Economic Bootstrapping of the Lightning Network
The Lightning network is on every Bitcoiner’s mind these days. We’ve been expecting it for years now, and despite the software not being officially released yet, it’s very exciting to hear that it’s already being used for first payments on the Bitcoin network.
But what’s not covered a lot is how the Lightning network is going to form. It’s very different from the Bitcoin network, where full nodes connect to each other automatically. Instead, every channel being opened will be an economic decision made by a human. There’s a cost for opening and closing a channel, and there’s liquidity that becomes tied up in the channel. So, it’s not clear, who’s going to connect to who, and on what timeline.
For a long time I did not see, how the bootstrapping of the Lightning network would happen in an economical way. Which user, which company would have an incentive to setup channels and with whom? What’s the best initial use-case? But I’ve since formed a basic idea, of how it could happen in three steps. Such that in each step users and companies can benefit, and which ends up as a fully formed Lightning network that could process transactions for millions or even billions of people.
As a preparation, consider a network that is fully decentralized, like in this simulation. Every user runs a Lightning node and connects to three or four peers. While complete decentralization is appealing (hard to fail, hard to censor, …), I don’t think this topology is likely to be realized. That’s because running a node and keeping channels open and liquid is not easy and requires constant attention, at least if you’re routing other people’s transactions. Most users will want to outsource that part to a business and just have a single Lightning channel with that business.
But which businesses are going to provide this service? If new companies need to be created it will take time for them to get funding, to find the right employees, and to make sure they understand and act within the laws of their jurisdiction. That could easily take another year or two.
So, it would be best if existing businesses had incentives to start using lightning channels. In my opinion, the businesses with the highest incentives, which are best prepared technologically, economically and legally, are cryptocurrency exchanges.
So, here’s how the Lightning network will be bootstrapped in three steps:
Step 1: Exchange with Lightning Accounts
An exchange offers its customers to “withdraw” coins by putting them in a Lightning channel. That would not really be withdrawing the coins, because they could be moved with “Lightning” speed between customer and exchange.
The customer would essentially have a “Lightning account” at the exchange with coins that are always tradable, but enjoy the safety provided by the Lightning technology.
This would also be safer for the exchange, as it has to hold less coins in its wallets (less responsibility), and deposits and withdrawals would be fast and cheap.
Step 2: Adding Businesses and Customers
Once businesses and their customers have a Lightning channel with the exchange, they can send each other coins without trusting the exchange. This augments the Lightning accounts to be spendable not just at the exchange, but also at businesses to purchase goods and services.
In some countries the exchange would become a money transmitter and it would have to know and comply with the corresponding laws. However, most exchanges already have KYC and AML procedures in place. They know who their customers are, and why they’re moving the money. So, exchanges are in the best position to manage these regulations.
Libertarians may not like this part, one could argue that exchanges become just like banks this way. But even if they have a similar function, exchanges will still operate on top of the Bitcoin network, and with Lightning accounts the customers don’t have to trust the exchange.
There’s another benefit from being connected to an exchange. If a customer or business has used up a channel’s capacity, the channel can simply be replenished by sending fiat money, or other cryptocurrency, to the exchange, and the exchange can then credit it to the Lightning account.
Step 3: Connecting Exchanges
Exchanges create Lightning channels between each other. This increases the number of businesses where customers can spend their coins.
This becomes the backbone of the Lightning network. While centralized between customers and exchanges at the subnet level, the network as a whole would still be relatively decentralized, with each exchange having roughly the same number of connections to other exchanges.
The exchanges make sure that the backbone channels remain open and liquid, while earning fees from the transactions running through them.
Do you run an exchange? Implement Lightning!
Exchanges are very busy at the moment because they’re dealing with a flood of new customers. Some haven’t even implemented Segwit transactions yet. However, it should be possible to set one developer aside to implement Lightning channels for their business. That way, if the Lightning implementations become production ready, they’ll be a step ahead of the competition, and they’ll be able to take advantage of this new business opportunity.
Do you agree or disagree with my assessment? Did I miss some major economical or technical factors? What topology do you expect for the network? Let me know in the comments.
The Lightning network will be bootstrapped by exchanges that open Lightning channels with their customers, businesses, and other exchanges, forming the backbone of the Lightning network.