Lightning Network – AML, KYC, and Success Rates

As most now know, the Lightning network is a second layer protocol that offers the ability to open off-chain payment channels.  Iinaddition to the utilization of TOR, the Lightning network increases speed, flexibility, and privacy in one fell swoop.

In recent months we have seen rapid adoption and development of this protocol.  From late 2017 when there was essentially no one using the network, to mid-2018 where we now see thousands of active nodes.  Despite this level of adoption, the Lightning network is far from becoming mainstream.  Just look at the update which paved the way for Lightning – Segwit.  It took a very long time for Segwit to become accepted to the point that it could even become active.  Although activation occured in August of 2017, it would be another 10 months until greater than 40% of active nodes utilized SegWit.  Expect Lightning to be the same.

For the current trailblazers building and testing the foundations of the Lightning network, it can be frustrating work.  In a research paper just released by DIAR, they found that transactions taking place on the network were only successful a very small amount of the time.  In denominations above $0.55, the chance of a confirmed transaction plummets. 

$0.03 = 100% success rate

$0.55 = 90% success rate

$1.84 = 73% success rate

$5.52 = 51% success rate

$18.39 = 25% success rate

$55.18 = 10% success rate

$122.62 = 5% success rate

$429.18 = 1% success rate

As the above figures show, the network is only reliable for micro-transactions at this point.  This is a great start, as tackling micro-transactions was a major driving factor for the development of the Lightning Network.  This inability to handle larger transactions simply puts the infancy and lack of true adoption into perspective.  Not being able to reliably handle large transactions simply comes down to the amount of active nodes on the network.  With currently over 2500 nodes, and almost 8000 channels open, it just isn’t enough to reliably send money from one random node to another.  This is because there simply isn’t a guaranteed pathway to be found.  The greater the number of channels open, the greater the degree of separation that can exist between random nodes. 

In addition to the issue of depressed success rates comes the potential avoidance of the Lightning network by large exchanges.  Due to regulatory changes coming into play in most countries, exchanges are being forced to adhere to typical AML and KYC laws.  The issue with Lightning network is that it utilizes TOR.  This means that if an exchange were to remain online as an active node facilitating transactions, they would not be able to adhere to these laws.  Due to the nature of TOR, the exchanges would not be able to determine if the recipient of the packet they are forwarding is the final hop.  By not being able to see beyond this hop, they would not be able to stop money-laundering etc.  This is an issue that will further delay mainstream adoption.

Overall we see two issues prevalent with the current iteration of the Lightning Network.

–          Reliability for large transactions – which can be fixed in time as more channels are opened.

–          Inability for exchanges to adhere to KYC and AML – this is an issue that may forever prevent adoption by large exchanges

Regardless of these two issues, development continues and hopes for the Lightning Network changing the way BTC functions are as high as ever.