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Bitcoin’s Lightning ‘play’ with derivatives is a pitch far from perfect

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The debates around Bitcoin’s Lighting Network have continued to make headlines, despite the fact that it has been years since these first emerged.

The 2nd layer payments protocol on the Bitcoin blockchain is supposed to solve Bitcoin’s scaling issues and enable more payments in a faster and reliable manner. However, it has been reported that developers are now trying to conceptualize the idea of utilizing Lightning to peg with the value of BTC. However, the decentralization aspect behind this particular idea does raise a lot of major question marks.

According to a recent Longhash report, the basic scenario is to efficiently hold other assets such as the U.S dollar or gold, on the Lightning Network, with the help of Bitcoin in a multi-sig address. It added,

“This would allow the user to hold derivatives  — a kind of asset whose price is based on the value of a different asset — in a potential censorship and seizure-resistant manner.”

Similar mechanisms are already AVAILABLE and popular among various DeFi applications on Etherem, but the bottom line is that it would need the users to lock up BTC in a smart-contract of multi-address.

Requiring the need for third-parties such as price oracles, one of the methods being discussed is the use of Discreet Log Contracts or DLCs. A DLC is an effective way to bring outside info in blockchain networks, while also nullifying the issues of scalability and privacy.

Although the positives of DLCs have been highlighted in the past, according to SuredBits’ Nadav Kohen, there are a few major concerns surrounding DLCs and the use of price oracles.

Censorship-resistant and DoS attacks on Oracles

If the DLC protocol is levied on Bitcoin’s Lightning network, the settlement of contracts would be solely dependent on the specific price Oracles’ output that would be taken as the reference rate. Further, there are major concerns with price oracles, especially with regard to whether they are censorship-resistant or not.

Bringing a third party into the equation is already walking a thin line with decentralization, and considering the fact that Oracles are susceptible to DoS attacks, there is a fair bit of risk with regards to price rate manipulation. Hence, these issues are required to be ironed out before implementation.

Also, including the case for a Dollar-Bitcoin use case, the number of signed transactions for each possible value within the range, (let’s say $5000, that means 5000 signature are needed) would require a staggering amount of signatures between the parties. Although a solution to this dilemma has been mentioned in DLCs’ whitepaper put forward by Tadge Dryja, it hasn’t been implemented yet.

Hence, at the moment, the use of derivatives in Lightning remains a distant dream, just like Lightning’s ambition to reduce Bitcoin’s scalability problems.


Biraajmaan is a full-time journalist at AMBCrypto covering the US market. A graduate in Automobile engineering, he writes mainly about regulations and its impact with a focus on technological advancements in the crypto space.
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