September 28, 2022

Community Banks Improve Bitcoin Adoption – Bitcoin Magazine

This is an opinion editorial by Leo Weese, co-founder of the Bitcoin Association of Hong Kong, where he has been organizing Bitcoin meetups since 2012.

Over the years, Bitcoin has continually proven itself to be a solid asset with a predictable supply that can be quickly transferred instantly for a nominal fee over the Lightning Network.

Despite its inflationary flaws, the US dollar remains in strong demand. having lost 90% of its purchasing power since the 1950s, it has remained an attractive store of value and unit of account. In an era of low profit margins, living paycheck to paycheck in a world where property, rent and wages are fixed in dollars, going 100% in bitcoin is risky.

The world has currently chosen the dollar as the global reserve currency. As long as bitcoin remains highly volatile, it is less attractive than the dollar for businesses and individuals in many circumstances, especially in places where instant conversion is cumbersome and expensive.

Despite its appeal, the US dollar has some notable downsides in practice. In El Salvador, where only a third of the population has access to bank accounts, it can be difficult to receive, store, and transact with digital US dollars. In Nigeria or Argentina, the official exchange rates are unfavorably fixed, pushing savers towards gray markets. Conflict zones like Ukraine are partially cut off from international settlement systems. Fortunately, bitcoinizing the dollar with Taro offers an alternative.

Bitcoin dollars on Taro

Taro is a new protocol for assets on Bitcoin and Lightning proposed in April 2022 by Olaoluwa Osuntokun, CTO of Lightning Labs. The company explained a mechanism through which anyone can mint arbitrary assets on the Bitcoin blockchain and share their vision for a stablecoin use case that can be instantly processed on the Lightning Network and held non-custodially in nodes and Lightning wallets.

As with Eurodollars or offshore dollars, we can refer to dollars held on the Bitcoin blockchain as bitcoindollars.

These bitcoindollars are currently issued by large, often opaque institutions, some of which are associated with cryptocurrency exchanges. While the first widely used stablecoin was anchored to the Bitcoin blockchain, today stablecoins often reside on alternative blockchains and are used to enter and exit bitcoin or cryptocurrency trading positions, or for settlement in arbitration transactions. In some contexts, they act as savings and payment vehicles.

With the Taro protocol, so-called bitcoindollars can be introduced into a Lightning Network payment channel without an additional blockchain footprint. This results in two or more parallel channels, one with BTC and the other with Taro assets, anchored in the same UTXO.

Alongside bitcoindollars in the form of bank deposits or stablecoins, we can also see other types of assets issued on Taro, primarily local fiat currencies. It may seem attractive to issue bonds, notes, debt securities or claims on commodities such as oil and gold.

This allows a Lightning wallet owner to choose to receive payments in BTC or a Taro asset, while issuing a regular Lightning invoice. The payer is not required to hold the same Taro Asset, or any Taro Asset. The payer also never knows what asset the payee ultimately chooses to hold in their wallet.

It works through edge nodes that “swap” incoming Bitcoin HTLC (hash time-lock contract) for an outgoing Taro HTLC, or vice versa. These peripheral notes, like any other routing node in the Lightning Network, charge routing fees covering investment costs, routing costs, and expected volatility. They will agree their benchmark rates for these exchanges with their peers and may be willing to lock in rates for short bill expiration windows. This happens instantly and without anyone taking on counterparty risk or custody at any time.

Strengthen network effects

Today, there are strong network effects in payment and settlement systems. We are only willing to accept something as payment that we can easily spend, and so it is no surprise that cryptocurrency exchanges mainly offer only two stablecoins: tether and USDC.

By exchanging assets for bitcoins via HTLCs, Taro removes friction and counterparty risk while retaining access to the entire Lightning Network, enabling the use of smaller stablecoins for savings and payments. At the same time, Taro enhances the network effects of the Lightning Network by increasing routing activity, creating demand for routing nodes and capital, while priming existing liquidity on the network to allow users to not only pay with n any asset, but also to route payment via Bitcoin.

In the example above, Alice has L-USD in a channel with Bob, who is connected to the larger Lightning Network and wants to exchange L-USD for BTC on demand and for a fee. Alice can now scan any Lightning Network invoice with her wallet. If Alice also has BTC in her wallet, she can choose to pay the bill with satoshis. Once Alice confirms the payment, she will build a route through Bob to the final payment destination. Bob will receive L-USD and transmit BTC with the same HTLC. Yana will receive BTC and transmit L-USD to Zane. He releases the preimage and the payment is final. These mechanisms allow anyone to use the assets in their wallet to pay any Lightning bill, or anyone to receive the asset of their choice by issuing a generic Lightning bill.

The rise of community banks

Inspired by the success of Bitcoin Beach in El Salvador, community banks are beginning to pop up around the world in an attempt to connect remote and underbanked communities to the world of digital finance through the Lightning Network. In some cases, these community banks are attractive because they provide access to dollars, while in others they allow people to transact online without friction.

Taro has the potential to significantly reduce the technological and logistical barrier for the operation of these community banks, while allowing their community to instantly connect with suppliers, customers and financial services around the world.

Step One: Transparent Bank Deposits as Taro Assets

Instead of using internal ledgers to track customer deposits and withdrawals, a community bank can choose to issue its own stablecoin for each deposit and destroy it when exchanging it for cash or bitcoin. By building the core of their banking infrastructure on open source and proven software, deposits remain more easily auditable and difficult to tamper with.

Step Two: Validate Community Bank Deposits in Lightning Network Channels

By opting for an open protocol, community banks can leverage existing software infrastructure, such as nodes, wallets, payment processors or liquidity marketplaces. A community bank does not need to develop its own wallet, it can simply open channels with Taro-enabled wallets easily found in Google and Apple app stores. There is no need to provide merchants with custom tools, as long as self-hosted payment processors such as BTCPay Server or LNBits are configured to manage Taro assets.

Some community banks may not even open such channels to their customers themselves, or instead rely on non-custodial liquidity markets or lightning service providers to do so.

Third step: connect your community to the world

Once an individual or business has an open channel on their wallet or node with sufficient inbound capacity in the Taro asset of their choice, they can charge others for their labor, services, or goods. Anyone in the world can instantly pay this bill from their own wallet, route it via Bitcoin to the edge node, which exchanges the payment amount to the desired destination asset. All this happens instantly and without anyone taking custody of the funds.

On the contrary, community bank customers can pay any Lightning bill directly from the dollar balance of their mobile wallet. They don’t need to take on volatility risk or rely on a custodial counterparty beyond the stablecoin issuer: their community bank.

Such a community bank does not need to maintain Lightning nodes itself. Anyone can act as an edge node for their local or remote community and compete on customers and transaction volume the same way they might run a Lightning Network routing node today.

Bitcoinization of the dollar

The vision of being able to receive any currency or asset, while transacting using the global, open-source, permissionless Bitcoin network is appealing. This will facilitate the digitization or bitcoinization of local dollar reserves, allowing billions of people to hold the asset of their choice while transacting digitally and at lower cost. As Taro routes transactions through Bitcoin, it allows smaller players in the stablecoin market to benefit and reinforce the network effects of the Lightning Network.

This allows people to access Bitcoin as a payment network and long-term savings tool without the risk of exposing users to short-term volatility. It dramatically increases the number of merchants and potential users on the Lightning Network and establishes bitcoin as the backbone and medium of exchange for a truly global and accessible reserve currency.

This is a guest post by Leo Weese. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.