⚡ BTC Lightning Payments 🔎 Crypto Ratings Agency — Cryptos for the Rest of Us
By: Shan Han
Tags: Credit Rating, Bitcoin, Cryptocurrency, Finance

First Bitcoin Lightning Payment

What’s the Story?

The first ever real-world transaction was made with Bitcoin on the long-in-development Lightning Network. TorGuard, a popular VPN service tweeted that it was accepting payments in Bitcoin and a user successfully completed a purchase. While it’s still highly experimental (TorGuard offer refunds if the payments fail) this is the first proof-of-concept for the Lightning Network.

What’s ‘Lightning Network’?

The Lightning Network (LN) promises to bring instant, near-free payments using Bitcoin. It was first proposed in 2015 and has been in development by various communities ever since. LN works as a separate ‘off-chain’ protocol that is designed to handle transactions at internet speeds.

As we know, the Bitcoin network is very congested and fees to get a transaction confirmed on the next block (~10 minutes) are about $15. This fee applies whether you want to confirm a $1 or $1,000,000 transaction making it clearly unsuitable for small, everyday purchases. This is because every single transaction ever recorded on the Bitcoin blockchain must be ‘downloaded’ every time a miner verifies a block. It’s a bit like if you had to download every single email ever sent in order to open a single email.

How Does it Work?

The LN works by creating a new layer where participants open ‘channels’ to make transactions between each other. When a channel is created, both parties put forward a BTC balance and this ‘opening’ is logged on the main blockchain. An unlimited number of peer-to-peer transactions can be conducted by adjusting respective balances, effectively for free. When the transactions are done, the channel is ‘closed’ and the final balances are recorded on the main blockchain. Since transactions are recorded only twice when a channel is opened and closed, the total fees required to conduct many transactions is much lower.

The benefit of such a method is obvious for repeated business and microtransactions. Channels can be opened for minutes, days, months, or even indefinitely. If you want to buy your daily coffee from Starbucks using Bitcoin, you and Starbucks could open a channel that allows you to make daily purchases instantly. If contractors want to be paid in Bitcoin over the course of a project they can open a channel with the client, receive periodic payouts, and close the channel when the project is over. Payments are free, as long as the channel is open.

The real power of LN comes from the ‘network’ part. Multiple channels can be chained together, allowing transactions to flow across the network very quickly. This requires some channels to act as ‘nodes’ which can charge a fee to transact. Critically, these fees are proportional to the amount transacted, unlike mining block rewards which are fixed. Therefore costs are expected to be minuscule.

Why Should I Care?

This comes as Stripe, a major payments processor dropped Bitcoin due to volatility and long transaction times.

Empirically, there are fewer and fewer use cases for which accepting or paying with Bitcoin makes sense. –Stripe Blog

If the LN takes off it could scale Bitcoin transactions in a much better way than existing proposals such as SegWit and increased block sizes. The analogy given by proponents is that LN is like HTTP, the protocol that transfers text across the internet, itself another protocol TCP/IP. In a similar way, LN operates on the Bitcoin Blockchain

Critics point out that high fees could still creep into the network, and the main blockchain could still become congested if there are many channels being opened and closed. The biggest problem though is the volatility of Bitcoin itself. With such large price swings its hard for merchants to accept. In addition, if the market expects the price to keep going up there is little incentive to spend.

It will be interesting to see if LN sees widespread adoption. It’s a novel idea that once again opens up the possibility of Bitcoin becoming a means of transaction. Even Stripe have not ruled out potentially bringing Bitcoin back as on their platform.

Ratings Agency Enters Cryptos

What’s the Story?

Weiss, a traditional ratings agency stirred emotions in the cryptocurrency world after it released a much-hyped letter-graded rating for 74 cryptocurrencies. Bitcoin earned a C+, while Ethereum earned a B. No cryptocurrency managed to earn an ‘A’ rank.

Cryptocurrency communities were enraged and a Korean group attempted to stop the release of the ratings by conducting a cyber-attack on the Weiss website.

Why So Angry?

Weiss is an independent ratings agency that covers 55,000 stocks. They have been around since 1971 and apparently don’t take payments from the companies they rate, unlike S&P or Moody’s.

Many in the cryptocurrency space were disappointed to hear that their coin of choice wasn’t rated an A+. Predictably, rants about how the ‘banksters’ were here to manipulate the crypto markets came up again.

One Reddit user dug up some SEC fines against Weiss in the past, claiming that it was just a long-standing pump-and-dump stock research operator.

Is this Good or Bad?

It seems like very few people have actually looked into how Weiss calculate their grade. According to their website, they use five layers that aggregate data points into comparable ratios that eventually turn into a grade. The main drivers of the data are these four factors:

1. Risk: Price volatility

2. Reward: Performance vs. a set of benchmarks

3. Technology: anonymity, sophistication of monetary policy, governance capabilities, the ability or flexibility to improve code, energy efficiency, scaling solutions, interoperability with other blockchains and many more.

4. Fundamentals: A composite of sub-indexes that evaluate transaction speed and scalability, market penetration, network security, decentralization of block production, network capacity, developer participation, public acceptance, plus other key factors.

So, by their own explanation, while Bitcoin scored an A on the Fundamental Index, it was dragged lower by other factors. Part of the reason no cryptocurrency got an A is that they all score low on the Risk Index — due to their extreme volatility.

Should I Listen to Them?

From an investment perspective, their methodology makes sense. It also explains why generally the grades were low. Whether the criteria are correct is ultimately subjective. They say they will release the sub-grades for each cryptocurrency too (to subscribers only of course) so investors can pick and choose which factors are important to them.

It seems odd to me that they separate Risk and Reward so clearly and give them such a high combined weighting. Traditional financial metrics usually combine the two into a Sharpe Ratio or something similar. It seems like they want to give momentum factors a similar weighting as fundamentals. Which might make sense given that most of the price action is dictated by momentum at the moment.

The claim that they’re a pump-and-dump only scheme seems dubious given that the business has been operating for a long time without actually being shut down by the SEC, despite an investigation. It’s entirely possible that they’re taking positions ahead of their recommendations. Their ratings seem to have had a market impact as some of the higher rated coins like Cardano and EOS have outperformed the broader market.

Given the opaque nature of their actual process, it’s hard to say whether their findings are accurate. However, the methodology itself seems like a framework that people could adopt for their own use.

Either way, a more robust approach to analysis is a good thing. If more companies start doing similar research the market should become much better at pricing cryptocurrencies in the long run.