Know & go
- A closer look: Lightning Labs announced that the latest version of its LND implementation will include support for watchtower services. A watchtower is a third-party that monitors channels to check whether invalid commitment transactions are being broadcast on-chain.
- Three things to know: (1) Facebook signed up 12+ companies, including Visa and Mastercard, to support its cryptocurrency network (2) CoinMetrics acquires Bletchley Indexes and plans to offer a smart-beta index (3) Microsoft to integrate developer tools built by Truffle into its cloud computing platform, Azure.
- Market snapshot: Total crypto market capitalization is around $251.5 billion at press time (up 2.8% w/w). BTC is trading at $8423 (up 6.4% w/w), ETH is at $259 (up 3.4% w/w). BVOL (the rolling 30-day annualized Bitcoin volatility as calculated by BitMEX) is 77.1%, down from 85.3% last week. (6/14 12:20PM ET)
Weekly market snapshot
A closer look: Lightning Network’s Eyes of Sauron
Lightning Labs will roll out the most complete build of a Lightning Network watchtower in version 0.7 of LND (Lightning Network Daemon), the most popular implementation of Lightning Network. A watchtower, which the CTO of Lightning Labs jokingly compares to the Eye of Sauron, is a service that monitors Lightning channels to check whether invalid commitment transactions are being broadcast on-chain. The idea of watchtowers is not new – it was informally proposed in the original Lightning Network whitepaper and has been under development since early 2018: “One should periodically monitor the blockchain to see if one’s counterparty has broadcast an invalidated Commitment Transaction, or delegate a third party to do so. [A third party] can be incentivized to watch the blockchain…by giving these third parties some fee in the output.” Further, some technical teams have run tests for watchtowers, including MIT’s Lit and Bitfury’s Lightning Peach.
Currently, users that run their own Lightning node have to periodically go online if they have payment channels open to make sure that their counterparties do not broadcast an old and invalid state and steal funds that are not rightfully theirs. At the moment, a counterparty can try to close a channel by submitting an older state, reversing previous transactions in their favor. However, the channel closing transaction is not immediately broadcast on-chain. Rather, the counterparty must wait for a period of time to pass, measured in number of blocks. The only way to protect against potentially being cheated is to monitor the channel on a regular basis. This creates a poor user experience by placing a burden on users to manually check if they’re being defrauded. Beyond being an inconvenience, it’s not always possible to users to make it online in time (e.g. say the user is in a remote location with no internet connection or experience a failure in hardware, software or connectivity), resulting in the loss of funds with no avenue for dispute or recourse.
A watchtower is a 24/7 fraud protection service provided by a third party Lightning node. Users looking to protect their Lightning accounts can connect to a watchtower and outsource the need to monitor counterparty activity. Once connected, watchtowers stay online at all times and track channel broadcasts for old states, which indicate a counterparty’s attempt to steal funds. If a watchtower detects a channel breach via an old state broadcast, it informs the affected party and penalizes the bad actor by returning the channel funds to the affected account. Therefore, the cost of broadcasting invalid states – unintentionally or with malicious intent – is the loss of all funds in the channel.
How do watchtowers work?
Every payment between two parties in a channel results in the creation of a “blob” (their terminology, not ours) for each channel user. A blob represents encrypted transaction data that corresponds to a user’s public key. Whenever a payment is initiated in a given channel, the blob and half of the previous payment’s transaction ID are sent to and stored within the watchtower’s database. In order to decrypt a blob, the watchtower would need the second half of the transaction ID to create the full ID. Thus, the blobs remain encrypted unless a channel party broadcasts an older, invalid state in an attempt to steal money. If an old state is published, the watchtower operator would be able to create a full transaction ID of one of the channel’s earlier payments and succeed in decrypting the corresponding blob they have stored. If that takes place, the watchtower automatically punishes the bad actor by routing channel funds to the other (honest) party’s account. This process occurs without the watchtower knowing the channel participants or the amount being exchanged (unless a prior channel state is broadcast).
What are the requirements to operate a watchtower?
This latest LND update will enable any user or business to operate a watchtower to monitor their channel or the channels of other Lightning users. In order to establish a watchtower, the Lightning node has to be running the latest version 0.7 of the LND software. In addition to the upfront setup and costs, watchtower services “operate with overhead regarding bandwidth, computation, and disk space.” The most costly requirement is storage space and the burden rises as the number of channels being monitored rise.
Thus, watchtower operators must be compensated for the resource-intensive services they provide. To incentivize a market of third party watchtower operators, Lightning Labs CTO Olaoluwa Osuntokun has mentioned different ways that watchtowers may monetize their services. The soon to be released implementation will not offer a business model* out of the box, but rather rely on the “good graces” of operators to keep users honest, free of charge. However, different monetization models have been proposed. A couple ways that watchtowers can impose service fees include penalty fees – a small fee paid when a breach occurs – or prepaid tokenized vouchers that entitle users to some portion of blob tracking and storage. Another monetization model that has been proposed is a subscription-based approach, which may help large-scale watchtower operations more effectively scale revenues parallel to resource usage and channels.
Some developers, including Lightning co-creator Tadge Dryja, have opined on the effectiveness of certain incentive models, specifically the penalty fee model. For instance, the penalty fee system may lead to misaligned incentives between user and service provider, as watchtowers would earn greater returns the more invalid state submissions they identify. Moreover, earning penalty rewards may not be sufficient compensation for the corresponding resource requirements of serving as a barrier to fraudulent activity and lessening the occurrence of breaches.
Challenges and potential mitigating factors
While bandwidth and computation can scale as the number of active users grows, disk space requirements for operators increase quadratically relative to user base. Watchtowers need to store all previous channel states – including every encrypted blob and previous half transaction ID – for each client that uses their service to enhance privacy at the cost of scalability. The size of each piece of data being stored, however, is relatively small – “blobs are akin to the size of a Tweet.” Individual operators may be able to manage storage costs by minimizing the number of channels they service and be compensated by leveraging different monetization models. But if demand for watchtower services increases, it is possible that large watchtower businesses with sufficient capital and disk space emerge – though this may lead to increased surveillance capabilities that could compromise the privacy of the network (see: What are the criticisms against watchtowers?).
Another key challenge is that this first implementation offers a limited feature set. Technological aspects such as automated watchtower discovery are still in development, meaning early watchtower location and connection processes will be relatively manual from a user’s perspective. Moreover, there is currently no support for hash time locked contracts (HTLC) – time-bound (in block time) conditional payments – due to privacy and efficiency concerns. Only manually closed channels can be monitored to start. The absence of each may add friction to user experience and hinder early adoption. Lightning Labs plans to offer both features in future watchtower implementations.
Criticisms against watchtowers
Some members of the crypto community criticize watchtowers for introducing the use of trusted third-parties, which is deemed antithetical to both Bitcoin and Lightning Network. While watchtowers may provide a solution for security and user experience issues on Lightning, critics argue it does so at the potential cost of decentralization. Digital Asset Research’s Lucas Nuzzi refutes this, saying watchtower trust requirements are optional: participants can still transact on Lightning without employing an overseer. Moreover, users can subscribe to many watchtower servicers, reducing trust placed on a single provider and lowering overall surveillance risk. Nuzzi also claims the overhead of running a watchtower is “orders of magnitude” lower than that of a Bitcoin miner, suggesting operators can reach an appropriate level of architectural decentralization.
Another concern regarding watchtowers is the potential of compromising user privacy should data storage requirements lead to the advent of large-scale watchtower operations. Specifically, sizable watchtowers may be able to track user activity via channel and transaction mapping. Users could attempt to mitigate the surveillance and consolidation of data in a single location by connecting to numerous watchtowers, but it is unclear how the market for watchtowers will evolve and whether this strategy will “provide a sufficient hedge against privacy intrusions.”
Upon release, LND will be the only main Lightning implementation to feature active watchtowers. Further, Lightning Labs recognizes watchtowers are very much in their early stages, with future economic models and technological features still in development. But as it matures, watchtower operators may lead to a “safer” and more user friendly network and, if successful, could boost Lightning Network adoption – which has stalled lately in terms of channel growth and network capacity. Future implementations may also leverage other recent Lightning developments. For instance, the Neutrino protocol’s light-client technology could reduce the bandwidth and storage burdens for watchtowers, possibly decreasing the likelihood of watchtower centralization.
*Osuntokun did allude to watchtowers charging a service fee in LND version 0.7, but it would have to be manually activated.
In other news
- Retail giant Target open-sourced its blockchain solution for supply chain management, dubbed ConsenSource, with a particular focus on supplier certifications. The firm also announced, via a blog post, plans to support the Hyperledger Grid supply chain framework. The post stated the company sees the “most potential for enterprise blockchain initiatives as open source” and pledged continued contributions. Source.
- Bitwage, a crypto-services companies that helps companies pay employees in crypto, added support for ether. The startup has been providing tax and HR-compliant direct deposits for bitcoin since 2014. Source.
- Bitcoin wallet Samourai Wallet partnered with hardware retailer Nodl to create a bitcoin node. The full bitcoin and lightning node is intended to be fully compatible with Samourai’s privacy-centric mobile wallet, enabling users to access the wallet without relying on Samourai Wallet’s servers. The collaboration will also see Samourai’s Dojo software added to Nodl nodes to improve bitcoin transaction privacy. Source.
- U.S.-based crypto exchange Bittrex will be geofencing 32 crypto assets from its U.S. clients effective June 21. The U.S. ban likely comes amid domestic regulatory uncertainty in the digital asset market. Source.
- Microsoft is set to integrate developer tools built by Truffle – the blockchain startup that spun off from ConsenSys – into its Azure cloud computing service. Truffle left ConsenSys to pursue enterprise expansion and has since integrated with JPMorgan’s Quorum and Axoni’s AxCore in addition to Azure. Source.
- GateHub suffered a security breach that enabled hackers to steal over 100 million XRP – worth more than $10 million at the time. Gatehub provides a gateway to the XRP Ledger and services such as wallet hosting, where the breach occurred. More than half of the stolen funds may have already been laundered “through exchanges and mixer services.” Source.
- Enigma announced the launch of its second test network that expands developer ability to create specialized smart contracts called “secret contracts.” These contracts perform off-chain computations on encrypted data via the Enigma protocol – an off-chain platform that creates a secure environment to “process sensitive and private blockchain data.” The next milestone for the data privacy startup, which started at MIT Media Labs, is to launch on a public Ethereum testnet. Source.
- Crypto derivatives exchange BitMEX observed an increase unauthorized attempts to access customer accounts. Source. The news comes as SIM swaps – a malicious attempt to port a user’s SIM card to a phone an attacker can control – targeting cryptocurrency holders are on the rise, as highlighted in Tony Sheng’s latest blog post.
- Blockchain development co-op dOrg announced it launched the first legally established decentralized autonomous organization (DAO) under U.S. law. dOrg formed a Blockchain-Based Limited Liability Company (BBLLC) in Vermont, which enacted a law that creates a legal framework for blockchain based governance and organizations last year. By linking the Ethereum-based DAO to the BBLLC, dOrg’s DAO now has official legal status and, thus, the ability to engage in enforceable contractual agreements. Source.
- Legal & General Reinsurance is a building a blockchain solution for bulk annuities using AWS’s managed blockchain service. According to Legal & General’s CEO, the long-term nature of annuities (which can span over 50 years) can be better managed and secured by a blockchain platform compared to traditional systems. The insurer will only launch the platform to businesses outside its core markets of the U.S. and U.K. Source.
- Visa launched its B2B Connect network designed to expedite cross-border payments and to remove the need for an intermediary in bank-to-bank transfers. The network utilizes the Hyperledger Fabric framework to facilitate financial transactions. Visa partnered with Fabric creator IBM as well as payment solution Bottomline Technologies and financial software provider FIS to help continue scale the network. Source.
- Facebook signed up over 12 companies – including Mastercard, Visa, PayPal, and Uber – to participate in the consortium – known as the Libra Association – that will govern its new cryptocurrency network. Each member will invest $10 million to help fund the creation of the digital coin, which will backed by various government-issued currencies to minimize price volatility. Source.
- Bakkt announced user testing for its physically-delivered Bitcoin futures product will launch on July 22. The firm intended to go live last year, but it has experienced a number of regulatory hurdles in its effort to become licensed Bitcoin custodian. Source.
- The National Association of Realtors (NAR) venture capital fund (Second Century Ventures) made an investment in real estate blockchain startup Propy, which allows connects buyers and sellers and allows users to track their real estate transactions and investments on chain. Source.
- Through its investment arm, ZX Ventures, Anheuser-Busch InBev made an investment in BanQu’s Series A funding round. BanQu is a “blockchain-as-a-service” company that connects unbanked workers with service providers further up the supply chain. Source.
- CoinMetrics announced its acquisition of Bletchley Indexes and plans to offer a smart-beta index as a result of the acquisition. According to The Block, smart beta indices combine the best of passive and active strategies. In traditional markets, index providers choose certain stocks based on non-market cap metrics to create a smart-beta index – this strategy could be effective when investing in nascent crypto markets where market cap isn’t the most reliable metric. CoinMetrics plans to rebrand Bletchley and roll out new indices using the data provider’s on-chain and market data. Source.
- Fireblocks announced a $16 million investment from Cyberstarts, Tenaya Capital and Eight Roads (Fidelity International’s investment arm). Fireblocks protects clients’ digital assets during transit and counts Galaxy Digital and Genesis Global Trading as customers. Source.
- STP (Standard Tokenization Protocol) network conducted an IEO for 75 million STPT tokens (3.75% of the token supply), raising ~$750K in BTC, on Bittrex, which sold out in a fraction of a second, making it the fastest IEO to sell out. The project plans to use the funds to further protocol development and build a mobile application. Source.
- The Ampleforth initial exchange offering on Ethfinex and Bitfinex IEO platform Tokenix raised $5 million in 11 seconds for 10% of the token supply. Ethfinex and Bitfinex will list the token on their respective platforms. Source.
- Multicoin and Union Square Ventures led a $15 million Series C round in Helium along with other notable investors. Helium creates an open network over which IoT devices can interact for a small fee (90-99% cheaper than subscribing to a plan via traditional cellular network providers) through its Helium Hotspot devices. The Helium blockchain is used to coordinate economic incentives at a much lower cost and capital requirement than centralized providers. Source.
- Crypto startup Bitrefill secured a $2 million seed round led by Coin Ninja. The company offers customers bitcoin gift cards and mobile refills and is in the process of developing Lightning-based products. The funds will be used to expand its products to markets outside of the U.S. and Europe. Source.
- Blockchain startup Spring Labs closed a $23 million Series A led by Great Point Ventures with additional participation from August Capital and General Motor Ventures. The funds will be used to continue the development of the Spring blockchain protocol, which has garnered interest from financial institutions for the exchange of identity, fraud, and risk information. Source.
Global regulatory roundup
- India’s government has proposed a bill intending to ban all use of cryptocurrencies. The bill would render any crypto mining, holding, or trading illegal with maximum penalty of up to 10 years in prison as well as fines up to three times any capital gains. Source.
- The G20 group of nations agreed to support the new anti-money laundering (AML) and countering the funding of terrorism (CFT) standards proposed by the Financial Action Task Force (FAFT). The new standards may be particularly tough on crypto exchanges by requiring digital asset trading platforms to verify and share user information similar traditional financial institutions. Source.
What we’re reading
- Unpacking Bitcoin’s Assurances by Nic Carter
- Using Bitcoin to Hedge Against Global Financial Crises by Matthew Beck (Grayscale)
- DeFi: What it Is and Isn’t (Part 1) by Justine Humenansky (Coinmonks)
- Design Principles of Ethereum 2.0 by Raul Jordan
- The Speed Dreams of Security Tokens by Noelle Acheson
- Crypto Lending — The Missing Ingredient by Sidney Powell
- Exchange Benchmarking by CryptoCompare Research
- Satoshi’s Rebuttal of Modern Monetary Theory by Jack Purdy
What we’re listening to
- Unchained: Oslo Freedom Forum 2019: Protecting Financial Freedoms in the Digital Age
- Chain Reaction: Decred’s Co-founder Jake Yocom-Piatt: Governance-First Crypto Aims to Challenge Bitcoin
- What Bitcoin Did: The Quantum Threat to Bitcoin with Quantum Physicist Dr. Stepan Snigirev
- Off the Chain: Haseeb Qureshi, Advisor to Metastable Capital: The Smart Contract Wars of Crypto’s Future
- Unconfirmed: LocalBitcoins on How Bitcoin Trading Compares Across the World
- Blockchain Insider: Live: Bitcoin – Not just for Lamborghinis!
- Base Layer: Muneeb Ail (Blockstack)
- Epicenter: Spacmesh – The Space-Time Consensus Blockchain
Circle in the news
- The CENTRE consortium, formed last fall by Circle and Coinbase, announced it is now accepting new members and industry participation. Source.
Where we’ll be in June
- Fortune Brainstorm Conference, Montauk, NY, 6/19
- MIT Professional Ed – Applied Blockchain Course, Cambridge, MA, 6/24-28