought these were the most important reasons. But during a recent twitter conversation with some BSV shills rehashing fork dynamics something else occurred to me: to successfully defend against a majority of miners trying to strong arm the community into accepting new rules we need to be able to carry on without the ability to transact on chain (or at least for much higher prices) for a period of time.

S2X fork wars revisited

2015-2017 were turbulent years for Bitcoin. The block space began to fill up, a fee market slowly developed and the community was getting more and more divided about whether this was a good thing. Users, while initially undecided, were persuaded by the technical arguments against increasing the block size and for letting a fee market develop. Yet many businesses saw increasing transaction costs as a threat to their profits and organized a backroom deal between each other and the biggest miners at that time. That deal included SegWit as a soft fork to appease the technical community and users but also a block size increase (2x) as a hard fork.

While SegWit went through without problems there was more and more resistance against the 2x part of the deal. Yet the majority of miners supported it, leading to a chicken's game between users and miners. Fortunately miners faltered under the pressure from users and most never attempted to activate the 2x part. The few that did created the a fork coin called bcash which never gained any relevance but gave a nice profit to whoever sold or shorted it.

But to this day there are arguments that it could have gone the other way, and I tend to agree more and more. Currently Bitcoin's economy is too reliant on transactions actually going through. That might sound absurd for something that wants to be money, but let me explain:

A future consensus war

Let's assume a scenario where a huge majority of miners attempts to push a hard fork that is mostly rejected by users. In an efficient market one would assume that the rejecting users at least sell if not even short the attacker's chain massively reducing its price compared to the original chain's token. At that point it doesn't make any economic sense to mine the fork anymore1. But they still might have big reserves or external funding and want to continue anyway.

In a world where hyperbitcoinization happened but is limited to on-chain activities that would be disastrous for users since there'd be no way to transact for a long time (remember, the network works at a fraction of its former capacity, blocks are slow, difficulty adjustments take time). The opportunity costs would be so big that after a few days a significant amount of users might falter given that the general population isn't ideologically motivated to preserve Bitcoin as a free money. Even worse, miners have a big motivation to succeed since most of the attack costs (lost block rewards) aren't costs if they win.

Getting to high ground

The best way to strengthen the user's stance is to make them independent of low latency transactions. That way people won't suffer any opportunity costs just because they aren't able to transact at the moment as long as the network recovers eventually.

Currently there are three strong contenders to achieve such a future:

The Lightning Network

Lightning only needs transactions to open and close channels. Thus day to day operations could mostly continue unhampered in a hyperbitcoinized future since a circular economy should emerge eventually making the closing and reopening of channels unnecessary. Only onboarding new users would be rendered impossible for the duration of the conflict.

One possible problem is that big channels could experience fraud if transactions are still going through at a slow rate but only with high fees. But this incentive problem can certainly be fixed by requiring higher reserves at channel creation time.

Federated systems

Pegged side chains like Liquid and federated chaumian banks like SCRIT are another viable second layer. They work by putting some bitcoins into a federated wallet and accounting for ownership changes in some other way. If one can prove the ownership of some bitcoins in the system these can be withdrawn too. It's easy to see that such a system doesn't need constant peg-ins and peg-outs as long as people trust the system to eventually release their coins.

Such systems are more centralized, but offer more resilience. Problems like unbalanced channels don't exist and not being able to transact should not lead to loss of funds. The centralization can be counteracted by increasing the size of the federation.

Centralized wallets

One might also think of centralized wallet providers as a possible solution2. They offer the same benefits as federated systems but add a big risk (besides counter party risk): they can decide for users which chain to support and thus gain undue influence.

Relevance for UASFs

A soft fork widely supported amongst users has similar properties to a hostile hard fork. From the users point of view a miner that doesn't enforce the soft fork is hard forking away. That means if nearly all users enforce a certain soft fork the miners are in the same situation as before: They can either attack the new chain and get people to cancel the soft fork or upgrade themselves and enforce it. That means the same power dynamics described for hostile hard forks apply and well prepared users can pressure miners into accepting any soft fork that has wide community support3.

tl;dr As discussed Lightning and federated layer 2 systems have huge potential to empower our decentralized user base to withstand attacks from more centralized adversaries that might get control of significant mining power. Hopefully, if we are well prepared, it might not even come to an all out war, but end before it even began. Just like last time.

Si vis pacem, para bellum.

1That's probably even true if the proposed change is to increase mining rewards since such a change would severely limit the trust in the attacking fork.

2Ok, not really, but for completeness sake.

3The support is hard/impossible to measure, so USAFs should still be used carefully, but it's important to have the option available.

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