Addressing the Realities of Tarot’s Limitations – Bitcoin Magazine
This is an opinion piece by Shinobi, a self-taught Bitcoin educator and tech-savvy Bitcoin podcast host.
Taro finally released beta code for the testnet and it has continued to be a big talking point for a few weeks now at this point. It is being discussed by many as a kind of panacea for the problems of people in developing countries or countries that are being decimated by near or outright hyperinflation. Many present it as the solution to everything. The ability to self-storage, to avoid the inherent volatility of bitcoin, to still have access to Lightning as a payment network. It would have the stability of fiat without losing access to Bitcoin’s transparency and censorship resistance. It can provide a lot of utility, and yes, it provides the “stability” of fiat while allowing interoperability with the Bitcoin network, but it is wildly oversold by many of those who discuss it.
Using Taro on the Lightning Network requires you to have a peer who understands the Taro protocol, and more importantly, own the asset you want to receive (or be willing to accept the asset you have and want to use), and trade that asset both ways with bitcoin. On the Lightning Network itself, nodes on the network simply exchange control of bitcoin in one channel in tandem with control of bitcoin in another channel. There is no currency risk there, there is no volatility risk – one bitcoin equals one bitcoin. To facilitate the transfer of Taro assets for bitcoin at the edges of the network, this whole assumption goes completely out the window. Every single transaction that a user performs is now an exchange rate risk for the node operator that provides services to Taro users on the Lightning Network. Every single time a Taro user with a channel open to that node receives money, the node operator buys bitcoin (which they receive over the Lightning Network) with the fiat tokens they send over a Taro channel to that user. Every time a Taro user sends money, the node operator sells bitcoin for fiat when they receive a Taro stablecoin and then transfers the bitcoin out over the Lightning Network.
There is a vastly different skill set required to operate such a node compared to a mere Bitcoin. You effectively have to trade at a ridiculously fast rate where the decisions about when to trade aren’t even made by you trying to look for beneficial opportunities, they are made by your Taro channel colleagues when they need to send or receive money. There are really only two options for dealing with this problem.
In the first option, you need to act beyond just the transactions you process. You must actively trade the market based on transactions you make (whether you buy or sell bitcoin), to balance out the potential risk you are exposed to. Every time you sell bitcoin by letting a Taro user send fiat, you have to buy the same amount of bitcoin because you risk losing some of that bitcoin if the price goes up before that user receives money again. Every time you buy bitcoin by letting a Taro user receive fiat, you must sell some of the bitcoin in your balance to ensure you have fiat to buy bitcoin the next time a Taro user sends money. This can be done through options, leverage trading, etc., – but the principle remains the same.
The other option would be to deny users from sending or receiving money when you feel the market is about to move against you. This would result in a totally degraded and inconvenient user experience for Taro users who opened channels with you. Think how frustrating it would be to have incoming or outgoing payments denied because the price of bitcoin is moving. Which it does, literally all the time.
These completely different dynamics require a much higher degree of specialization and skill to operate a Lightning node offering Taro services. This will almost certainly lead to a very high degree of centralization in terms of how many nodes on the network will actually support users opening Taro channels with them.
Further exacerbating that centralization pressure will be an even bigger elephant in the room: regulations. Currently, according to existing legislation, Lightning is not declared as an act of money transfer or regulated financial activity, and a 2014 US Financial Crimes Enforcement Network (FinCEN) decision that escrow services using cryptocurrency are explicitly not money transfer provides an incredibly strong argument to stand on it Lightning is on a technical level exactly that – just a deposit.
Exchanging one asset for another is certainly a clearly regulated activity in most jurisdictions. That’s exactly what Lightning nodes that support Taro channel do when a Taro peer sends and receives – they exchange a stablecoin (fiat) for bitcoin or vice versa. As a number of prosecutions against LocalBitcoins traders have shown in the United States, this act regularly committed for a profit rather than just managing your own personal investments is certainly considered a Money Service Business (MSB).
This comes with all regulatory requirements for such; record keeping, KYC and AML regulations, in accordance with government requests for actions and court orders. That effectively makes these nodes Strike, a business that must comply with a whole host of government regulations and requirements. Don’t get me wrong, for people who are comfortable interacting with businesses subject to these requirements, it can certainly provide a great deal of utility and value, but it is still a regulated business. There is no magical decentralized panacea that opens the door to scalable sovereign use of stablecoins. It is a protocol that can make it easier and less problematic for a business that offers bitcoin/fiat integration like Strike to handle the fiat side of their business.
Now to discuss on-chain activity, Taro has some utility in this regard. There is no requirement to depend on a Lightning node that will facilitate cross-asset exchanges here – it’s all direct on-chain transactions, but there are still two potential complications here. On-chain use for day-to-day payments is not something that scales for everyone; blockspace may be cheap today, but drivers of blockspace demand increasing mean that space will become more expensive. Being presented as a solution to problems of currency volatility and uncensorable payments, this limitation should be recognized just as with Bitcoin itself. The other complication is the question of how Taro works; as a commitment of data inside a Taproot UTXO, it actually requires creating bitcoin outputs to use and hold Taro assets. For any users who are primarily concerned with only using Taro assets and not bitcoin, this will likely play out with them handling a lot of bitcoin UTXOs of very little value just to hold and use Taro assets. The only way out of this would be to construct a protocol using something like PayJoin for the sender to work with the receiver to make a transaction that transferred Taro assets while ensuring that each can maintain only a single Bitcoin UTXO instead of creating many small ones with each transaction. However, this will have quite large implications for the privacy of Taro users.
So to conclude, Taro presents real utility as a means of payment without the volatility of bitcoin itself, but it is by no means a magic panacea. To interact with Taro over the Lightning network, users have to open channels with Lightning nodes which open themselves up to a huge amount of regulatory requirements, and to use Taro directly on-chain users have to deal with all the scaling limitations and costs of Bitcoin itself as well to the requirement of having to have a reasonable amount of bitcoin to trade Taro assets in the first place (if they are mainly Taro users and do not already own a certain amount of Bitcoin that can be used as a Taro anchor).
This is a very valuable tool for companies that want to offer fiat/bitcoin interfaces as a service, streamlining the technical integration and management of the fiat side of it, and it can be a tool for direct on-chain use of stablecoins and other Taro assets – but it is not a magic panacea. There is no decentralized wonderland. It’s a business tool, and a new way to keep other tokens on chain. No more.
This is a guest post by Shinobi. Opinions expressed are entirely their own and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.
