How the Lightning Network Will Nearly Eliminate Custodial Risk for Bitcoin Traders

Ryan Kneer Blocked Unblock Follow Following Dec 2, 2017

The stakes are very high in the world of bearer-assets. Every trader’s greatest fear is that they’re going to wake up one morning and discover that their usual exchange has been compromised and they’ve lost everything with no hope of getting any of it back. To mitigate this risk, some adopt the habit of withdrawing their funds each day before going to sleep and depositing again in the morning, since the danger is simply a function of time spent on the exchange. But even then, we’re still a far cry from the bulletproof system we wish existed.

Fortunately, something is being worked on that will dramatically increase the security of each user’s funds: the Lightning Network. In short, instead of surrendering ownership of their private keys to the exchange, a user will be able to commit funds to a payment channel they open with the exchange, in which these funds can flow back and forward as needed, on the fly. Any funds not currently reserved on order will be pushed back to the user where they will remain safely in their custody until required for a new order. Cancelling an order will be synonymous with withdrawing funds — a single event.

This feature will also put to rest fears of exchange insolvency, since users will always know with certainty that their funds exist on the blockchain, rather having to trust that the number they see in HTML really means something when they click the withdraw button. Exchanges will be more of what they should be — a robust matching engine — and less of what they shouldn’t be — a bank, greatly curtailing the pressure they endure from attackers when protecting, in some cases, upwards of a billion dollars worth of customer deposits. Anything that shrinks the honey pot is a win for everybody.

Here’s to hoping some ambitious exchanges get this implemented in 2018. Because one nine-figure implosion is enough for our industry.