Lightning Network Explained

The Bitcoin Lightning Network is an autonomous solution that’s signaled as the key to all problems keeping Bitcoin from mainstream implementation. It claims to solve the bleak scaling problem, make instant transactions, keep transaction fees minuscule, and take your transactions off the blockchain.

In this article, we’ll discover what the Bitcoin Lightning Network really is, how it can make the guarantees it provides, and its current state. Bitcoin has a scaling problem. Bitcoin is designed to store all transactions in a data structure called a block. A block contains information about the previous block, miscellaneous data about mining rewards, and most of the block is just transaction data. Blocks are also fixed at a maximum of 1 MB in size. This last bit is where the trouble is.

Because blocks are 1 MB in size, and a block is created every 10 minutes, assuming the transactions are not SegWit (coming up later) the network can process a maximum of between 3.3 and 7 transactions per second. For a currency designed for mass use by billions of humans and their machines, 7 transactions a second just isn’t up to par. Visa, on the other hand, claims to be able to process 24,000 transactions per second.

As the number of transactions starts to increase, your individual transaction competes with every other for inclusion inside a limited block space, and so, the likelihood of having yours included in the block starts to decrease. Since miners can arbitrarily decide which transactions to include in a block, on these occasions, the only way to incentivize the miners to include your transaction is by increasing your transaction fee. However, this starts to make transactions prohibitively expensive—such as this 192 byte transaction for $92.98 where the transaction fee was $14.86.

The Bitcoin Lightning Network

The Lightning Network is a second-layer network that transmits signed, but un-broadcast, transactions among peers and relies on the Bitcoin blockchain only for final settlement of funds. This means that transactions aren’t limited to the block size at all, confirmation times are irrelevant, and the Bitcoin blockchain doesn’t need to store every transaction that ever happens.

Who developed the Bitcoin Lightning Network? It was first described in a white paper authored by Joseph Poon and Thaddeus Dryja but has since evolved into a community effort with third-party individuals and even companies contributing to specifications and implementations.

A Lightning node runs much like and unlike a Bitcoin node in that it operates in a networked fashion, validates transactions, and communicates with other nodes, but it does things that Bitcoin nodes historically do not: it holds funds, act as an automated financial intermediary, actively monitors Lightning “channels” for malicious behaviour and reacts defensively (this is explained in detail later), etc.

History of Blockchain

Blockchain technology has to be one of the principal innovations of the 21^stcentury assumed the ripple effect it is having on various sectors, from financial to manufacturing as well as education. Unknown to many, is that Blockchain history dates back to the early 1990’s. Since its popularity started increasing a few years back, a number of requests have cropped up all but underlining the kind of impact it is destined to have as the race for digital economies heat up.

How blockchain emerged?

Stuart Haber and W. Scott Stornetta intended what many people have come to know as blockchain, in 1991. Their first work complex working on a cryptographically secured chain of blocks whereby no one could tamper with timestamps of documents. In 1992, they upgraded their system to incorporate Merkle trees that enhanced efficiency thereby enabling the collection of more documents on a single block. However, it is in 2008 that Blockchain History starts to gain relevance, thanks to the work one person or group by the name Satoshi Nakamoto.

Satoshi Nakamoto is accredited as the brains behind blockchain technology. Very little is known about Nakamoto as people believe he could be a person or a group of people that worked on Bitcoin, the first application of the digital ledger technology. Nakamoto conceptualized the first blockchain in 2008 from where the technology has evolved and found its way into many applications beyond cryptocurrencies. Satoshi Nakamoto released the first whitepaper about the technology in 2009. In the whitepaper, he provided details of how the technology was well equipped to enhance digital trust given the decentralization aspect that meant nobody would ever be in control of anything. Ever since Satoshi Nakamoto exited the scene and handed over Bitcoin development to other core developers, the digital ledger technology has evolved resulting in new applications that make up the blockchain History.

Structure of the blockchain:

In simple terms, Blockchain is a peer-to-peer distributed ledger that is secure and used to record transactions across many computers. The ledger’s contents can only be updated by adding another block linked to the previous block. It can also be envisioned as a peer-to-peer network running on top of the internet. In layman or businesses term, blockchain is a platform where people are allowed to carry out transactions of all sorts without the need for a central or trusted arbitrator. The created database is shared among network participants in a transparent manner, whereby everyone can access its contents. Management of the database is done autonomously using peer-to-peer networks and a time stamping server. Each block in a blockchain is arranged in such a way that it references the content of the previous block. The blocks that form a blockchain hold batches of transactions approved by participants in a network. Each block comes with a cryptographic hash of a previous block in the chain. Read more about what is blockchain.

Blockchain and Remittance

Remittance is the transference of money from a migratory worker to someone back in their home country. People have always moved in search of better work forecasts in high-income (or high currency value as compared to home) countries. Based on the World Migration Report 2018, there are presently a projected 244 million international migrants living in other countries. This number has either unswervingly or indirectly contributed to the global remittance’s $689 billion-dollar industry with India being top of the pile, contributing $80 Billion or 11.6% of its entirety. The global remittance industry is expected to grow by more than 3% in 2019.

Blockchain can be the future for remittance

The most prevalent Cryptocurrency is Bitcoin. It has been labelled as the future of the global financial industry. Bitcoin positively has great potential to be the digital currency of the world but before that, one of two things needs to happen:

Bitcoin becomes less volatile
Products and Services everywhere become priced in Bitcoin rather than fiat

We are still a long way from that and therefore, let us focus our attention on not Bitcoin but on its underlying technology: the Blockchain Technology.

The key proponents of blockchain technology suggest that it can reduce the costs for remittance services. Interesting things are happening behind the scenes where blockchain technology is attempting to replace the current financial services industry’s centralized business model. Financial institutions and banks are exploring ways to implement blockchain to reduce transaction costs, increase transaction speed, reduce fraud and eliminate third-parties.

By cutting out the traditional middlemen, blockchain technology can speed up and simplify cross-border payments, making remittances more affordable. Currency fluctuations can result in a loss when transactions are being made cross borders and blockchain can provide an almost guaranteed, real-time transaction.

Distributed Ledger Technology or DLT can serve as the backbone for a new cross-border payment infrastructure that can potentially solve inefficiencies and provide a faster, secure and more affordable service.

The average transaction cost of remitting money currently is more or less 4–5% per transfer. This cost includes exchange rate margins, charges from both the sender and recipient intermediaries, agents, overheads etc in remitting USD500, USD20–25 will go into transaction fees. Online Money Transfer Platforms like TransferWise was able to reduce the cost to 1%. Blockchain can reduce the cost from 5% to a fraction of a percentage. This will drastically reduce the USD30 billion dollars in the cost of sending remittances to an absurd amount in the thousands and thus, be an effective cost-saving method.

Federal Reserve System

The Federal Reserve System is the central bank of the United States and debatably the most powerful financial institution in the world. The Federal Reserve System was instituted by the U.S. Congress in 1913 to deliver the nation with a innocuous, flexible, and stable monetary and financial system.

It is founded on a federal system that encompasses a central governmental agency (the Board of Governors) in Washington, D.C., and 12 regional Federal Reserve Banks that are each accountable for an exact geographic area of the U.S. The Federal Reserve is considered to be independent because its decisions do not have to be ratified by the president or any other government official. However, it is still subject to Congressional oversight and must work within the framework of the government’s economic and financial policy objectives. Often known simply as “the Fed.”

The Federal Reserve’s creation was precipitated by repeated financial panics that afflicted the U.S. economy over the previous century, leading to severe economic disruptions due to bank failures and business bankruptcies. A crisis in 1907 led to calls for an institution that would prevent panics and disruptions. The 12 regional Feds are built in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. The Federal Reserve’s responsibilities can be characterized into four wide-ranging areas:

Conducting national financial policy by influencing monetary and credit conditions in the U.S. economy to ensure maximum employment, stable prices and moderate long-term interest rates.
Supervising and regulating banking institutions to ensure safety of the U.S. banking and financial system and to protect consumers’ credit rights.
Maintaining financial system stability and containing systemic risk.
Providing financial services – including a pivotal role in operating the national payments system – to depository institutions, the U.S. government and foreign official institutions.

The Fed’s main income source is interest on a range of U.S. government securities it has acquired through its operations. Other income sources include interest on foreign currency investments, interest on loans to depository institutions, and fees for services (such as check clearing and fund transfers) provided to these institutions. After paying expenses, the Fed transfers the rest of its earnings to the U.S. Treasury.

Perpetual Future Contracts Explained

To understand the functions of a Perpetual Future Contract it is important to first fully understand the meaning of a future contract. A futures contract is an arrangement to buy or sell a commodity, currency, or another tool at a prearranged price at a definite time in the future.

Unlike an old-fashioned spot market, in a futures market, the trades are not ‘settled’ promptly. Instead, two counterparties will trade a contract, that defines the clearance at a future date. Also, a futures market doesn’t allow users to unswervingly purchase or sell the product or digital asset. Instead, they are trading a contract representation of those, and the actual trading of assets (or cash) will happen in the future – when the contract is exercised.

As a simple example, consider the case of a futures contract of a physical commodity, like wheat, or gold. In some traditional futures markets, these contracts are marked for delivery, meaning that there is a physical delivery of the commodity. As a consequence, gold or wheat has to be stored and transported, which creates additional costs (known as carrying costs). However, many futures markets now have a cash settlement, meaning that only the equivalent cash value is settled (there is no physical exchange of goods).

Additionally, the price for gold or wheat in a futures market may be different dependent on how far is the contract settlement date. The longer the time-gap, the higher the carrying costs, the larger the probable future price uncertainty, and the larger the potential price gap between the spot and futures market.

Perpetual Future Contract

A perpetual contract is a special type of futures contract, but unlike the traditional form of futures, it doesn’t have a termination date. So, one can hold a position for as long as they like. Other than that, the trading of continuous contracts is based on an underlying Index Price. The Index Price contains of the average price of an asset, according to major spot markets and their relative trading volume.

Thus, unlike conservative futures, perpetual contracts are often traded at a price that is equal or very similar to spot markets. Still, the principal difference between the traditional futures and perpetual contracts is the ‘settlement date’ of the former.

Advantages and Disadvantages of Fiat and Cryptocurrency

Since we’ve already understood what fiat currency and cryprocurrencies are in our previous blog. Let’s look at what advantages and disadvantages that each of them entails.

Advantages of Fiat Money

Fiat Money has remained legal tender in most countries in part because they are highly stable and controlled. Unlike other forms of money, such as cryptocurrencies and commodity-based currencies, fiat currencies are relatively stable. The stability allows regulators and governments to navigate the economy against recession and inflation. Stability also allows fiat money to act as a means of storing value and facilitating exchange. It can also be used to provide a numerical account. Greater control also allows central banks to manage various economic variables such as liquidity, interest rates and credit supply key to ensuring a robust, stable economy.

Disadvantages of Fiat Money

Though Fiat Money is considered a stable currency, yet that is not always the case. Economic recessions over the years have highlighted some of the deficiencies associated with Fiat money. The fact that a central bank’s greater control at times does little to stop inflation or recession has led most people to believe that gold could be a much stable currency given its unlimited supply. The notion of central banks control over the economy and the constant increase in global prices create the need for cryptocurrencies.

Cryptocurrencies Advantages

Cryptocurrencies are available on a click of a button, all over the world. Anyone that can make an online transfer can also acquire and own a digital coin of choice. Although the process is still complicated, in the futures, it will be easier to transact and own cryptocurrencies.

Fast settlement times are another attribute that continues to accelerate widespread adoption of virtual currencies. Unlike other electronic cash settlement systems that take days to process transactions, cryptocurrencies enable instant settlements. Lower transaction fees have seen cryptocurrencies emerge as a preferred means of sending money across borders. Transferring money using other bank gateways can be quite expensive given the number of fees charged along the way. Privacy is another aspect that has made cryptocurrency desirable as users don’t have to share their identity to be able to complete transactions. There are altcoins which the main functions are to maintain the privacy of people behind transactions.

Disadvantages of Cryptocurrencies

Cryptocurrencies can be quite difficult to understand – one of the reasons why some countries and regulators continue to shun them. A lack of knowledge on how to use them is another headwind that continues to clobber digital currencies prospects and sentiments. The fact that it is not possible to reverse a transaction once it is made is another headache that has forced most people to shun cryptocurrencies. If a wrong a transaction is made the only thing one can do is ask for a reversal from the recipient. There is nothing one can do on recipients of a wrong transaction turning down a request for a refund. Volatility is by far the biggest disadvantage that has clobbered cryptocurrencies sentiments. Volatility goes a long way in affecting the value of a coin, which can be difficult to comprehend or contend with.

Fiat Currency Vs Cryptocurrency

Before we get into the the differences lets understand what Fiat currency and Cryptocurrency. Fiat Money is a kind of currency, issued by the government and regulated by a central authority such as a central bank. Such currencies act like legal tender and are not necessarily backed by a physical commodity. Instead, it is based on the credit of the economy.

Fiat currencies such as the US Dollar, Pound or Euro derive their value from the forces of supply and demand in the market. Such currencies are always at risk of becoming worthless due to hyperinflation as they are not linked to any physical reserves such as commodities.

Fiat currency first came into being at around 1000 AD in China before spreading to other parts of the world. Initially, currencies were based on physical commodities such as gold. It is only in the 20th century that President Richard Nixon stopped the conversion of U.S dollar into gold.

A cryptocurrency is a form of digital or virtual currency that can work as a medium of exchange. Being virtual in nature, they use cryptography technology to process, secure and verify transactions.

Unlike Fiat currencies, cryptocurrencies are not controlled by any central authority such as a central bank. Instead, they are limited entries in a database such as a blockchain that no one can change or manipulate, unless certain conditions are met.

Cryptocurrencies came into being as a side product of Satoshi Nakamoto, the brainchild behind Bitcoin cryptocurrency. Nakamoto did not intend to develop a currency but a peer-to-peer electronic cash system for facilitating transactions without any central oversight.

The decentralization aspect of the network means there is no central server where transactions are hosted or controlling authority. In a decentralized network like Bitcoin, every transaction to have ever happened is displayed for everyone to see. Each transaction file also consists of senders and recipients’ public keys.

Differences Between Fiat Money and Cryptocurrencies

While both fiat money and cryptocurrencies can be used as a means of payment, there are some differences.

Legality

Governments issue fiat currencies, which are in return regulated by the central bank. Fiat money is deemed legal tender in that it is often the official means of finalizing transactions. Governments control fiat money supply and issue policies from time to time that affects their value.

Cryptocurrencies, on the other hand, are merely digital assets that act as a medium of exchange that governments have no control over. The decentralization aspect means no central body can control or influence their value.

Some countries have banned cryptocurrencies on concerns that some of them are being used to fuel illegal activities such as terrorism and money laundering.

Tangibility

It is not possible to have a physical feel of cryptocurrencies as they operate online as virtual coins. Fiat currencies, on the other hand, have a physical aspect as they can exist as coins and notes thus possible to have a physical feel. Fiat money physical aspect at times does present a lot of challenges as it can be a nuisance to move around with vast chunks of money.

Exchange Aspect

Cryptocurrencies exist in digital form as they are created by computers and operate as private pieces of code. The means of exchange is thus purely digital. In contrast, fiat money can exist in both digital and physical form. Electronic payment services allow people to transfer fiat money digitally. In addition, people can transact with one another and exchange money physically.

Supply

A major difference between fiat money and cryptocurrency has to do with supply. Fiat money has an unlimited supply which means central authorities have no cap to the extent in which they can produce money.

Most cryptocurrencies have a cap when it comes to supply, which means there is a set amount of coins that will ever be in supply. For example, the total number of Bitcoin coins that will ever be in supply is capped at 21 million.

With fiat money, it is impossible to tell the amount of money in circulation at any given time, but with cryptocurrencies, it is possible.

Storage

Cryptocurrencies virtual aspect means they can only exist online thereby stored in digital wallets commonly referred to as cryptocurrency wallets. While most digital wallets claim to offer secure storage, some of them have been hacked resulting in people losing a substantial amount of holdings.

The versatility of fiat money, on the other hand, means it can be stored in various forms. For instance, there are payment providers such as PayPal that allow people to store fiat money in digital form. Banks also do act as custodian of hard currencies. Cryptocurrencies and fiat money come with attributes that make them stand out as a means of legal tender regardless of jurisdiction. However, they also come with cons that have seen them continue to divide opinion around the world.

While there are many advantages of cryptocurrencies over fiat money, it seems that cryptocurrencies are not yet mature to replace the current standard payment method. It is a matter of time and not necessarily will be in the form of Bitcoin, Ethereum or any other cryptocurrency. The crypto market will most likely evolve to create a positive product that might change the current money system.

Financial Crisis of 2008

The 2008 financial crisis is the worst economic catastrophe since the Great Depression of 1929. It happened notwithstanding Federal Reserve and Treasury Department goes through great lengths to prevent it.

It led to the Great Recession. That’s when the cover prices fell 31.8 percent, more than the price plummet throughout the Depression. Two years afterward the slump ended, unemployment was still above 9 percent. That’s not as well as disheartened workforces who had given up observing for work.

The first sign that the economy was in distress happened in 2006. That’s when covering prices began to fall. At first, realtors celebrated. They thought the excited housing market would reappearance to a more justifiable level.

Realtors didn’t comprehend there were too many homeowners with dubious credit. Banks had permissible people to take out loans for 100 percent or more of the value of their new homes. Many liable the Community Reinvestment Act. It broke banks to make investments in subprime areas, but that wasn’t the fundamental cause.

The Gramm-Rudman Act was the real villain. It permitted banks to occupy in trading lucrative derivatives that they sold to investors. These mortgage-backed reservations needed home loans as guarantee. The offshoots fashioned a voracious demand for more and more mortgages.

Hedge funds and other financial institutions around the world owned the mortgage-backed securities. The securities were also in mutual funds, corporate assets, and pension funds. The banks had chopped up the original mortgages and resold them in tranches. That made the derivatives impossible to price.

Why did stodgy pension funds buy such risky assets? They thought an insurance product called credit default swaps protected them. A traditional assurance company known as the American International Group sold these swaps. When the derivatives lost value, AIG didn’t have enough cash flow to honour all the swaps.

The first signs of the financial crisis appeared in 2007. Banks panicked when they grasped, they would have to absorb the losses. They stopped offering to each other. They didn’t want other banks giving them worthless mortgages as guarantee. No one wanted to get stuck holding the bag. As a result, interbank borrowing costs, called Libor, rose. This mistrust within the banking community was the primary cause of the 2008 financial crisis.

The Federal Reserve began pumping liquidity into the banking system via the Term Auction Facility. But that wasn’t sufficient.

How It Could Happen Again

Many legislators blame Fannie and Freddie for the entire crisis. To them, the answer is to close or privatize the two agencies. But if they were shut down, the housing market would collapse. They guarantee 90 percent of all mortgages. Furthermore, securitization, or the bundling and reselling of loans, has spread to more than just housing.

The government must step in to regulate. Congress approved the Dodd-Frank Wall Street Reform Act to prevent banks from taking on too much risk. It allows the Fed to decrease bank size for those that become too big to fail.

But it left many of the procedures up to federal regulators to sort out the details. Meanwhile, banks keep getting bigger and are pushing to get rid of even this regulation. The financial crisis of 2008 proved that banks could not regulate themselves. Without government oversight like Dodd-Frank, they could create another global crisis.

Forward Contracts Vs Future Contracts

In this article we will look into the key differences between Future and Forward contracts. If you would like to keep yourself informed on the same then please read on…

Forward Contract

The forward contract is an agreement between a buyer and seller to trade an asset at a future date. The price of the asset is set when the contract is drawn up. Forward contracts have one settlement date—they all settle at the end of the contract. These contracts are private agreements between two parties, so they do not trade on an exchange. Because of the nature of the contract, they are not as rigid in their terms and conditions.

Many hedgers use forward contracts to cut down on the volatility of an asset’s price. Since the terms of the agreement are set when the contract is executed, a forward contract is not subject to price fluctuations. So, if two parties agree to the sale of 1000 ears of corn at $1 each for a total of $1,000, the terms cannot change even if the price of corn goes down to 50 cents per ear. It also ensures that delivery of the asset, or, if specified, cash settlement, will usually take place.

Because of the nature of these contracts, forwards are not readily available to retail investors. The market for forward contracts is often hard to predict. That’s because the agreements and their details are generally kept between the buyer and seller, and are not made public. Because they are private agreements, there is a high counterparty risk. This means there may be a chance that one party will default.

Futures Contracts

Like forward contracts, futures contracts involve the agreement to buy and sell an asset at a specific price at a future date. The futures contract, however, has some differences from the forward contract. First, futures contracts—also known as futures—are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, a settlement for futures contracts can occur over a range of dates.

Because they are traded on an exchange, they have clearing houses that guarantee the transactions. This drastically lowers the probability of default to almost never. Contracts are available on stock exchange indexes, commodities, and currencies. The most popular assets for futures contracts include crops like wheat and corn, and oil and gas. The market for futures contracts is highly liquid, giving investors the ability to enter and exit whenever they choose to do so.

These contracts are frequently used by speculators, who bet on the direction in which an asset’s price will move, they are usually closed out prior to maturity and delivery usually never happens. In this case, a cash settlement usually takes place.

The South Sea Bubble: An Introduction

The South Sea Bubble was formed by a more multifaceted set of situations than the Dutch Tulip mania, but has nonetheless gone down in history as an additional classic instance of a financial bubble. The South Sea Company was formed in 1711, and was promised a monopoly by the British government on all trade with the Spanish colonies of South America. Expectant a repeat of the achievement of the East India Company, which had a flourishing business with India, investors snapped up shares of the South Sea Company. As its directors circulated tall tales of unconceivable riches in the South Seas (present-day South America), stocks of the company gushed more than eight-fold in 1720, from £128 in January to £1050 in June, before crumpling in the succeeding months and instigating a severe financial crisis.

The South Sea Company‘s foundation in 1711 followed the normal joint-stock company model. A joint-stock company held a royal charter which allowable it certain privileges which other companies did not have. Joint-stock company shareholders were protected by limited liability. This meant that they could not be pursued for debts owed by the company. Secondly, joint-stock company shares were readily assignable, i.e. they could be passed easily to another holder by sale or gift. This was an important feature not shared by many other early financial instruments. For instance, government annuities were not readily assignable and could not be sold quickly if the holder required cash urgently. Joint-stock companies such as the South Sea Company sometimes performed debt-for-equity swaps for the government. They would offer their shares in exchange for government debt such as annuities. A debt for equity swap was supposed to benefit all parties. The government would reduce its costs and the complexity of managing its debts. The company would gain the right to increase its capital and gain bargaining power. The former government debt holders would have a more liquid asset with the possibility of higher returns.

The government had issued a large number of annuities as part of its war-financing programme. Annuities were supposed to pay a fixed sum each year, but the government’s payments often fell into arrears. Holders of annuities might prefer to swap their claims on the government for some other sort of investment. A debt-for-equity swap allowed them to exchange their annuities for joint-stock company shares. They would still be paid an annual fee which would now be administered by a company. Their new shares would also give them the possibility of dividend payments or capital gains (by selling the shares on). The shares were easy to sell or bequeath, which was a valuable feature in itself. It was difficult for a large number of small creditors to pressurise a government. By joining together under the aegis of a joint-stock company, small creditors could have a stronger voice. This might make it more difficult for the government to fall behind with payments.

The government could also benefit from a debt-for-equity swap. The bureaucratic costs were reduced as it could now deal with one company, rather than a myriad of small creditors. It had to pay a single fee to the company, rather than different fees to different people. Government debts had often been arranged on a short-term and ad hoc basis and were highly complex to manage. One type of debt contract which was particularly onerous was the so-called ‘irredeemable debt‘. Irredeemable were annuities which the government had no right to redeem, i.e. the government could not compel the holders of this type of debt to sell it back, so creditors often did not receive all the payments they were entitled to. This has to be taken in deliberation when likening annuities with South Sea shares.

Ideally, the government would have the option to redeem its debts. If market interest rates fell, then the government should borrow money cheaply in the market and use it to pay off its more expensive debts. For example, suppose that the government borrows £100 at an interest rate of 5 per cent. If the market interest rate drops to 2 per cent, then the government should borrow enough money to pay back the principal of £100 plus any interest owed and any bureaucratic fees. It now must pay 2 per cent rather than 5 per cent on its debt, but this should still constitute a saving. The government could not automatically take advantage of a fall in the interest rate when dealing with irredeemable debt. Therefore, it was important to persuade the holders of irredeemable annuities to relinquish their claims in exchange for joint-stock company shares.