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Lightning Labs Rolls Out Marketplace for Lightning Channel Liquidity

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Lightning Network development startup Lightning Labs is rolling out a new product: dubbed Lightning Pool, the new tool seeks to bring together node operators to trade access inbound and outbound Lightning channel capacity with each other. With the launch, Lightning Labs tackles one of the Lightning Network's major pain points: efficient capital allocation, and through that, increased overall liquidity.

The Problem With Lightning Liquidity

The Lightning Network operates via a grid of channels which can be opened between counterparts such as merchants and consumers and used to transact satoshis (or sats), the smallest units of a bitcoin. A channel is opened through an on-chain Bitcoin transaction in which bitcoin is locked up on the Bitcoin mainchain and unlocked on the Lightning Network.

Lightning channels allow for rapidly accelerated Bitcoin transactions in a trust-minimized environment. Channels can, for example, allow merchants to accept bitcoin for goods and services, as transactions are near-instant.

However, it's not as simple as that: on Lightning, nothing works without liquidity - the right kind of liquidity.

When a Lightning user opens a basic channel with another party, the amount of sats they lock on the Bitcoin mainchain forms the respective channel's total capacity. That capacity sits on the side of the user who opened the channel. Because the channel is at capacity, the user who created the channel can only send sats to the other party, but not receive any through that specific channel.

This results in some detriments to the user experience. Users that want to receive sats, for example merchants, must first spend some of the balance in their channels, or must convince other node operators to open channels to them. 

A Marketplace for Liquidity

Lightning Labs has set out to solve Lightning's "widely-felt pain point" of inefficient capital allocation by launching a peer-to-peer marketplace that allows node operators to buy and sell liquidity. 

The market connects buyers and sellers of channel liquidity. A press release obtained by the BTC Times explains: 

Existing node operators do not have access to pricing signals to help determine where in the network their outbound liquidity should be allocated, and new node operators have no way to signal that they need new inbound liquidity. Lightning Pool brings these two sides together into a single market while allowing them to maintain custody of their funds. 

Elizabeth Stark, CEO of Lightning Labs, elaborated further to the BTC Times that Pool ensures the efficiency of capital on the Lightning Network:

Before Pool, actually sourcing this liquidity was difficult as people typically used social media or ad hoc arrangements to ask for inbound channels. Plus, when people ask for others to put up capital and open channels to them, there's little incentive to do so. 

The system is non-custodial. Funds transacted via Lightning Pool are kept in a time-locked, 2-of-2 multisignature account, where the funds are "fully in the user's control at all times." 

Lightning Pool also batches transactions between buyers and sellers of channel liquidity, "greatly reducing individual chain fees." 

The Lightning Finance Era

Aside from its potentially significant implications for the development of payments on the Lightning Network, Lightning Pool is also the first instance of a "Lightning Finance"—or "LiFi," as Lightning Labs calls it—product. 

The first market that will be offered through Lightning Pool is a Lightning Channel Lease, which is an inbound channel with a pre-agreed duration.

Those that sell these leases will earn "yield on real bitcoin without trusting a third party or losing custody of their funds." The yield is derived from lease buyers, who must pay a premium for gaining access to inbound liquidity.

The yields offered on Lightning Pool Leases will initially be determined by the market, which clears on a per-block basis and with sealed bids.  

Olaoluwa Osuntokun, CTO of Lightning Labs, added that the first lease length will be 2016 blocks, one Bitcoin difficulty epoch, or approximately two weeks. Lengthier lease durations such as one, two, or six months are expected to be added in the future.

According to Lightning Labs, the introduction of Lightning financial products with different maturities will create a natural yield curve, which may "provide benchmark rates of return for nascent bitcoin-native capital markets."  

The Rise of the Shadowchains

Lightning Pool also marks the first instance of an application built on what Lightning Labs calls a "shadowchain." 

This shadowchain system is a way for developers to "design applications on top of Bitcoin with more complex logic" using the Bitcoin Script language. While allowing developers to build various financial or commercial applications for Bitcoin, shadowchains ensure that participants always have "control of their funds at all times," Osuntokun added. 

What's important is that at the core of each shadowchain lies the Bitcoin blockchain, which acts as the clearing and security layer for shadowchain applications. 

Lightning Labs is a leading player in Lightning Network development. The startup has been funded by Twitter and Square chief executive Jack Dorsey, who has stated previously that he thinks for Bitcoin to work as a means of payment, it must become more time-efficient and cost-effective for its users.

Lightning Labs also counts Robinhood co-founder Vlad Tenev, Craft Ventures' David Sacks, Proof of Capital (now Race Capital), and other venture capitalists and Silicon Valley founders as investors.

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Nick is a writer and analyst who has been following Bitcoin since 2013. When he is not writing, he works on HTC's Bitcoin phone, EXODUS.