The Lightning Pool serves as a marketplace where routing nodes can trade channels, providing an effective connection between liquidity providers and node operators.
Bitcoin brought a revolution to the traditional finance industry since 2009. However, amidst the celebration lies the need for the blockchain to at least reach the transaction speed of conventional systems.
Unfortunately, a transaction on the Bitcoin blockchain can take up to 60 minutes to complete. In the same breadth, transaction cost is still high compared to legacy systems.
Lightning Labs found a solution to these problems by introducing a layer two scaling solution called Lightning Network (LN). Notably, LN was purposely built to enhance BTC-based payments.
Despite being the largest off-chain payment channel, it wasn’t perfect. This necessitated the creation of another LN-based solution, Lightning Pool. To understand how the solution works, let’s look at how LN handles payment transactions, the issues presented by this approach, and why Lightning Pool holds the solution.
How LN Works
LN works by enabling participants in a transaction to open payment channels. The engagement is handled off-chain and later recorded on the Bitcoin blockchain. Note that when a user wants to receive the digital currency on the LN network, there must be someone else with an open channel.
However, the total amount that can be transacted on a channel is dictated by the amount committed to the channel.
In simpler terms, when one wants to receive Bitcoin using the layer two solution, they have to convince another party to open a channel and allocate funds, mostly equivalent or higher than one the receiver wants. On LN, this is called inbound bandwidth or liquidity. For example, for you to receive K amount of BTC using an LN channel, another party must allocate a minimum of K Bitcoins to a channel towards you.
However, the network rewards those that commit capital to the system to facilitate send and or receive requests. The incentives earned are shared among all nodes that participated in forwarding the transaction across the platform.
Forwarding nodes on LN are called routing nodes. Nodes can be outbound or inbound. Unfortunately, the effective operation of the nodes is hindered by a bootstrapping issue on the system.
The Capital Deployment Problem
The problem makes node operators without enough capital to turn to off-chain. This includes avenues such as forums and social media platforms such as Twitter to seek more funding.
On the other side, those with wealth and want to earn routing fees don’t know where to place their funds. This disconnection is exacerbated by the lack of proper mechanisms for nodes to survey which parts of the network are in absolute need of capital.
What follows is the creation of channels where they’re not needed. In return, there are ineffective capital and resource usage occurring. Furthermore, the nodes won’t be forwarding any transaction, hence, no routing fees while other areas are starving. This approach has been compared to building a road where no one needs it, and no roads where it’s an emergency.
Lightning Pool: the Solution
Lightning Pool, or simply Pool, provides a clear and effective connection between liquidity providers and node operators. The Lightning Pool serves as a marketplace where routing nodes can trade channels.
Observe that the marketplace operates on a peer-to-peer (P2P) basis. As such, it’s users are incentivized for using the system without delegating control and security of their digital wealth.
It builds on the conventional auction implementations to create a channel lease marketplace (CLM). The CLM allows participants to trade inbound channels in a process known as Lightning Channel Lease (LCL). In an abstract sense, an LCL can be considered to be a virtual path joining two destinations within the LN ecosystem.
Notably, the implementation of LCL leads to efficient utilization of capital on the network. Participants can interact with pricing signals. Consequently, capital is deployed where it’s needed most.
Interestingly, Lightning Pool provides a system to score nodes. The score offers those buying channels with quality and reliable nodes. Note that Pool participants can opt-out of the rating system.
Major Lightning Pool Attributes
- Periodic clearing intervals – Pool shifts from operating as a centralized order book to performing transaction clearing in intervals. This approach guards against front running and order snipping.
- P2P or Non-custodial – Participants using the new feature operate special accounts. The accounts hold funds to pay for, among other things, transaction fees and purchase amounts when buying channels.
However, the funds in these accounts are entirely controlled by their users. P2P implementation on Pool also gives clients the ability to survey whether the market is appropriately operated.
- Batch processing – Since the Pool clears transactions on a given interval, transactions waiting to be transferred to the Bitcoin blockchain pile up. This necessitates processing them in batches. The orders cleared in an interval are processed on the main blockchain as a single transaction.
Therefore, it reduces the transaction charges incurred if the transaction was to be individually written on the main chain or when interfacing directly with the BTC-powered decentralized platform.
- Sealed bid: Orders on Pool are sent to an auctioneer avoiding agents to have prior information on placed orders. This enhances transparency because all agents have access to the same public information.
Advantages of Lightning Pool
Instant Usage of new Wallets
In the past, the layer two scaling option for Bitcoin did not allow new wallets to conduct transactions if they didn’t have any coins. To reverse this scenario, Pool uses the “side-car channel” concept.
Here, a third party can dedicate a channel with both inbound and outbound liquidity to a new user. Those that sell the channel to the third-party earn rewards from the new user.
A Clear Connection Between Nodes and Liquidity Providers
When it comes to routing nodes and liquidity providers, LN has been operating as a closed system where the two mostly rely on guesses that produce more misses than hits.
Pool addresses the misses by providing signals to node operators, in turn, helping them gauge the actual market demand. Also, nodes have the option to dedicate their entire capital to channels. Before Pool was launched, the capital can automatically be allocated throughout the LN ecosystem.
Encouraging Enhanced Use Cases
Previously, accepting payments for merchants was tiresome since they had to set inbound channels. But, with Lightning Pool, a merchant only needs to configure what LN calls “introduction points.”
Luckily, the Lightning Pool marketplace facilitates negotiations involving these points. On the other hand, the merchant can commit to paying a percentage of the funds allocated to the points, effectively incentivizing the liquidity providers.
Consistent Routing Node Compensation
Before Pool, routing node operators could not have guaranteed regular routing traffic hence no frequent routing rewards. Pool compensates nodes for the capital they deploy on the network. Interestingly, this feature is one way that Pool powers decentralized finance (DeFi) on the Bitcoin blockchain.
It’s clear that Lightning Pool brings DeFi features to Bitcoin enthusiasts by rewarding liquidity providers. Furthermore, by allowing merchants to set introduction points, Pool drives the adoption of BTC payments by making it easy for merchants to receive the cryptocurrency.
Batch processing of orders lowers the transaction costs and improves the transaction speed, further increasing BTC’s usage for day-to-day activities. A non-custodial approach, on the other hand, increases BTC holders’ confidence to provide liquidity and earn rewards while maintaining full control of their virtual wealth.