El Salvador adopting Bitcoin could make it lose market dominance

El Salvador recently added Bitcoin as legal tender. In barely over a decade, an open-source, cypherpunk, radically new money system, with no publicly known creator and open to participation in both using and building from anyone in the world, has gone from zero value and branded as a tool for criminals to now being accepted by a government as a legitimate legal tender. To say this has been a wild ride is an intense understatement. Now, for the first time in history, a fully decentralized digital money is recognized by a state as being just as legitimate as said state’s own currency.

That being said, there’s some devil in the details of this otherwise wonderful announcement: The law specifically mentions Bitcoin (BTC) rather than cryptocurrencies as a whole and includes a government partnership with Strike, a payments company based around the Lightning Network, the primary off-chain scaling solution for Bitcoin. Because of the current scaling limitations of the first layer and the state of development of the second, this historic adoption could come with some headaches.

I’ve been using cryptocurrency for about eight years now, living unbanked off of them for five. I also run my own Lightning node, and as such can compare and contrast the relative experiences between Bitcoin and what other networks could offer. Let’s dive into why the Salvadoran experiment could move the whole crypto space forward, though possibly not in a Bitcoin-first direction.

Related: Adopting the Bitcoin standard? El Salvador writes itself into history books

Potentially hundreds of thousands of businesses are about to be forcibly onboarded. Rather than simply allowing and encouraging the adoption of Bitcoin, the new law in El Salvador specifically compels all merchants to accept it as payment:

“Every economic agent must accept bitcoin as payment when offered to him by whoever acquires a good or service.”

This compulsion will trigger a mass onboarding of new merchants to accept Bitcoin, whether they want to or not. This will result in hundreds of thousands of businesses, potentially more, seeking access to a network that already processes about that number across its entire ecosystem in a day. Imagine each merchant receiving a Bitcoin payment per day, doubling the number of transactions on a network that is already past capacity and creating a user-experience nightmare. Of course, the intent here is to use the Lightning Network to put as little activity on-chain as possible. However, even this may prove difficult. Here’s why, with a couple of different potential situations.

Related: An asset for all classes: What to expect from Bitcoin as a legal tender

First case: Businesses integrate Lightning directly

Let’s first imagine a case where a majority of businesses onboard to Bitcoin directly, using the network in a decentralized manner. On-chain fees fluctuate wildly but are frequently in the several-dollar range, if not higher. Even if customers are willing to pay those fees for smaller items, the merchant must pay those fees to move those funds eventually, incurring high fees (expected to be significantly higher after the additional pressure on the network). This is not a situation any merchant would likely appreciate.

A more likely scenario is that they onboard to the Lightning Network, which in theory can allow them to both receive and send small payments for sub-cent fees. In reality, its structure and complexity would pose significant initial onboarding issues.

To begin, using Lightning requires opening at least one channel, which necessitates an on-chain transaction. This, in turn, triggers the congestion and fee issues mentioned above, as well as maintaining the infrastructure online at all times. Additionally, one cannot receive funds without having them in a channel, meaning you need to either have someone lock up their own funds in a channel to you (which may necessitate payment), or you have to open a channel yourself to another node with your own money, then send that money through the channel to another source (such as making purchases, or to a separate wallet/node you control) in order to free up inbound liquidity.

In short, a business must either be technically competent and initially possess the number of funds that they expect to receive before they have to rebalance a channel, or they must pay a service provider. The amount of funding and technical know-how necessary to make this happen may seem doable by upper-class standards, but the chances that most merchants in a developing country can afford a Raspberry Pi and several dollars of extra startup capital just to receive Bitcoin are slim.

Second case: Businesses integrate via custodial solutions

Now, there’s a second case where businesses simply onboard to a centralized, custodial solution that settles in fiat currency directly to their bank account. This certainly solves many of the issues posed by direct exposure to the Bitcoin ecosystem, though not all, and additionally, it introduces new ones.

First, if a service like Strike actually does open Lightning channels for all users, then each new user onboarded represents one on-chain transaction. Even though this is fewer than in the previous case, this still represents X transactions or the entirety of Bitcoin’s on-chain capacity for Y days straight. And lest we forget, Strike itself needs to scale in addition to the network, and a fledgling company will certainly face growing pains when jumping to onboarding an entire country’s merchants. Does anyone remember the numerous times when exchanges like Coinbase have gone offline when faced with an influx of new customers? Imagine that, only worse.

Additionally, let’s not forget the entire reason this was thought of as helpful to begin with: Many Salvadorans are unbanked and have issues getting access to key financial services. A world in which most businesses accept Bitcoin through just those financial services faces the same challenges which prevented them from being included before. How many Salvadorans lack the necessary documentation to open a bank account? How will they be able to instantly convert to fiat currency without a bank account? Those problems will not only still be present under a mass adoption scenario, but they will be amplified by unfamiliar infrastructure and nascent services.

The likely scenario will be a mix of both cases, but predominantly the second. This will invariably result in a user experience and onboarding nightmare which, while exposing many more people to cryptocurrency, will cause a lot of them to come away with a negative opinion, and possibly seek alternatives.

Comparison with a key crypto payments competitor

Let’s take a quick look at what an alternative scenario might look like. I have the most experience with Dash since it’s what I use for my daily money, but any cryptocurrency with successful on-chain scaling — Bitcoin Cash (BCH) or Nano, if the latter solves its recent spam problems — should provide a similar, though not equivalent, experience. Because of Dash’s masternode network of incentivized nodes and emphasis on mass on-chain scaling, all transactions are finalized in under two seconds for a fraction of a cent. Any merchant can create a wallet at no cost, waiting period or stress to the network (unless they use custodial solutions and are at the mercy of the centralized architecture’s scaling concerns). Any user can easily download an app, receive DASH, and send it smoothly for a negligible cost, with the payment secured instantly without a realistic chance of failure. The merchant can then move those funds instantly, any number of times, also for fractions of a cent. Moreover, the DashPay username wallet leveraging decentralized digital identities, already publicly available on testnet, will soon make the experience even better by eliminating confusing and long cryptographic hashes.

Contrast this with Lightning, where every customer and merchant has to pay an on-chain transaction fee (and merchants must solve liquidity) in order to operate in a decentralized manner. When using centralized solutions, there must be a certain level of trust between each party to ensure that the perfect conditions to enable a relatively smooth experience are met. A major hub node going down, a spike in on-chain congestion, an influx of new users, or difficulties in a service provider maintaining profitability can all result in an inability to route payments, higher fees, long wait times, critical features turned off or service refused to customers altogether. And remember, all costs must ultimately be passed on to the consumer, meaning that the numerous variables, infrastructure and capital investment involved in running Lightning infrastructure at scale will be passed on to the end-user.

Bitcoin opens the door

How will this exciting new chapter in cryptocurrency’s history pan out? It’s impossible to know for sure, but if it extensively leverages the Bitcoin Lightning Network, we may be in for a bumpy road in the short term. Even if it fails, however, it will likely be a success in that it will pave the way for all types of cryptocurrency to be used in commerce and considered as official as money, which will inevitably continue the global financial revolution.

While the Salvadoran experiment will certainly accelerate the space forward, it may be too much usage for Bitcoin to comfortably handle at this point. Thankfully, hundreds of other cryptocurrencies are waiting in the wings to step in. Bitcoin bottleneck or not, the crypto space is going to be just fine.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.