Self Custody and the Lightning Network

??Self-Custody and the Lightning Network

Chapter 6.

To create a wallet, you can simply download a Bitcoin wallet application, use an online service that provides wallet creation functionality, or buy a hardware device with wallet creation functionality.

This virtual account, often referred to as a "wallet," is protected by a master private key, much like how a bank account is safeguarded by a personal PIN or password. Just as you have control over the funds in your bank account, you can manage the Sats in your wallet and use them to make purchases or transfer them to other accounts.

The key difference is that while banks are centralized and subject to government regulations, a Bitcoin wallet is decentralized and operates on a person-to-person network. Bitcoin has no central point of failure, but it is important to be cautious as someone’s Bitcoin can be in the possession of a third party who is managing it.

Bitcoin wallets come in two main types: self-custodial and custodial. With self-custodial wallets, you hold the private keys, ensuring true ownership of your Bitcoin. On the other hand, custodial wallets entrust the private keys to a third party.

To use Bitcoin, you'll need to set up a digital wallet on your computer or phone. Your wallet, whether self-custodial or custodial, allows you to store, send, or receive Bitcoin from others, as well as make online purchases.

??Different Types of Wallets

Online Wallet:

• Description: An online wallet, also known as a web wallet, is hosted by a third-party service provider accessible via the internet.
• Advantage: Convenient and easy to use, accessible from any device with an internet connection.
• Disadvantage: Prone to security risks such as hacking and phishing attacks. Users rely on the security measures implemented by the service provider.
• Example User: Sarah, a casual Bitcoin user who wants quick access to her funds for online transactions.

Mobile Wallet:

• Description: A mobile wallet is an application installed on a smartphone or tablet that allows users to store, send, and receive Bitcoin.
• Advantage: Portability, enabling users to manage their Bitcoin on the go. Some mobile wallets offer additional features like QR code scanning for easy transactions.
• Disadvantage: Vulnerable to device theft or loss. Users must ensure their device is secure and back up their wallet properly.
• Example User: Tom, a frequent Bitcoin user who often makes in-person transactions using his smartphone.

Desktop Wallet:

• Description: A desktop wallet is software installed on a computer that enables users to store and manage their Bitcoin.
• Advantage: Generally more secure than online wallets as the user has control over their private keys. Can be used offline, reducing exposure to online threats.
• Disadvantage: Limited portability compared to mobile wallets. Users must ensure their computer is secure and regularly update their software.
• Example User: David, a trader who prefers to manage his Bitcoin investments from his home computer.

Hardware Wallet:

• Description: A hardware wallet is a physical device, often resembling a USB stick, designed specifically for storing Bitcoin securely offline.
• Advantage: High level of security as private keys are stored offline and protected by encryption. Immune to malware attacks.
• Disadvantage: Costlier than other wallet types. Users must ensure the physical safety of the device and keep backups of their recovery seed.
• Example User: Emily, a long-term investor with a significant amount of Bitcoin holdings who prioritizes security and peace of mind.

Paper Wallet:

• Description: A paper wallet is a physical document containing a user's Bitcoin public and private keys, usually generated offline for added security.
• Advantage: Highly secure if generated and stored correctly, as it's entirely offline and immune to digital threats.
• Disadvantage: Prone to physical damage, loss, or theft. Users must take extra precautions to safeguard the paper wallet, such as storing it in a safe or vault.
• Example User: Michael, a Bitcoin enthusiast who values the simplicity and security of storing his funds offline. He stores his paper wallet in a fireproof safe at home.

When selecting a Bitcoin wallet, there are several factors to consider:

• Security: Ensure the wallet implements robust security measures like two-factor authentication and secure password policies.
• Privacy: Evaluate whether the wallet prioritizes anonymity or requires personal information for account setup.
• Ease of Use: Opt for a user-friendly wallet, especially if you're new to Bitcoin.
• Compatibility: Confirm that the wallet is compatible with your device and operating system.
• Fees: Compare fees charged by different wallets to ensure you're getting the best deal.
• Reputation: Research the wallet's reputation and the trustworthiness of its team.
• Control: Decide whether you prefer a wallet that grants full control over your private keys, which can enhance security, or one that sacrifices some control for user-friendliness.

Ultimately, choose a wallet that aligns with your security preferences and usability needs.

??The Process of Onboarding and Securing Your Bitcoin

Before proceeding further, it’s crucial to understand the steps for onboarding and acquaint ourselves with the process of buying and securing Bitcoin safely.

1. Choose a Bitcoin exchange or brokerage: There are numerous reputable platforms that enable you to buy and sell Bitcoin. Select one that aligns with your requirements and has a good reputation.
2. Create an account: Follow the platform’s instructions to set up a new account. This may involve providing personal information and undergoing identity verification.
3. Connect a payment method: Most platforms allow you to link a bank account, credit card, or debit card to fund your account. Follow the platform’s guidelines to add your chosen payment method.
4. Place an order: Once your account is established and funded, you can initiate an order to purchase Bitcoin. The platform will provide a price quote, and you can specify the amount of Bitcoin you wish to buy.
5. Confirm the transaction: Review the transaction details and confirm the purchase. The platform will process the transaction, and the Bitcoin will be transferred to your account on the platform.

Secure Bitcoin

6. Withdraw the Bitcoin: If you intend to transfer the Bitcoin to a self-custodial wallet, you’ll need to withdraw it from the platform and send it to your wallet. The platform will provide instructions on how to complete this process.

"Not your keys, not your coins" is a popular adage among Bitcoin holders, emphasizing the importance of controlling the private keys associated with your Bitcoin wallet to truly own the coins. The private key serves as a secret code enabling access to and spending of your Bitcoin. When entrusting your Bitcoin to a third-party service such as an exchange or online wallet, you rely on them to safeguard your private key. However, if the service is compromised or ceases operation, you risk losing access to your Bitcoin. Therefore, taking control of your private keys and securely storing them is essential. This ensures full control over your Bitcoin, enabling access whenever needed.

??Off-Chain vs On-Chain

We've talked a lot about Bitcoin, its network, and how to create a wallet as well as send and receive Bitcoin.

It is important to note that not all Bitcoin transactions are recorded on the main Bitcoin blockchain; some networks use different blockchains called sidechains to record transactions.

??On-Chain Transactions (Bitcoin Blockchain)

These transactions occur directly on the Bitcoin blockchain. Miners take about 10 minutes to confirm blocks, and the fees depend on the size of the transaction in bytes and how many transactions are attempting to get confirmed at a given time in the network. While they are secure, they can be slower.

?Off-Chain Transactions (Lightning Network)

These transactions take place on a separate network built on top of the Bitcoin blockchain. They settle faster and with lower fees. They are commonly used where regulations and laws support their adoption and where the speed and cost of transactions are more critical. However, compared to on-chain transactions, they are less secure.

The Lightning Network is a scaling approach to Bitcoin, focusing on moving a lot of Bitcoin transactions out of the blockchain and into private channels between users while still relying on the blockchain's security.

??Payment Networks: Bitcoin Network & Lightning Network

Advantages:

??Bitcoin Network:

-Decentralized and secure

-No chargebacks or fraud

-Can be used anonymously

-Global acceptance

?Lightning Network:

-Faster and cheaper transactions

-Increased scalability (off-chain transactions do not clog the blockchain)

Disadvantages:

??Bitcoin Network:

-Slow transaction times

-High fees for certain types of transactions

-Complex for beginners

?Lightning Network:

-Requires trust in the channel operators

-Still experimental and not widely adopted

-Requires on-chain transactions to open and close channels

?The Lightning Network

Bitcoin is known for its unalterable public ledger, but it may not be the best choice for everyday transactions like buying coffee. The process of broadcasting transactions to every node and storing them in a shared database can be slow and cumbersome. For personal or private transactions, it’s better to use peer-to-peer payment channels.

A better solution is a layered approach to scaling, such as the combination of Bitcoin and Lightning Networks. This allows users to pick the network that best fits their needs. Bitcoin is a decentralized digital currency, while the Lightning Network provides quick, cheap, and confidential payments.

The Lightning Network operates as a separate network connected to the Bitcoin blockchain and is designed to work seamlessly with Bitcoin. Taro, a recent addition to Lightning, now enables the network to be used for other types of assets, such as stablecoins, allowing users to make nearly instantaneous, low-cost payments in a currency linked to traditional finance, such as the US dollar. Payments can be made directly to the recipient, bypassing intermediaries, and converting the payment into the original currency before it reaches the store.

Using stablecoins in the Lightning Network for international transactions, such as remittances, provides many benefits:

• Reduced Costs: Cross-border transactions can be expensive due to fees charged by banks or other intermediaries. By using stablecoins in the Lightning Network, these fees can be reduced or eliminated, making cross-border payments more affordable.
• Increased Speed: Cross-border transactions can take several days to complete when using traditional methods. By using stablecoins in the Lightning Network, international transactions can be processed quickly, reducing the time required to complete the transaction.
• Improved Access: For individuals or businesses in countries with limited access to traditional banking services, the use of stablecoins in the Lightning Network can provide a means to make international payments, thereby improving access to financial services.

??Early Development

The Lightning Network is a relatively new technology that is still undergoing active development. While it shows immense promise for scaling Bitcoin and enabling fast, low-cost transactions, it is not yet widely adopted or fully matured. Many aspects of the network, including its user interface, security features, and interoperability with other platforms, are still being refined.

??Limited Adoption

Despite its potential benefits, the Lightning Network has not yet reached mainstream adoption. While there is growing interest and investment in Lightning technology, particularly within the Bitcoin community, many users and businesses are still unfamiliar with how it works and how to integrate it into their daily operations.

??Technical Challenges

Implementing and operating Lightning nodes requires a certain level of technical expertise, which may be a barrier to entry for some users. Additionally, there are ongoing technical challenges related to scalability, routing efficiency, and network stability that need to be addressed before Lightning can become a widely-used payment solution.

??Regulatory Considerations

As with any financial technology, the Lightning Network is subject to regulatory scrutiny and legal considerations. Regulations surrounding digital currencies and payment networks vary by jurisdiction, and compliance with these regulations may impact the development and adoption of Lightning-based services.

Given these factors, a presentation on the Lightning Network focusing on explaining its potential benefits and use cases, and discussing the current state of development and adoption will be coming at a later date. For now, back to the main Bitcoin Blockchain.