5 minutes to understand the Lightning Network liquidity rental market Lightning Pool

Today, Bitcoin finally has its own decentralized financial system, LiFi.

Written by: LeftOfCenter

The liquidity problem of payment channels has always been one of the bottlenecks restricting the development of the Lightning Network. In fact, in the Lightning Network , transactions cannot be completed without “inbound liquidity”. Especially for merchants or service providers who use the Lightning Network as a payment option, how to always maintain sufficient “inbound liquidity” is a very difficult problem.

November 2, Lightning web development team Lightning Labs announced the launch of a peer rental market liquidity “Lightning Pool” to try to resolve this originally because of the inherent technical limitations caused problems by designing an ingenious economic model, namely the lightning network The liquidity is packaged into a tradable asset, allowing users to buy and sell freely . On the other hand, it allows users to obtain a considerable return on capital while self-custodial of assets, and ultimately solve one of the main pain points of the Lightning Network: effective capital allocation Increase the overall liquidity in the network.

For Bitcoin holders, in addition to earning income through the centralized custodial platform and the Ethereum blockchain by lending, encapsulating and synthesizing Bitcoin, they can also borrow Bitcoin liquidity on the Lightning Network to obtain stable income. This means that not only does Bitcoin have one more method of guaranteed financial management, but it is also non-custodial, so it is more secure .

At present, Lightning Pool is still in the closed beta period, and it is temporarily unable to predict the future development prospects, but as the first decentralized finance native to the Bitcoin ecosystem ( called LiFi, or Lightning Finance ), it is of great significance , Which means that, independent of the Ethereum network, Bitcoin finally has its own financial system.

Liquidity pain points in the Lightning Network

The Lightning Network is a two-layer payment channel based on the Bitcoin blockchain. It mainly distributes the transactions of the Bitcoin main network to the two-layer Lightning Network to achieve a faster and lower transaction cost payment solution.

The Lightning Network consists of a series of peer-to-peer payment channels. Whenever a user has a transaction demand, a peer-to-peer payment channel can be constructed, and one of them will send bitcoin to the other to complete the payment. Opening a payment channel requires sending a small amount of Bitcoin to the address on the chain. At this time, the Bitcoin is locked on the Bitcoin mainnet and then unlocked on the Lightning Network.

Lightning Network, as a two-layer expansion solution based on Bitcoin blockchain, can instantly trade small amounts of Bitcoin in an environment with minimal trust. At the same time, the solution has low transaction costs and is very suitable for merchants to use Bitcoin as payment The program sells goods and services.

However, the reality is more complicated. In the Lightning Network, building a payment channel is only the first step. The completion of a payment requires “inbound liquidity”. In fact, the efficient allocation of capital for “inbound liquidity” has always been one of the pain points in the Lightning Network. One.

What is “inbound liquidity”?

To understand inbound liquidity, you first need to understand how the Lightning Network channel works.

As we have learned earlier, the first step in building a lightning channel is to create an on-chain transaction. Both parties need to take out a certain amount of Bitcoin to lock in the channel. The amount invested by the channel initiator is called the local balance ( local_balance ) , The amount invested by the opposite end is called remote balance ( remote_balance ).

However, for the payee, the successful completion of a transaction requires the payer in the transaction channel to deposit a sufficient amount of remote balance, that is, it is necessary to ensure that the peer has also invested sufficient purchase funds in the channel. This is called Is “ inbound liquidity “ (inbound liquidity). On the contrary, the funds required to pay the other party is called liquidity outbound (outbound liquidity).

Generally speaking, merchants or service providers are the payees. They are the initiators of the channel. It is natural for them to put funds in the channel, but the other party is not obliged to cooperate with you to put the funds.

In fact, in the absence of an effective source of “inbound liquidity”, users of various lightning networks have begun to find some solutions on their own to meet their own needs:

For example, Bitfinex exchange will post through the official launch of a specific period to collect payment channel connection requirements from users

Other node operators create dedicated Telegram groups, create channel maps based on channel supply and demand, or post demands on Twitter to seek inbound liquidity.

In addition, a number of specialized OTC services for purchasing inbound liquidity have appeared on the market. For example, Bitrefill directly sells inbound capacity, LNBig is a channel charging service, and PeerNode provides channel application services. Users can fill in the application form and attach the required Inbound liquidity draws demand.

The emergence of these solutions proves to a greater or lesser degree that the demand for liquidity in the Lightning Network is gradually increasing. However, the supply and demand of liquidity scattered on various platforms and corners of the Internet cannot form an effective market. On the one hand, the demand side seeks liquidity needs in various chat groups, forums or Twitter posts. On the other hand, those nodes that want to provide liquidity to earn income cannot know where the liquidity needs are greatest.

Failure to form an effective market means that node operators need to take greater risks and may open channels where there is no demand, leading to low capital efficiency.

To this end, Lightning Pool came into being, it will “inbound mobility” as a scarce resource, create a two-way market-based buyers and sellers, allowing participants to participate in the exchange liquidity lightning network, and obtain pricing signals, thereby Achieve efficient resource allocation.

What is Lightning Pool?

According to the official announcement of Lightning Labs, Pool is a non-custodial peer-to-peer market that allows Lightning Network node operators to buy and sell access to “inbound liquidity”. To be precise, Pool allows participants to buy and sell the Lightning Channel Leases (LCL ) of the Lightning Network , using inbound (or outbound) liquidity as a tradable asset, packaged into an LCL for placement Free trade in the market. As a hybrid asset, the leaser actually lent bitcoin through the payment channel in exchange for income. On the other hand, enterprises and service providers can purchase liquidity on demand to manage the payment process of the Lightning Network.

This is the problem Pool is trying to solve, that is, by building an open market for liquidity based on the Lightning Network, allowing merchants or service providers to purchase channel liquidity from the market for routing. On the other hand, Lightning Network node operators can put idle Bitcoin into the Pool and earn interest through borrowing.

Most importantly, Pool will add the pricing signal of the leasing market to the system so that it can know where the greatest liquidity demand comes from.

Pool will match supply and demand orders according to the “Frequent batch auctions” ( FBA ) mechanism. After the bid and ask price window period ends, the Pool engine will match the buyer and the seller based on the quotations of both parties.

“Frequent batch auctions” are a way to deal with market manipulation through reordering. In FBA, instead of processing transactions in order, a series of transaction batch processing based on a certain time interval will be collected. This batch processing order design will make the order of sending orders irrelevant, thereby eliminating transaction manipulation Possibility to make early trading unprofitable.

In other words, Pool based on this auction mechanism can effectively match the supply and demand parties, match those who want to deploy funds based on the channel and the merchants who need liquidity to receive payments, thereby solving the problem of effective resource allocation.

Every time an auction is successfully executed, the current interest rate of a single block can be obtained, which is actually equivalent to the current capital lease rate in the Lightning Network, expressed as a block percentage return or BPY . This means that if a new Bitcoin block is generated every 10 minutes, liquidity interest will be immediately paid to the liquidity provider’s lightning wallet. At the same time, all orders in the same batch are cleared in one transaction, which greatly reduces the cost of the chain compared with creating channels separately.

Similar to traditional bonds, the maturity date of an LCL is represented by Bitcoin block time. The expiry date of an LCL is enforced by the Bitcoin contract. During the time period set by both parties, the contract buyer can freely use the leased liquid capital and pay interest to the seller during the validity of the contract. At present, Pool is still in a closed test period, and liquidity providers will adopt the method of charging prepaid fees. The longest liquidity lease time is two weeks, or 2016 Bitcoin block time, which will be extended to 6 months in the future More rental time options.

Lightning financial LiFi native to Bitcoin ecology

In the past, if Bitcoin holders wanted to carry out capital-guaranteed wealth management, they could use a centralized custodial service such as BlockFi to lend Bitcoin to obtain stable annualized interest. The other way is to convert into synthetic Bitcoin or package Bitcoin for DeFi mining. Mine earns income and farming , and the launch of Pool brings a new way of profiting to the Bitcoin ecosystem. This model is not only native, but also non-custodial compared to centralized custodial services like BlockFi, so it is safe Higher sex. This financial model native to the Bitcoin ecosystem is called LiFi, or Lightning Finance.

At present, Lightning Pool is still in the closed test stage. It supports the use of Pool’s open source alpha client to participate in auctions, and uses Pool’s command line tools or RPC API to buy and sell channel lease contracts. In addition, a number of mainstream exchanges, wallets and service providers have tested this. The current order capacity is up to 10 BTC when it starts. Once the stress test is passed, the maximum capacity will increase.

Source link: lightning.engineering