What if you could rent out bitcoins that you do nothing with in a trustless way for a little interest, so that others can set up Lightning Network payment channels with them? That’s pretty much what Lightning Pool is: a marketplace for liquidity on the Lightning Network, where you can rent incoming liquidity to open new payment channels or rent liquidity if you don’t use it yourself.

The Lightning Network

Because the transaction speed and capacity of the Bitcoin network is limited, many people expect that most Bitcoin transactions in the future will take place via second-tier scalability solutions, such as the Lightning Network. This makes bitcoin transactions lightning fast and cheap.

Due to the technology, the Lightning Network works in a different way than the Bitcoin network. Lightning Network transactions propagate across the network through payment channels that Lightning Nodes open to each other.

When someone makes a transaction through one of the payment channels, the funds in it, known as liquidity, move from one side of the channel to the other. A reverse transaction is then required to return the funds to the original side. Like a kind of jigsaw puzzle, transactions move across the Lightning Network in this way until they arrive at their destination.

One of the teething problems is that the jigsaw puzzle sometimes gets stuck because the liquidity is not on the right side of the payment channels. After all, some Lightning nodes mainly pay via the network, while other nodes receive more often . Because liquidity is therefore regularly concentrated on one side of the payment channels, it is regularly necessary to open new channels or close and reopen old ones.

Moreover, new Lightning Network nodes can only receive and distribute transactions through the network when other nodes first open payment channels to them and provide them with a bit of bitcoin. For the time being, Lightning node managers had to arrange this themselves and the payment channels are therefore usually not optimally set up.

Lightning Pool: rent out liquidity against interest

Lightning Labs therefore created Lightning Pool, a kind of marketplace for buyers and providers of liquidity. In plain language, this means that Lightning nodes that have bitcoins with which no transactions are made can rent them out for a while to other Lightning nodes that need them.

The rented bitcoins are used to open payment channels to the tenant, allowing the tenant to receive transactions. It works non-custodial and the lender of liquidity is guaranteed to get back the bitcoins used, even if other parties misbehave.

The landlord receives a percentage of interest for the rental. The amount can be set, but market forces apply and buyers decide for themselves whether they want to pay the requested percentage. At the end of a pre-agreed period, the payment channels are automatically closed and the leased funds are released back to the owner.

It is therefore a way to earn extra income with bitcoins that you do not use yourself, without handing them over. Conversely, service providers, webshops and providers of wallet software can use it to set up the necessary payment channels at a low rate and provide them with liquidity, without having to own the full funds themselves. The ‘auctioneer’, in this case Lightning Labs, also earns a little bit for the service.

It improves the efficiency of the Lightning Network because it allows payment channels to be set up less arbitrarily and mainly where they are needed. Routing fees for Lightning Nodes are also likely to improve, as the channels are more likely to actually be used since people pay for them.

To make it all possible, Lightning Pool uses all kinds of cryptographic feats. The smart contracts are created via MultiSig and time locks and the transactions to open the payment channels are bundled using batching , which keeps transaction costs low.

Innovative

It is a special idea with a lot of potential. After all, things happen that are not possible in the old traditional financial system. You can lend money there, but you must always trust that another (third) party will comply with the agreements. This is not necessary with Lightning Pool, because cryptography and the code ensure that the rules of the contract are always followed exactly and that the funds are returned afterwards.

If you use Bitcoin for savings, this could be a way to earn interest on your savings. In a way where you are still the only one with access to the private keys . That might be quite an interesting proposition for many Bitcoiners.

It also solves practical problems at a low cost, introduces new financial incentives for Lightning nodes, and improves the overall efficiency of the Lightning Network. Thanks to innovations like this, the Lightning Network is slowly but surely growing into a network for large-scale use.

Experimental

In theory there are few disadvantages, but a small warning is in order. Lightning Pool is still an experimental technology and participation is therefore not entirely without risk.

Also, there are always inherent security risks associated with running a Lightning node, which you don’t have with more secure ways of storing bitcoins (such as a hardware wallet). If you are interested in Lightning Pool, do your research first and carefully weigh all the pros and cons.

Want to know more about this exciting new technology? At Beginnenmetbitcoin.com you will find a handy Dutch-language podcast about Lightning Pool that explains it in great detail. Readers with more technical knowledge can visit the Lightning Labs github. You can find the white paper here.