Electric explosives have increased in recent times as more liquidity has come into the network. Since the beginning of 2021, the network has grown from 33,000 or more channels to more than 65,000. The amount of bitcoin on those channels has increased from about 1,000 BTC to about 2,500. It is widely seen as a major indicator of success, and it is, but it is beginning to illuminate the growing division of attitudes about what will actually affect the incentives of individual node operators in the future. This rapid growth has resulted in reduced routing fees for node operators and some of them do not pay attention.
Since the launch of PLEBNET (not to mention that it is virtually related, when it starts to come to my notice), I have seen more and more Lightning node operators show an attitude that they don’t think about earning routing fees to run their nodes. This is the complete opposite of my long-term concern about how the Lightning Network will develop financially. And I don’t mean “don’t want to profit” in routing, I’m not literally taking routing fees. This seems completely unreasonable in terms of economic incentives, and I apologize for any misrepresentation of the reason why people want to run such nodes. It seems to me that people want to get involved in this behavior out of a sense of philanthropy and maintain lightning as a “plub-owned” part of the financial infrastructure. I don’t see it as economically sustainable.
Conventional thinking of profit incentives
Before entering into profit dynamics, let’s just consider the cost aspect of things. To close and open a Lightning channel you need to make an on-chain transaction, which carries a mineral fee. This is completely unavoidable and the main cost of entering or leaving the Lightning network. Now consider the routing fees collected with these on-chain fees, if the routing fees are higher than the on-chain fees, you make a profit and if they are lower, you lose. So obviously the goal of an economically reasonable node operator should be to maximize the routing fees they collect in a competitive market so that they can earn more than the routing fees payable for opening a channel before the end of the channel’s lifetime.
As more liquidity enters the Lightning network, the amount of routing fee nodes will decrease, as we have seen for many node operators during this year’s massive increase in channels and liquidity. Now it’s a little more subtle than “more money = everyone makes less money”, as many people point out, the channels and their liquidity aren’t quite camouflaged. A channel that is frequently open to a large merchant will be able to charge a higher fee than the channel that is open to a random person named Bob, some people occasionally send small payments. But as more channels are opened for those big merchants, the fees of those channels will go down as people try to lower each other at competitive prices. It’s just basic economics.
The way I have always seen Lightning Networks evolve in the long run is the economic competition over the establishment of channels between nodes or entities that have high transaction demands. Those who can do this effectively will make a good profit, and those who can’t, so to speak, will be “kept out of business.” Also a last mention before moving on, obviously, in this way of thinking, since the on-chain fee will increase the routing fee as required over time.
Now let’s consider a routing node operator who is not concerned with profit. I’m going to consider two subcategories here, who will at least recover their costs and who won’t think about doing it.
Operators who still aim to recover their costs will still have to charge routing fees but will be able to deduct profit-seeking routing nodes in the case of non-profit. This will inevitably attract more volume to such nodes rather than charging higher fees in search of profit and will consume the revenue of the profit seeking node. Now considering the dynamics of more liquidity to pull revenue, it is possible, if a sufficient number of nodes work under such a model, to make it more difficult (or extreme, potentially impossible) to make a profit in lightning transactions.
In the case of node operators who do not even think of recovering their costs, there is a similar dynamic with profit-seeking nodes but there are two main differences: It can be detrimental to stay competitive instead of losing. Apparently, it turned out to be an extreme chicken game and in the end someone had to blink. I don’t believe for a second, especially when the fees go up, that anyone will continue to lose money to subsidize others in Layer 2 transactions.
Rounding it off
There are some deeper subtleties that I’ve put up just to keep the mental models I’m describing simple, such as root-finding heuristics that can intentionally look for routes that charge higher fees as a sign of higher reliability, further channel rearrangement blockchain for delays. Touching over time, and so on but I think, even considering all these things, is a major dynamic remnant: these are two completely different economic schools in terms of motivation and incentives to run routing nodes in the Lightning network. They will not be in a vacuum, they will communicate with each other in the same marketplace as the network grows. It will be interesting to see how this works.
This is a guest post from Shinobi. The opinions expressed are entirely their own and BTC, Inc. Bitcoin Magazine.