Monthly Archives: January 2020

Confidential Transactions in Bitcoin

Confidential transactions (CT) is a cryptographic protocol which results in the amount value of a transaction being encrypted. The encryption is special because it is still possible to verify that no bitcoins have been created or destroyed within a transaction but without revealing the exact transaction amount.

However, confidential transactions require a soft fork consensus change to be added to bitcoin, although they could be added to a sidechain too.

The basic essence of a Confidential Transaction is that information is open to only the sender and the receiver. The outside observer is not privy to any information pertaining to the amount being transferred.

However, the network must also be able to determine the validity of a confidential transaction. This is achieved by ensuring that the number of inputs at the beginning of a transaction is equal to the number of outputs at the end of the transaction.

So how does Confidential Transaction benefit?

In the current structure, the Bitcoin protocol suffers from a few lacunae.

  • Lack of anonymity
  • Lack of fungibility

Lack of anonymity

When it first appeared on the fintech scene, Bitcoin was marked as a truly decentralized anonymous digital currency. However, this is not the case. Because each user on the Bitcoin network is represented by a public address, their transaction history can be traced using a block explorer. If a link between a public address and a real-life user were ever to be established, other users would be able to know exactly who it was they were transacting with. At best, the Bitcoin protocol can only be described as pseudonymous.

Lack of fungibility – Fungibility means the ability for one unit of a good or currency to be interchangeable for another unit, e.g. the US dollar is fungible because 1 dollar can be exchanged for another one without loss of value. Conversely, because Bitcoins can be tracked through an open and accessible blockchain, if those Bitcoins were ever used for, or gained by, illicit activity, they may be labeled as “tainted”. Merchants may refuse to accept these tainted Bitcoins, and thus, they may become less valuable when compared to other Bitcoins. Exchange without loss of value is no longer possible, i.e. these Bitcoins are said to be non-fungible.

To overcome these pitfalls the process of Confidential Transactions was created by Adam Back, a Bitcoin developer. With the advent of cryptocurrencies, this will hold in good stead.

The Bitcoin Lightning Network

Scalability has always been an issue with Bitcoin. When it was first created, the promise was that of a system which would overcome all the issues the modern banking system faced. Tech bottlenecks, bureaucracy and high transaction fees. Bitcoin started with a capacity of seven transactions a second. Those were early days and it was perfectly standard for the system to be able to process that rate. The tragedy is that the rate has not done up ever since. This has led to slow transaction speeds, delays, and a slowly rising fees. The entire premise of ease of usage is slowly getting hampered due to the limitations arising out of this issue.

To put things into perspective, Bitcoin intends to become an alternative to the current payment systems. Visa handles a normal rate of 24000 transactions a second. Peak hour rates go as high as 50000 per second. Now compare this with the measly 7 transactions per second Bitcoin handles currently. Get the drift. It still has a long way to go before it can really challenge the current contenders.

Over a period in time, several proposals have popped up from different quarters to improve the Bitcoin mess. The resultant being, numerous different systems have come up based on the Bitcoin model, with none of them being able to provide a lasting solution.

But like every proverbial tunnel, there is light here too.

The Lightning network is what it’s being called. Currently being tested, the Lightning network seems to be the answer to all our woes pertaining to Bitcoin.

The model is simple. It does away with recording each and every transaction in the appended ledger. Instead, it adds another layer to the Bitcoin blockchain and lets users create payment channels instead. What this does is increases the speed of transactions manifold.

And the best part is, at no extra cost. The financials if such transactions automatically come down. With greater demand and more hits to the system, it would finally stabilize and become a near costless exchange.

These personal channels can exist for as long as necessary and required.

However, the concern here could be that of security. The Lightning Network would use the Bitcoin protocol but not the security. Hence, to begin with, the transaction amount would be limited to smaller degrees. Large transactions would still require the usage of the decentralized system.