The Lightning Network’s (LN) configuration is becoming increasingly centralized, with multiple hubs being formed. This is the finding of a yet-to-be-reviewed research paper, released on pre-print site arXiv on Feb. 7.
A team of academics from Switzerland, France, Italy and Canada authored the paper. Jian Hong-Lin and Kevin Primicerio conducted the analysis, while others, including Blockstream Inc. researcher Christian Decker, designed the research.
Core-periphery model
The team gathered Lightning Network information for a period of 18 months from Jan. 18, 2018 to July 13, 2019. Researchers then analyzed the payment network in terms of its node and wealth distribution.
They discovered that the network showed high Gini coefficients both in terms of node centralization and wealth distribution. Notably, the values were found to rise as more nodes were added.
The distributions of Bitcoin (BTC) across every node in the network was found to be extremely uneven as well. The Gini index amounts to 0.88, which corresponds to 10% of nodes holding 80% of BTC.
The goal of the research was to understand which idealized model best describes the network. While researchers identified the Undirected Binary Configuration Model (UBCM) as a good candidate, the network was found to be more centralized than expected. The researchers concluded:
“This suggests that the BLN [Bitcoin Lightning Network] is becoming an increasingly centralised network, more and more compatible with a core-periphery structure.”
An idealized network graph based on LN data on days 16 and 34. Blue represents hub nodes. Source: Research paper.
The UBCM system does imply a degree of centralization, which would result in the presence of several hubs. The actual network appears to be too reliant on them, which could make it a “target for the so-called split attacks,” researchers argue.
Actual LN graph on days 16 and 34. Orange and red represent hub nodes. Source: Research paper.
The research paper follows findings by BitMEX Research focusing on the higher than expected amount of “uncooperative closures.”
Lightning Network Progress
The network is currently hosting more than 11,500 nodes, with an average node capacity of $1,300 and average channel capacity of just under $240. The network had reached 10,000 nodes in September 2019.
The journey has also seen some stumbles, with reports of users temporarily losing money through LN. A vulnerability was also disclosed in September, with some reports noting that it was exploited “in the wild.”
In December, Bitfinex introduced LN support to make instant purchases through Bitrefill.
On March 14, Tyler Winklevoss, the co-founder and CEO of Gemini and prominent early Bitcoin investor, took to Twitter to defend Bitcoin despite the recent market crash.
In the tweet, Tyler emphasizes that Bitcoin is still in its infancy, stating:
“If bitcoin isn't gold 2.0, then what is it? The fact that it's not acting how you might expect only underscores just how early it is.”
Supporting Winklevoss’ assertion, Anthony Pompliano, the co-founder and partner at Morgan Creek Digital, has attributed the recent crypto market meltdown to a broader liquidity crisis coursing through the global economy. He said:
“Bitcoin and gold are doing the same thing, just as you would expect them to in a liquidity crisis..they go down. Same thing happened to gold during liquidity crisis of 2008 too.”
As in 2008, the metals markets have suffered enormous losses as a result of the current liquidity crisis, with gold futures falling 4.25% and silver futures crashing 8% in a single day on India’s markets. Over the past week, gold is down about 10% compared to Bitcoin’s (BTC) 50% while becoming increasingly correlated since January.
Liquidity crisis drives market collapse
In a recent episode of his Off the Chain podcast, Pomp argues that the shutting down of economic activity in response to the COVID-19 coronavirus pandemic has sparked a liquidity crisis — driving down the prices of Bitcoin and gold despite their status as a safe-haven asset.
“A liquidity crisis means that investors all rush to the exit doors at the same time, but there are so many more sellers than buyers that investors actually have a hard time offloading their assets for cash. Quite literally, investors begin aggressively lowering the price they are willing to accept for each asset in exchange for the cash which they are desperately seeking right now.”
Pomp points to the 30% crash in the price of gold during the 2008 global financial crisis, stating: “This [wasn’t] because gold is a bad store of value or that it had lost safe-haven status after 5,000 years. It [was] because gold has a liquid market and investors needed liquidity over anything else.”
Despite gold’s sudden drop in price, the Morgan Creek Digital co-founder notes that the price of gold nearly trebled in five years from $650 in 2006 to more than $1,800 in 2011 as concerns regarding U.S. monetary policy, inflation, and debt increasingly gripped the markets.
“Simply, gold served as a store of value and safe-haven asset over the full timeline of the crisis, but it succumbed to the liquidity crisis during the worst 6 months. This is what I believe is happening to Bitcoin right now.”
Can crypto recover from a liquidity crisis?
Pomp asserts that most investors who were holding Bitcoin for cash likely sold over the last week — driving the huge losses recently sustained across the crypto markets.
While hesitating to “guarantee” that BTC will not see deeper local price lows, Pomp speculates that most investors who are still holding Bitcoin are “holders of last resort” who will not sell their BTC.
“Regardless of price movements in the USD exchange value, the holders of last resort won’t sell their Bitcoin. They are strong hands. They can’t be shaken out of their belief. In fact, they are likely to be buying Bitcoin on these large price drops, rather than selling. They are exchanging USD for Bitcoin right now.”
Further, Pompliano expects that the upcoming halving will coincide with the introduction of monetary stimulus measures and may further drive an influx of investors seeking safe-haven exposure.
Predicting interest rate cuts and quantitative easing, Pomp expects that investors will soon seek to weather the liquidity crisis by seeking exposure to “sound money” and “safe-haven assets,” adding:
“Both gold and Bitcoin should do incredibly well during this time period.”
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