## Lightning network thoughts

I’ve been intrigued by micropayments for, like, ever, so I’ve been following Rusty’s experiments with bitcoin with interest. Bitcoin itself, of course, has a roughly 10 minute delay, and a fee of effectively about 3c per transaction (or $3.50 if you count inflation/mining rewards) so isn’t really suitable for true microtransactions; but pettycoin was going to be faster and cheaper until it got torpedoed by sidechains, and more recently the lightning network offers the prospect of small payments that are effectively instant, and have fees that scale linearly with the amount (so if a$10 transaction costs 3c like in bitcoin, a 10c transaction will only cost 0.03c).

(Why do I think that’s cool? I’d like to be able to charge anyone who emails me 1c, and make $130/month just from the spam I get. Or you could have a 10c signup fee for webservice trials to limit spam but not have to tie everything to your facebook account or undergo turing trials. You could have an open wifi access point, that people don’t have to register against, and just bill them per MB. You could maybe do the same with tor nodes. Or you could setup bittorrent so that in order to receive a block I pay maybe 0.2c/MB to whoever sent it to me, and I charge 0.2c/MB to anyone who wants a block from me — leechers paying while seeders earn a profit would be fascinating. It’d mean you could setup a webstore to sell apps or books without having to sell your sell your soul to a corporate giant like Apple, Google, Paypal, Amazon, Visa or Mastercard. I’m sure there’s other fun ideas) A bit over a year ago I critiqued sky-high predictions of bitcoin valuations on the basis that “I think you’d start hitting practical limitations trying to put 75% of the world’s transactions through a single ledger (ie hitting bandwidth, storage and processing constraints)” — which is currently playing out as “OMG the block size is too small” debates. But the cool thing about lightning is that it lets you avoid that problem entirely; hundreds, thousands or millions of transactions over weeks or years can be summarised in just a handful of transactions on the blockchain. (How does lightning do that? It sets up a mesh network of “channels” between everyone, and provides a way of determining a route via those channels between any two people. Each individual channel is between two people, and each channel is funded with a particular amount of bitcoin, which is split between the two people in whatever way. When you route a payment across a channel, the amount of that payment’s bitcoins moves from one side of the channel to the other, in the direction of the payment. The amount of bitcoins in a channel doesn’t change, but when you receive a payment, the amount of bitcoins on your side of your channels does. When you simply forward a payment, you get more money in one channel, and less in another by the same amount (or less a small handling fee). Some bitcoin-based crypto-magic ensues to ensure you can’t steal money, and that the original payer gets a “receipt”. The end result is that the only bitcoin transactions that need to happen are to open a channel, close a channel, or change the total amount of bitcoin in a channel. Rusty gave a pretty good interview with the “Let’s talk bitcoin” podcast if the handwaving here wasn’t enough background) Of course, this doesn’t work very well if you’re only spending money: it doesn’t take long for all the bitcoins on your lightning channels to end up on the other side, and at that point you can’t spend any more. If you only receive money over lightning, the reverse happens, and you’re still stuck just as quickly. It’s still marginally better than raw bitcoin, in that you have two bitcoin transactions to open and close a channel worth, say,$200, rather than forty bitcoin transactions, one for each $5 you spend on coffee. But that’s only a fairly minor improvement. You could handwave that away by saying “oh, but once lightning takes off, you’ll get your salary paid in lightning anyway, and you’ll pay your rent in lightning, and it’ll all be circular, just money flowing around, lubricating the economy”. But I think that’s unrealistic in two ways: first, it won’t be that way to start with, and if things don’t work when lightning is only useful for a few things, it will never take off; and second, money doesn’t flow around the economy completely fluidly, it accumulates in some places (capitalism! profits!) and drains away from others. So it seems useful to have some way of making degenerate scenarios actually work — like someone who only uses lightning to spend money, or someone who receives money by lightning but only wants to spend cold hard cash. One way you can do that is if you imagine there’s someone on the lightning network who’ll act as an exchange — who’ll send you some bitcoin over lightning if you send them some cash from your bank account, or who’ll deposit some cash in your bank account when you send them bitcoins over lightning. That seems like a pretty simple and realistic scenario to me, and it makes a pretty big improvement. I did a simulation to see just how well that actually works out. With “Alice” as a coffee consumer, who does nothing with lightning but buy$5 espressos from “Emma” and refill her lightning wallet by exchanging cash with “Xavier” who runs an exchange, converting dollars (or gold or shares etc) to lightning funds. Bob, Carol and Dave run lightning nodes and take a 1% cut of any transactions they forward. I uploaded a video to youtube that I think helps visualise the payment flows and channel states (there’s no sound):

It starts off with Alice and Xavier putting $200 in channels in the network; Bob, Carol and Dave putting in$600 each, and Emma just waiting for cash to arrive. The statistics box in the top right tracks how much each player has on the lightning network (“ln”), how much profit they’ve made (“pf”), and how many coffees Alice has ordered from Emma. About 3000 coffees later, it ends up with Alice having spent about $15,750 in real money on coffee ($5.05/coffee), Emma having about $15,350 in her bank account from making Alice’s coffees ($4.92/coffee), and Bob, Carol and Dave having collectively made about $400 profit on their$1800 investment (about 22%, or the $0.13/coffee difference between what Alice paid and Emma received). At that point, though, Bob, Carol and Dave have pretty much all the funds in the lightning network, and since they only forward transactions but never initiate them, the simulation grinds to a halt. You could imagine a few ways of keeping the simulation going: Xavier could refresh his channels with another$200 via a blockchain transaction, for instance. Or Bob, Carol and Dave could buy coffees from Emma with their profits. Or Bob, Carol and Dave could cash some of their profits out via Xavier. Or maybe they buy some furniture from Alice. Basically, whatever happens, you end up relying on “other economic activity” happening either within lightning itself, or in bitcoin, or in regular cash.

But grinding to a halt after earning 22% and spending/receiving $15k isn’t actually too bad even as it is. So as a first pass, it seems like a pretty promising indicator that lightning might be feasible economically, as well as technically. One somewhat interesting effect is that the profits don’t get distributed particularly evenly — Bob, Carol and Dave each invest$600 initially, but make $155.50 (25.9%),$184.70 (30.7%) and \$52.20 (8.7%) respectively. I think that’s mostly a result of how I chose to route payments — it optimises the route to choose channels with the most funds in order to avoid payments getting stuck, and Dave just ends up handling less transaction volume. Having a better routing algorithm (that optimises based on minimum fees, and relies on channel fees increasing when they become unbalanced) might improve things here. Or it might not, and maybe Dave needs to quote lower fees in general or establish a channel with Xavier in order to bring his profits up to match Bob and Carol.