Lightning has been on an explosive growth tear lately in terms of more liquidity coming to the network. Since the start of 2021, the network has grown from 33,000 or so channels to more than 65,000. The amount of bitcoin in those channels has grown from around 1,000 BTC to almost 2,500. This is widely viewed as a massive indicator of success, and it is, but it is starting to illuminate a growing divide in attitude about what will actually dominate the incentives of individual node operators in the future. This rapid growth has led to a diminishing return in routing fees for node operators, and some of them don’t care.
Since the launch of PLEBNET (not to say this is causally related, just when it started coming to my attention), I have been seeing more and more Lightning node operators espousing the attitude that they do not care about earning routing fees for running their node. This stands in complete contrast to all of my long-term thinking about how the Lightning Network will evolve financially. And I don’t mean “don’t want to earn a profit” in routing, I mean literally not charging routing fees. This seems completely irrational in terms of economic incentives, and for any misrepresentation of the reasons people want to run a node like this I apologize. To me it seems like people want to engage in this behavior out of a sense of altruism and to maintain Lightning as a “pleb-owned” piece of financial infrastructure. I don’t see this as economically sustainable.
Conventional Thinking Of Profit Incentives
Before we get into the dynamic of profit, let’s just consider the cost side of things. In order to close and open a Lightning channel you have to transact on-chain, which incurs a miner fee. This is completely inescapable and is the base cost to enter or leave the Lightning Network. Now consider the routing fees collected in relation to these on-chain fees, if the routing fees are in excess of on-chain fees, you pocket a profit and if they are less you incur a loss. So obviously an economically rational node operator’s goal should be to maximize the routing fees they collect in a competitive market so that, before the end of a channel’s lifetime, they have earned more in routing fees than they paid to open the channel and will pay to close the channel.
As more liquidity enters the Lightning Network on average, the amount in routing fees nodes will collect will go down, as we’ve seen for many node operators during this year’s massive growth of channels and liquidity. Now it’s a little more nuanced than just “more money = everyone makes less money,” as many people point out, channels and their liquidity are not quite fungible. A channel open to a large merchant everyone frequents is going to be able to collect higher fees than a channel open to a random guy named Bob some people occasionally send small payments to. But as more channels are opened to that large merchant, fees in those channels will trend down as people try to competitively undercut each other on price. That’s just basic economics.
The way I’ve always seen the Lightning Network evolving long term is economic competition over placing channels between nodes or entities that have high transactional demand. Those that can do this cost effectively will earn a nice profit, and those that can’t will, so to speak, “be put out of business.” Also a last mention before moving on, obviously, in this mode of thinking, as on-chain fees increase over time by necessity routing fees will increase as well.
Now let’s consider a routing node operator who is not concerned with profits. I’m going to consider two subcategories here, those who will at least recoup their costs and those who will not even care about doing that.
Operators who still aim to recover their costs will still have to charge routing fees but, because of not caring to earn profit on top of that, they will be able to undercut profit-seeking routing nodes in terms of fees. This will inevitably lead to such nodes attracting more volume than ones charging higher fees in search of profit and eat into the revenue of profit-seeking nodes. Now taking into account the dynamic of more liquidity dragging down revenue, this could, potentially, if a large enough number of nodes operate under such a model, make it much more difficult (or in the extreme, potentially impossible) to earn a profit routing transactions on Lightning.
In the case of node operators who don’t even care about recouping their costs, the same type of dynamic with profit-seeking nodes exists but with two major differences: The nodes “distorting” the market in this way are actually in the long term going to incur a loss and the profit seeking nodes because of that could actually themselves be pushed into incurring losses to stay competitive instead of just missing out on profits. Obviously though, this becomes a game of chicken in the extreme, and eventually someone has to blink. I do not believe for a second, especially as fees go up, that someone will just, in perpetuity, continue losing money to subsidize other people’s Layer 2 transactions.
Rounding It Off
There are some deeper nuances I’ve left out above just to keep the mental models I’m describing simple, such as route-finding heuristics that might intentionally look for routes that charge higher fees as a sign of higher reliability, channel rebalancing to delay touching the blockchain longer, and so on but I think, even considering all of these things, one major dynamic remains: These are two entirely different economic schools of thought in terms of motivations and incentives to operate routing nodes on the Lightning Network. They will not exist in a vacuum, they will interact with each other in the same marketplace as the network continues growing. It will be interesting to see how that plays out.
This is a guest post by Shinobi. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
Lightning has been on an explosive progress tear these days when it comes to extra liquidity coming to the community. For the reason that begin of 2021, the community has grown from 33,000 or so channels to greater than 65,000. The quantity of bitcoin in these channels has grown from round 1,000 BTC to nearly 2,500. That is broadly seen as an enormous indicator of success, and it’s, however it’s beginning to illuminate a rising divide in angle about what’s going to truly dominate the incentives of particular person node operators sooner or later. This fast progress has led to a diminishing return in routing charges for node operators, and a few of them don’t care.
For the reason that launch of PLEBNET (to not say that is causally associated, simply when it began coming to my consideration), I’ve been seeing increasingly more Lightning node operators espousing the angle that they don’t care about incomes routing charges for working their node. This stands in full distinction to all of my long-term fascinated with how the Lightning Community will evolve financially. And I don’t imply “don’t need to earn a revenue” in routing, I imply actually not charging routing charges. This appears utterly irrational when it comes to financial incentives, and for any misrepresentation of the explanations individuals need to run a node like this I apologize. To me it looks like individuals need to interact on this conduct out of a way of altruism and to keep up Lightning as a “pleb-owned” piece of monetary infrastructure. I don’t see this as economically sustainable.
Standard Considering Of Revenue Incentives
Earlier than we get into the dynamic of revenue, let’s simply contemplate the price facet of issues. As a way to shut and open a Lightning channel you must transact on-chain, which incurs a miner price. That is utterly inescapable and is the bottom value to enter or go away the Lightning Community. Now contemplate the routing charges collected in relation to those on-chain charges, if the routing charges are in extra of on-chain charges, you pocket a revenue and if they’re much less you incur a loss. So clearly an economically rational node operator’s objective ought to be to maximise the routing charges they acquire in a aggressive market in order that, earlier than the top of a channel’s lifetime, they’ve earned extra in routing charges than they paid to open the channel and pays to shut the channel.
As extra liquidity enters the Lightning Community on common, the quantity in routing charges nodes will acquire will go down, as we’ve seen for a lot of node operators throughout this 12 months’s large progress of channels and liquidity. Now it’s a bit extra nuanced than simply “more cash = everybody makes much less cash,” as many individuals level out, channels and their liquidity will not be fairly fungible. A channel open to a big service provider everybody frequents goes to have the ability to acquire greater charges than a channel open to a random man named Bob some individuals sometimes ship small funds to. However as extra channels are opened to that giant service provider, charges in these channels will development down as individuals attempt to competitively undercut one another on value. That’s simply fundamental economics.
The best way I’ve at all times seen the Lightning Community evolving long run is financial competitors over putting channels between nodes or entities which have excessive transactional demand. These that may do that cheaply will earn a pleasant revenue, and people that may’t will, so to talk, “be put out of enterprise.” Additionally a final point out earlier than shifting on, clearly, on this mode of pondering, as on-chain charges improve over time by necessity routing charges will improve as properly.
Now let’s contemplate a routing node operator who isn’t involved with income. I’m going to think about two subcategories right here, those that will at the very least recoup their prices and those that won’t even care about doing that.
Operators who nonetheless intention to recuperate their prices will nonetheless must cost routing charges however, due to not caring to earn revenue on prime of that, they are going to be capable of undercut profit-seeking routing nodes when it comes to charges. This may inevitably result in such nodes attracting extra quantity than ones charging greater charges searching for revenue and eat into the income of profit-seeking nodes. Now bearing in mind the dynamic of extra liquidity dragging down income, this might, probably, if a big sufficient variety of nodes function below such a mannequin, make it way more troublesome (or within the excessive, probably unimaginable) to earn a revenue routing transactions on Lightning.
Within the case of node operators who don’t even care about recouping their prices, the identical sort of dynamic with profit-seeking nodes exists however with two main variations: The nodes “distorting” the market on this manner are literally in the long run going to incur a loss and the revenue searching for nodes due to that might truly themselves be pushed into incurring losses to remain aggressive as a substitute of simply lacking out on income. Clearly although, this turns into a recreation of rooster within the excessive, and ultimately somebody has to blink. I don’t consider for a second, particularly as charges go up, that somebody will simply, in perpetuity, proceed dropping cash to subsidize different individuals’s Layer 2 transactions.
Rounding It Off
There are some deeper nuances I’ve neglected above simply to maintain the psychological fashions I’m describing easy, similar to route-finding heuristics which may deliberately search for routes that cost greater charges as an indication of upper reliability, channel rebalancing to delay touching the blockchain longer, and so forth however I believe, even contemplating all of this stuff, one main dynamic stays: These are two solely completely different financial colleges of thought when it comes to motivations and incentives to function routing nodes on the Lightning Community. They won’t exist in a vacuum, they are going to work together with one another in the identical market because the community continues rising. Will probably be attention-grabbing to see how that performs out.
This can be a visitor submit by Shinobi. Opinions expressed are solely their very own and don’t essentially replicate these of BTC, Inc. or Bitcoin Journal.