Go small: Bitcoin and microtransactions

Bitcoin has been hailed as the saviour of microtransactions, small payments of cents or even less that up until now have not been an option due to simple economics. Traditional online payment methods charge fees for transactions that they process, be it mobile payments, credit card transactions, or direct transfers. You’re not going to pay 2 cents cost for a 2 cent transaction, are you? Enter Bitcoin, a frictionless, decentralized system that allows anyone to send any amount of money anywhere in the world for little or no cost. Hello, efficient and cost-effective microtransactions.

Only it doesn’t work like that.

Bitcoin is not useful for microtransactions.

Here’s why: On the Bitcoin blockchain, most payments will eventually need to include a transaction fee to incentivize the miners. Why do miners need to be incentivized? Because running the powerful computers that perform the validation functions is expensive, due to the hardware needed and the electricity consumed. Miners get rewarded with new bitcoins every time they successfully validate a block, but the amount of bitcoins they get halves every four years and will eventually reach 0. Transaction fees, a sort of voluntary “tip” added on to each transaction, will become more important to the miners – if there’s no transaction fee attached, they might choose to leave your transaction out of the block, in favour of a more lucrative operations. And as the block size limit is approached (unless the community can agree on an increase), space will become scarce and allocated to those transactors willing to pay extra. Transaction fees, however small, make micropayments less viable.

image via IMAX
image via IMAX

Yet nature, sorry, programming abhors a vacuum. Brilliant minds are working at coming up with a way to make micropayments easy and cheap or even free.

One of the most-talked-about micropayment solutions is the Lightning Network. This proposal is an efficient way to process transactions, even micro-transactions, faster and cheaper than one can on the blockchain. It’s a clearing network that sits on top of the blockchain, and eventually settles on it. But until then, it can pass around payment information in a secure and trust-less fashion (trust-less means that you don’t need to know or even trust your payment counterparty). And because there are no miners that need incentivizing, transaction fees are low or even non-existent.

To understand this better (because it’s darn complicated), visualize a Bitcoin earth with lots of payment channel spikes leading up to little moons. Each Lightning user can have one or several spikes. If he or she has several, each leads to a different moon. It’s a bit like having several bank accounts, or several bitcoin wallets. Your choice. And the moons have thin tunnels leading to some of the other moons. In my case, say I have only one spike (I’m a simple soul, really). I upload some bitcoin to my spike. Say I want to send a payment to you via these payment channels. The transaction goes up to my moon, which then figures out the quickest route through the thin tunnels to your moon. It then trickles down your spike to you.

This may sound inefficient, but it’s not, and it’s how the Internet works today. This packet of information that you’re reading found its way to your screen via a convoluted yet efficient route of hubs, it didn’t get to you directly. But it got to you quickly.

So, since the transaction is just between me and you, and doesn’t have to be broadcast to all the nodes, it’s almost instantaneous. And, since no miners are involved and there are virtually no costs (except perhaps a payment channel creation and/or maintenance fee), it’s almost free. When we’re done transacting, we can bring the transactions back down to the Bitcoin earth for settlement. It is not as secure as Bitcoin, but with microtransactions, that shouldn’t be an issue worth worrying about. And it is much more convenient.

The Lightning Network is in development, with no release date announced yet. But the idea is generating buzz amongst developers and Bitcoin enthusiasts alike, who see it as a way to make Bitcoin more efficient without losing the decentralisation. Stand-alone implementations (that don’t need the blockchain) are being built for testing, and crypto think-tank/developer  Blockstream has started Lightning application development.

Strawpay’s Stroem protocol (a Swedish company, be grateful that they didn’t insist on Ström) is very similar, with a few technical differences that I confess I don’t quite understand yet (working on it). They seem to be a bit further along the development rail, but they are making a lot less noise and receiving a lot less attention. Amiko Pay is another potential contender for a role in Bitcoin micropayments, but it is in early stages still.

So who will be the first to launch? My money is on Lightning. Keeping hefty brainpower focussed takes money, as even programmers need to eat. I mentioned earlier that Blockstream has begun work on the Lightning Network, hiring a specialized developer. Late last year Blockstream secured a $21 million funding round from 40 investors, including top venture capital firms. A few months ago Strawpay received a 500,000K (about $60,000) grant from the Swedish government, which is better than nothing, but probably won’t last very long.

The race is on, and the stakes are high. If we have access to an efficient micropayment platform, imagine what that can do for the media industry. It will be possible to pay per article read. The music industry could find a viable, fair business model. We could pay cents for each song listened to, and artists could receive income directly from listeners. Telephone bandwidth in which you pay by the minute, streaming in which you pay by the episode… With minimal overheads, the costs to the consumer would be low and proportional to consumption. With minimal overheads, the creators or originators receive more for their creation or service. And the economic boost to the intersection of creativity and quality will have ripple effects in culture, business and finance. Exciting.