Exchanges have significant regulatory oversight as they develop. Regulatory oversight has only increased in recent times with KYC/AML requirements increasing in an effort to combat illicit usage and terrorist funding, as well as involvement in other illegal activities.
With the recent disappearance of NEM from CoinCheck, regulators worldwide will likely be increasing their oversight even further in an effort to enforce some consumer protections in the trustless environment.
Due to a difficulty tracking transactions, Andreas Antonopoulos has stated that he does not expect regulated exchanges such as CoinBase to accept Lightning. KYC/AML requirements are reliant on being able to track the flow of funds from one account to another.
Despite pseudo-anonymity, cryptocurrencies such as bitcoin allow for these transaction records to be followed, while lightning changes the way transactions are processed, making these trace actions near-to-impossible.
What is Lightning?
Lightning Network is a protocol upgrade for bitcoin which allows users to create small “side-chains” in which they can transact at will, off of the blockchain until both parties agree on the outcome of a transaction. Once users have agreed, the side chain is closed out and the final record of funds exchanged is published to the main chain.
Side chain resolution allows users to transact in parallel, significantly increasing the transaction throughput potential of the bitcoin network. Lightning protocol is currently being tested in the LiteCoin ecosystem on top of the SegWit protocol. Bitcoin activated SegWit in August of 2017, paving the way for Lightning to be implemented once it has been sufficiently tested.
Why will regulated exchanges not accept it?
Regulated exchanges have certain responsibilities in terms of currencies they can accept and patrons they can serve. KYC/AML regulations require exchanges to collect personally identifiable information (PII) from users so that they can be tied to a bank account, an identity, and a taxpayer profile.
Know Your Customer (KYC) checks allow regulators to ensure that buyers are not outstanding criminals, cannot evade taxes, and are not participating in less than legal activities. Anti-Money Laundering regulations help ensure that the funds being sent to and from exchanges are legal and obtained legitimately.
Without a clear method of tracing transactions, KYC and AML regulations cannot run down the source of funds, and cannot be applied effectively to user accounts.
How much pressure is on exchanges to accept Lightning?
Lightning stands poised to disrupt the bitcoin ecosystem through significant improvement. Increased transaction throughput, improved privacy features, reduced fees, and several other improvements will be applied to bitcoin once/if Lightning goes live on the bitcoin mainnet.
Due to the skyrocketing value of bitcoin over the last several months and increasing network load, Lightning is in higher demand than ever. At the time this article was written, the Lightning test network carries over 200 network nodes, over 700 payment channels, and has a total transaction value of more than $35,000 worth of transactions.
How is the development team responding to community pressure?
Lightning Network developers have displayed excitement for the increased community interest in their project. According to Bitcoinist.net, the development team intends to put in “about 1321 hours per week” to develop the network.
Development pressure and increased community interest indicate that a solution to bitcoin scaling issues may be nearing implementation, but how will this positive change benefit users if they can no longer transact between fiat and other cryptocurrency using bitcoin?