Lightning has been on a massive growth stage lately in terms of more liquidity coming into the network. Since the beginning of 2021, the network has grown from 33,000 or so channels to over 65,000 channels. The amount of bitcoin in these channels has grown from around 1,000 BTC to nearly 2,500. This is widely seen as a huge predictor of success, and it is, but it is beginning to highlight the growing divide in attitudes over what will actually dominate the incentives of single node operators in the future. This rapid growth has resulted in diminishing returns in routing fees to contract operators, some of whom are not even interested.
Since the launch of PLEBNET (not to mention this is causally related, just when it started to catch my eye), I’ve been seeing more and more Lightning node operators adopting the attitude that they don’t care about earning routing fees to run their own node. This is in stark contrast to all of my long-term thinking about how the Lightning Network will develop financially. And I don’t mean “I don’t want to make a profit” in routing, I mean literally NO guiding fees. This seems completely illogical in terms of economic incentives, and I apologize for any misrepresentation of the reasons why people want to run a knot like this. To me, it seems that people want to engage in this behavior out of altruism and to maintain Lightning as part of the “commonly owned” financial infrastructure. I don’t see this as being economically sustainable.
Conventional thinking about profit incentives
Before we get into the profit dynamic, let’s just look at the cost side of things. In order to close and open the Lightning Channel, you must perform cross-chain transactions, which charge a fee to the miner. This is completely inevitable and is the primary cost of entering or exiting the Lightning Network. Now consider the routing fee collected with respect to this on-chain fee, if the routing fee is more than the on-chain fee then you get a profit and if it is less then you incur a loss. So obviously the objective of an economically rational node operator should be to increase the routing fees they collect in a competitive market so that, before the end of the channel’s life, they earn more routing fees than they paid to open the channel and would pay to close the channel.
As more liquidity enters the Lightning Network on average, the amount in the routing fee contract will decrease, as we have seen for many contract operators during the explosive growth of channels and liquidity this year. Now that it’s a little more accurate than just “more money = everyone makes less money”, as many people point out, the channels and their liquidity are not completely replaceable. A channel open to a large merchant frequented by everyone will be able to charge a higher fee than a channel open to a random guy named Bob, some people sometimes sending small payments to him. But as more channels are opened for this big trader, the fees in these channels will tend to go down as people try to compete with each other on price. That’s just the basics of economics.
The way I’ve always seen the development of the Lightning Network over the long term is the economic competition to place channels between nodes or entities that have a high transaction demand. Those who can do it cost-effectively will make a good profit, and those who can’t, so to speak, will “go out of business.” Also one last mention before moving on, obviously, in this line of thinking, where the fees on the string increase over time out of necessity, the routing fees will also increase.
non-profit thinking
Now let’s consider a routing node operator that doesn’t care about profits. I’ll think of two subcategories here, those who will at least recoup their costs and those who won’t even bother to do so.
Operators still aiming to recover their costs will still have to charge the routing fee, but since they are not interested in earning a profit on top of that, they will be able to undermine the routing contract that is seeking profit in terms of fees. This will inevitably cause such nodes to attract more volume than those that charge higher fees in search of profit and eat up the proceeds of profit seeking contract. Now considering the dynamic of increasing liquidity that leads to lower revenue, it is likely that, if there are a large enough number of nodes running under this model, it will make it more difficult (or at its most, likely to be Impossible) to earn profit directing transactions on Lightning.
In the case of contract operators who are not even interested in getting their costs back, there is the same kind of dynamic with for-profit nodes but with two main differences: nodes that “distort” the market in this way are in fact in the long run going to incur a loss and the profit-seeking contract may be paid due to It actually leads to losses to remain competitive rather than simply losing profits. This obviously becomes a chicken game in the extreme, and eventually someone has to blink. I don’t think for a second, especially with higher fees, that someone will, forever, continue to lose money to support other tier 2 transactions.
round it
There are some deeper nuances I left above just to keep the mental models I describe simple, such as path discovery heuristics that might intentionally look for ways to charge higher fees as a sign of higher reliability, channel rebalancing to delay touching the blockchain for longer, etc., but I think, even considering all of these things, one key dynamic remains: These are two completely different economic schools in terms of motivations and incentives to run routing nodes on the Lightning Network. They will not exist in a vacuum, they will interact with each other in the same market as the network continues to grow. It will be interesting to see how this is done.
This is a guest post by Shinobi. The opinions expressed are their own and do not necessarily reflect the opinions of BTC, Inc. or Bitcoin Magazine.
