By James Dewar
This report has been prepared as a submission to The Cobden Centre, a UK thinktank.
The report reviews factors related to the hypothesis that there is a causal relationship between the timing of Layer 2 and 3 Bitcoin technology innovations and the sudden acceleration in the growth of UK merchants accepting Bitcoin and the Bitcoin social network.
The report aims to provide insight to readers who otherwise wouldn’t be aware of what’s happening in Bitcoin development, real world use and the growth of the social layer. Part of the reason for the lack of awareness is that it is still relatively small scale, so where this recent growth does get picked up in the media it’s currently limited to local newspapers or radio1. These developments are being replicated across the globe with some regions further ahead of, others behind, where we are in the UK.
The report is split into five sections:
- Bitcoin background and technology history
- Payment application and service development
- Historical limitations
- Merchant adoption
- Bitcoin social network growth
Before delving further into details, here is a brief overview of why and how Bitcoin is relevant for proponents of The Cobden Centre’s mission, and the importance of distinguishing it from other cryptocurrencies.
Bitcoin vs other cryptocurrencies
The Cobden Centre holds a vision which includes the following “…a society must be built on honest money”. Bitcoiners fully agree with this vision. It is therefore useful to understand why and how the Bitcoin community believe that Bitcoin fulfils that role whilst almost2 no other cryptocurrency can.
The table below highlights how and why Bitcoin fulfils the honest money specification, whilst other cryptocurrencies cannot.
|Core vision||Peer to peer money/cash||‘World computer’, smart contracts, thousands of others. Common feature (as distinct from benefit) of using tokenised Blockchains.|
|Algorithm Control||Nodes, currently estimated 20k-100k worldwide. Cheap to run, every home could have one||Company, foundation or group of ‘insiders’|
|New supply methodology||Proof of Work (like having to mine for gold)||Mainly Proof of Stake (similar to existing monetary system)|
|Overall supply constraint||Decentralised algorithm control produces a game-theoretic outcome that means near zero probability that supply will ever be increased beyond the preprogrammed 21 million fixed limit (reached asymptotically over 130 years, current inflation rate 1.4% and falling to zero on current estimates by late 2130s)||Due to algorithm having a set of controllers, there is no physical or mathematical constraint even if the current algorithm contained one (similar to existing monetary system). |
For example, both Ethereum’s supply rules and methodology were changed in 20223 and its Blockchain was rolled back in 20164 due to a hack. These demonstrate that it is under centralised, human control, rather than decentralised around maths/physics.
Bitcoin technology history
Bitcoin started running on 3rd January 2009. Its first documented acquisition of a measurable monetary value was 5th October 2009 when ₿1,309.03 could be bought for $1, with the price being determined from the average marginal cost to mine Bitcoin in the USA5. Bitcoin could be bought online from 17 March 20106, and the first use to buy real world goods was on 22nd May 2010 when Laszlo Hanyecz famously bought two pizzas for ₿10,000. Bitcoin could be argued to have acquired value in January 2009 on the basis that some people were incurring hardware and electricity bills in order to mine it so they must have valued the Bitcoin mined more than these factors of production.
Bitcoin demonstrably has these five of the six critical features of money: Durability, Divisibility, Portability, Scarcity and Fungibility. The sixth, Acceptability, will be a natural market response if the other features can be delivered in a consumer-friendly manner. Bitcoin is an immutable, fixed supply commodity money that has rules without rulers.
Throughout Bitcoin’s history there have been technological and social limitations to its progress as a day-to-day medium of exchange. These limitations have been:
- Speed of transacting (slowness, timeliness)
- Cost of transacting
- Complexity of IT integration
- Practicality of Bitcoin’s ability to carry value (total value of all Bitcoin, existence of pricing, volatility of pricing)
These limitations led to some developers going away from Bitcoin and trying to develop cryptocurrencies that they hoped would solve these issues. Unfortunately, in so doing many of them missed the importance of a critical feature of Bitcoin – the inability to extract rent value from it. To fund any new project requires some way to extract a payback and therefore the new cryptocurrencies had to be structured to resemble securities (think of their coins as shares in a company), rather than the commodity that Mises recognises money needs to be.
For larger transactions (>c.£1,000) Layer 1 payments have never had an issue with the Speed and Cost limitations. For a possible solution to those limitations below that level it took until February 2015, almost halfway through Bitcoin’s life to-date, for a whitepaper outlining possible technology solution to problems 1 and 2 to emerge7,8.
The authors, Poon and Dryja, spent another year updating and adding detail to the draft which was released in January 20169.
2018 saw an initial release of code implementing the Lightning Network, and it took another two years (2020) until it started to become practically usable for those with moderate technical skills.
Fast forward to today and the Lightning Network is a well-established cryptographically secured, peer to peer ‘Layer 2’ payments network sitting on top of Bitcoin’s blockchain. The network is made up of thousands of channels, and payments flow from payee to recipient using Bitcoin locked on Layer 1. It can be analogised as similar to all the people in a village using their public house bar tabs to transact, and eventually settle, all intra-village trade and consumption.
The Lighting Network addresses the Speed and Cost limitations for day-to-day transactions. It delivers instant final settlement at very low to zero cost.
Payment application and service development
The Lightning Network (LN), assessed here as having been functional from 2020, has provided the technology stack upon which many more recent developments have been, and are, being built.
Whilst before 2020 LN was usable for those with technical skills, it still suffered from two drawbacks preventing widespread adoption. The first was the Complexity limitation – it was still complex to use in its raw form; the second was the necessary growth of channels and channel liquidity.
Since 2020 there has been an enormous proliferation of Apple, Android and other LN apps becoming available. These apps have been highly successful at abstracting away the complexity of interacting with and using LN, making it easily accessible across a range of devices. Further, there is a large diversity of functionality and options amongst and between these apps leading to rich choice for specific solutions both for the customer and the merchant. This has effectively removed the Complexity limitation for day-to-day transactions. This choice among apps has made LN usable for both customer and merchant. The first UK merchant application was released in Q2 20227. These apps, some open, some proprietary, could be considered as a part of Layer 3 of the network.
Age of Bitcoin technology layers
|Bitcoin (Layer 1)||14.5 years||Secure, open source, immutable provision of fixed supply, valued, transferable commodity|
|Lighting Network (LN) (Layer 2)||3-5 years||Near free, instant final settlement, peer to peer, payments network|
|LN applications (Layer 3)||1.5 years||Customer and merchant provision of easy-to-use applications built on LN|
The growth of channels and liquidity was happening in the background as these Layer 3 LN customer and merchant apps were being developed.
The graph below shows how these have grown between 2020 and 2022 to give the network sufficient capacity.
Lightning Network Capacity Growth 2018-2023
The hypothesis suggests merchant adoption can be explained in large part by these Layer 2 and Layer 3 innovations making it easy to accept Bitcoin.
Practical Value Limitation
The previous section saw how technology development in Layers 2 and 3 has removed the Speed, Cost and Complexity limitations.
Bitcoin also needs to have a market price that is expressible in existing currency, it needs to carry sufficient value to satisfy day to day transactions, and its price volatility needs to be tolerable.
Bitcoin has had an easily identifiable market price for at least ten years. The chart below shows the long-term value carried by the Layer 1 network which has only been increasing for ten years. LN channels hold $120m of liquidity10 that can be used and reused for different transactions many times a second.
Bitcoin’s price volatility has been falling over time. However, some of the Layer 3 solutions can now entirely remove volatility for merchants by allowing them to receive local currency at the time of sale, even though the payment is made in Bitcoin and the value transmission mechanism is entirely Bitcoin.
In a free market, with all other limitations removed, the Acceptability limitation, should be expected to vanish – and the evidence suggests that acceptability is indeed increasing in the UK.
At the beginning of 2022 Bitcoin was 13 years old, and there were fewer than 50 merchants in the UK that accepted Bitcoin as payment. In the subsequent 18 months that number has risen to around 200.
The hypothesis is that this growth has been driven in response to technology innovation combined with the growth of the Bitcoin social network (the merchants’ intended market) and is set to continue, possibly at an even faster rate.
Map of UK Merchants accepting Bitcoin
The main driver for merchant adoption has been the ability to directly attract new customers due to their interest in Bitcoin11. The mechanism for this is communication using the social network, such as the website source of the above map, the physical meet up groups and social media. Marketing services are generally offered for free by Bitcoiners keen to see the growth of the acceptability of their preferred money.
Merchant mapping on a global basis is maintained in OpenStreetMap by btcmap.org.
Below is an image showing Bitcoin accepting merchants in Lugano, Switzerland. By comparison with the UK (pop. ~60m) you can see that Lugano (pop. ~60k) has almost as many places that accept Bitcoin so there’s evidence from there that growth of 1000x is possible in the UK even with today’s technology. The numbers in circles represent the total number of merchants in that area accepting Bitcoin.
The increasing availability and usability of LN applications has attracted Bitcoin users to them. Interestingly this has been happening at the same time as the rapid growth in the social layer of the Bitcoin network in the UK since Q1 2022.
The hypothesis is that these developments are inter-related and are creating a positive feedback loop. The social growth can be seen in the numbers of physical groups who gather in person, usually monthly, in cafes, pubs and restaurants as shown in the maps below. Many of the groups now meet at venues that accept Bitcoin. Most of these groups also exist as heavy traffic social media chat groups.
UK Meet up group map
Q1 2022 Q3 2023
The hypothesis is that there is a causal relationship between the timing of the Layer 2 and 3 technology innovations and the sudden acceleration in the growths of UK merchants accepting Bitcoin and the social network. It is not possible to be sure that the relationship is directly causal, but whether or not it is, the growth is happening. Further, the relationship between growth of merchant adoption and social networks looks like a positive feedback loop.
We in the UK may be on the cusp of a dramatic growth in Bitcoin’s use as a medium of exchange.
This report was written over the period of two weeks in late August 2023. Towards the end of this period another Layer 3 innovation was announced which is likely, in late September, to double in a very short period the number of UK merchants accepting Bitcoin. Bundled in a regular software update, an existing payments system supplier with an installed base will allow all its merchants to accept Bitcoin without any hardware changes being needed.
Up until now accepting Bitcoin has been mainly among small merchants with 1-3 sites. Because of this latest innovation, In Q4 2023 we will start to see the first large corporates accepting Bitcoin, beginning with sites with outsourced catering services like some universities, entertainment sites, visitor attractions and corporate canteens.
The nature of this latest innovation should be of concern to the existing payment services providers such as Mastercard, Visa and American Express, as it will directly eat into their revenues. The existing card payment terminals are redundant when paying in Bitcoin because the payment request is integrated into the till device itself.
James Dewar is a CIMA qualified Accountant who worked in Financial Services for 20 years where he specialised in Finance Systems. In 2020 he gained a Research MSc in Finance and Accounting on the topic of Bitcoin. He has spent the last three years researching, building and running businesses in the Bitcoin industry. He will be giving a seminar and exhibiting with Bridge2Bitcoin at Hospitality Tech Expo at ExCeL London on 10/11 October 2023 and talking at the Plan B Forum in Lugano, Switzerland on 20/21 October. He can be contacted via Twitter @bitcoinshire.
James would like to thank Max Rangeley at The Cobden Centre for prompting and publishing this article, and also @bitcoms and @Alistair280Aftw (Twitter) for their time editing.
2There may be a small few that match Bitcoin’s features, but a good global money will tend to one. Bitcoin and its network are overwhelmingly dominant amongst this few, and as the others offer no material benefits network effects should mean that all value will ultimately bleed into Bitcoin.
5https://web.archive.org/web/20131031064421/http://newlibertystandard.wikifoundry.com/page/2009+Exchange+Rate and https://twitter.com/marttimalmi/status/423455561703624704 where Malmi – an early dev – records a sale of Bitcoin for dollars on 12 October 2009
10https://bitcoin.clarkmoody.com/dashboard/, as at 3rd September 2023
11Feedback to author from merchants