The Rise of Lightning Service Providers
Growth in the Lightning Network
The Lightning Network has seen significant growth in the last year, reaching an estimated capacity of 5,432 BTC, and is continually growing at approximately 30% annualized. According to an article from NASDAQ, growth was highest in 2021 over the last two years, with the 30-day growth reaching a peak annualized growth rate of nearly 400% YoY with more than 80 million users having access to Lightning payments (https://ccw.fm/l5uC4). Since then, growth in public channel capacity has slowed but is still growing over 30% annualized when averaging the growth over the last 30 days.
Here is a chart of the top Nodes in terms of liquidity on the Lightning Network. The top 10 nodes’ capacity equate to 3784.76 BTC or roughly 69.9% of the total liquidity on the network. Snapshot taken on 04/05/2023 at the time of writing of this report.
Something that is also keeping up with the growth of Lightning, unfortunately are custodial solutions. Those have completely overtaken non-custodial apps in terms of usage (more on that later).
Perhaps this shouldn’t come up as a surprise, since Lightning is hard to use. For someone who is trying out Lightning for the first time, using a non-custodial app can be somewhat cumbersome - from a UX standpoint, we still have a long way to go to try and catch up with custodial apps.
Lightning Liquidity and Onboarding Challenges
As mentioned previously, Lightning is hard to get your head around and admittedly still, hard to use. Hence why we need to introduce a few key concepts. First one being liquidity on Lightning. Let’s review what is meant by Liquidity in the context of Lightning.
Liquidity is required to send and receive BTC on the Lightning Network. The Lightning Network consists of two-sided channels, each having a local and a remote balance available for routing, sending, or receiving payments.
The total amount of funds locked in a particular channel is called channel capacity or liquidity. There are two types of liquidity.
Inbound Liquidity
Due to the structure of Lightning, if one is to use the Lightning Network one would need inbound liquidity to receive payments. Inbound liquidity is BTC that your counterparty currently owns.
Outbound Liquidity
Conversely outbound liquidity refers to the amount of satoshis that a user is able to send over Lightning. Outbound liquidity is BTC you currently own.
This all sounds good, until we look at this process through the perspective of someone who is new to Lightning. In order for someone to have the ability to receive funds that person has to make a payment first, which is counter intuitive and somewhat confusing to newcomers.
Providing sufficient Liquidity on the Lightning Network can be especially challenging for onboarding new users for several reasons:
Channel Funding: To open a payment channel on the Lightning Network, participants need to commit a certain amount of Bitcoin to the channel, essentially locking in those funds for a period of time. However, if there is a lack of participants willing to fund channels or if the funds are concentrated in a few channels, it can lead to liquidity imbalances and make it difficult for users to find routes for their transactions.
Channel Rebalancing: As transactions occur on the network, the balance of funds within a payment channel will inevitably shift. For example, if one party is receiving more payments than they are sending, the channel balance can become skewed, potentially limiting the amount that can be sent in the other direction. To maintain liquidity and enable seamless transactions, channel participants need to actively re-balance their channels by either receiving or sending funds to maintain an optimal balance which is a complex and time-consuming process.
Routing Challenges: The Lightning Network relies on participants finding a path of well connected channels to route their transactions successfully. If there are liquidity imbalances or insufficient available channels along the desired route, it can hinder the successful completion of the transaction. Routing becomes more challenging as the network grows and the number of participants and channels increases.
Incentives for Liquidity Provision: Providing liquidity on the Lightning Network comes with certain risks, such as the possibility of locked funds for prolonged periods of time if channels are not utilized or potential losses in case of channel closure disputes. Without adequate incentives for users to provide liquidity, there may be a shortage of available funds, leading to liquidity challenges.
Inversely this is why Lightning Service Providers (LSPs in short) are crucial to the growth of the network and overcoming these challenges.
Introducing Lightning Service Providers
Akin to ISPs which provide you with access to the internet, as the name suggests, LSPs provide users and businesses on the Lightning network with liquidity and network services. Some of these services can include:
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Opening channels to users
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Routing
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Connectivity & Channel Management
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Automation
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Selling inbound liquidity
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Channel rebalancing
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Zero-confirmation channel openings
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Traditional payment processing
LSPs charge fees for some or all of these services, and structure their fees in various ways - more on that below.
As previously mentioned, LSPs play a crucial role in the onboarding process of users on Lightning which in turn triggers a virtuous cycle as described by Roy Sheinfeld CEO of Breez:
The idea is that the more payments someone routes, the more fees they will earn on their bitcoin locked in on the network. That being said there is a tradeoff in that bitcoin used for liquidity on the network is riskier than keeping your coins in cold storage.
LSPs are crucial to improve the user experience and simplify things for merchants and app providers. For Lightning to scale to hundreds of millions of people around the world, we can't expect everyone to be an expert at Lightning. People should be able to use Bitcoin and Lightning without knowing how it works “under the hood” akin to how the internet works today.
Increasing adoption whilst preserving self custody
Currently, payment channels are financed by the party that initiates them. This will change once dual-funded channels are more mature and widely supported - https://bitcoinmagazine.com/technical/first-dual-funded-lightning-channel-opens.
Opening payment channels only grants you the capacity to send funds (i.e. outbound liquidity), but not to receive them (i.e., inbound liquidity). To get inbound liquidity, you must either open a channel and then spend money through it, or use a service (LSP) which can supply you with liquidity on demand.
The way LSPs open channels to users varies quite significantly thus providing very different user experiences. Like everything, these methods come with their own tradeoffs in privacy and in trust.
With the rise of custodial solutions, there are now more users on Lightning using custodial solutions compared to non-custodial solutions. One reason for such trends is the liquidity constraints required to use Lightning. Custodial solutions abstract these problems, but of course they come with a trade off.
One underrated aspect which isn’t talked about enough is that LSPs not only help with improving scalability and thus adoption of Lightning, but they do that whilst allowing users to retain self custody of their funds.
Unlike custodial solutions, where users have to rely on third parties to manage their funds, one can use an LSP but maintain full ownership of their assets without having to give control of their keys, staying true to the Bitcoin ethos.
Technologies Solving Inbound Liquidity
LSPs leverage several different technologies to make self custody convenient. Here is a brief overview of some of the different approaches and technologies built to simplify the user experience on Lightning.
Lightning as a Service (LaaS)
Breez has announced their proposal for scaling Lightning - Lightning as a Service (LaaS). Their open-source Breez SDK enables developers and 3rd party providers to integrate P2P Lightning payments into their apps with zero learning curve or technical expertise.
Zero-Confirmation Channels
To get on Lightning you first need to do an on-chain transaction on the Bitcoin layer and wait for a confirmation between 10 and 30 minutes. This does not create the most optimal user experience.
A zero-confirmation channel allows users to use the channel without having to wait for the transaction to be confirmed on chain, thus speeding up the onboarding process for new users.
The trade off here is that a certain level of trust is required. The user must rely on the LSP's assurance that they will not cancel the transaction after the payments have been executed.
Atomic / Submarine Swaps
Submarine Swaps facilitate atomic swaps between on-chain and off-chain layers, simplifying the Bitcoin transfer process for users, who can move their funds between Layer 1 and Layer 2 without needing to manage the opening or closing of payment channels.
Peerswap - is a method developed by Blockstream, which allows a user to rebalance channels in a trustless way using submarine swaps.
Loop - Developed by Lightning Labs Loop is a submarine swap provider (essentially a bridge between on chain and off chain bitcoin). If a user needs more inbound liquidity, you can send your funds to Lightning Labs in a non custodial way and they will return the funds on-chain.
Splicing - The ability to change the capacity of a channel dynamically without closing the channel whilst leaving a smaller on chain footprint. Effectively makes the channel capacity variable as opposed to fixed allowing LSPs to reallocate capital.
Liquidity Ads
Developed by Blockstream, Liquidity Ads is a protocol, providing a lightweight way to coordinate liquidity being deployed across the network in a decentralized manner. Nodes can announce publicly that they are willing and offering liquidity in exchange for a set fee. One can think of it as a billboard system for making announcements about liquidity you can deploy. You can set your own rate, which then is broadcasted on the “gossip network” available to every node to send and receive.
LSP Spec
Commonly agreed protocols to create interoperability between wallets and LSPs.
Types of LSPs
LSPs do come in different forms catering for different user experiences and market segments. The 3 most common categories of LSPs are:
Built-in wallets - Breez, Bitkit(Blocktank), Blixt and Phoenix Wallet
Liquidity and P2P Marketplaces - Magma, LightningNetwork+, Lightning Lab’s Pool, Liquidity Ads
Web Portals / Widgets - Blocktank, LNBig, Lightspark
Protocols - Liquidity Ads by Core-Lightning, LSP Spec
List of LSP Providers & Protocols
Boltz is a submarine swap provider, but it opens channels with users who don’t have enough receiving capacity.
Breez opens zero-confirmation channel, thus using the liquidity of the user in order to allocate liquidity on the user end. Once a user downloads the wallet, Breez will automatically open a channel for them.
Blocktank LSP is full service LSP. It comprises a set of software tools that businesses, apps, web platforms or Bitcoiners can use to monetize Lightning Network connections and automatically manage channel liquidity.
Blocktank LSP includes solutions for several types of businesses and their users.
The tool is one of very few open source tools and is available both as a Web Widget and API depending on the business’s individual requirements.
C= is amplifying the lightning ecosystem by providing liquidity, services, and infrastructure that enables everyone to benefit from fast, low cost global payments.
Purchase inbound channel capacity from our node and pay with on-chain bitcoin or lightning invoice.
This is still Work In Progress, not suited for production just yet. Dunder is a Lightning Service Provider for the Bitcoin Lightning Network.
It currently supports "on demand channel openings", meaning if a Lightning wallet gets an inbound payment while not having any inbound capacity, Dunder will open a channel to the wallet with a push amount equal to the inbound payment minus the on-chain fee. Dunder is powering the Blixt Wallet.
Helping Lightning Nodes with Liquidity issues.
Offers opening a channel in exchange for a fee.
Lightning Network Plus (LN+) is a free web app that helps the users of the Bitcoin Lightning Network find other peers and create liquidity swap triangles, squares and pentagons, in order to create outgoing and incoming liquidity. Such liquidity swaps are also referred to as the Ring of Fire. Claim your node on LN+ and join a channel swap for free
Lightspark services and tools aim to be the fastest, easiest and most reliable way to send and receive payments globally, with exceptionally low fees, using the Lightning Network.
Network of LND servers with Great Liquidity. Although LNBig does not advertise themselves as a LSP, they were the first large entity on Lightning - the anonymous group started opening hundreds of channels and currently has the most BTC and the most channels on the Lightning
Network.
Automate advanced workflows with Torq and ensure that your capital is never standing still. Automatically adjust channel fees and rebalance while you sleep. Manual channel management is a thing of the past.
LNRouter offers incoming channels for a fee. Improve payment speed and capital efficiency.
Liquidity advertisements are a feature of LN that allows a node to publicize its willingness to contribute funds (liquidity) to a new channel requested by a remote peer. The offering node specifies the duration of time they’ll lease the liquidity and the amount they’ll charge for it; the purchasing peer pays the lease fee using a dual-funded channel open.
LQwD is a Lightning Network Service Provider (LSP) focused company developing payment infrastructure and solutions. The Company's mission is to develop institutional grade services that support the Lightning Network and drive improved functionality, transaction capability, user adoption and utility and scaling Bitcoin. LQwD also holds Bitcoin as an operating asset establishing nodes and payment channels across the Lightning Network.. It is worth noting that this is the only company that is only providing Lightning Network Liquidity Services
API specifications for Lightning Service Providers.
The current scope is limited to channel sales and services specifically about your channel and the peer that provides it. Once the important aspects are covered, we may work on liquidity marketplace concepts, and other wallet or info services.
Magma is a liquidity marketplace for the Lightning Network. Users can buy or sell channels from other participants via the Magma marketplace. Magma is intended to be simple to use for any lightning node operator without restrictions on the implementation.
Run a separate LN node on your phone or desktop where you can move some funds, so remote balance/ inbound liquidity is created. Channels are managed manually or on autopilot.
Pool is a peer-to-peer marketplace for opening channels on Lightning. It provides the ability to connects users who need access to inbound liquidity to those who have capital to deploy on the network
This technology from Voltage utilizes Lightning Labs Pool feature and provides the ability to easily purchase channels from other nodes on the Lightning Network. You have the ability to create dual funding channels thus being able to both send and receive funds. Voltage LSP
Open a channel in exchange for a upfront fee, promising zero routing fees (bear in mind this is only from and to their Node, does not include fees to other Nodes) - now closed
Monetization Models
Altruism won't get us to where we need in terms of self-custodial adoption. The incentive model is such that LSPs will help onboard more users, because it is in their interest to do so. From a LSP point of view, liquidity is an investment.
People deploying capital on the Lightning network should consider the opportunity cost of not deploying on Lightning and using a custodial solution (something that is against the Bitcoin ethos) or simply HODL-ing their coins. Locking up capital on the Lightning Network comes with challenges - a problem arises when a user who has opened a channel becomes less active, which by extension means that the channel is less active and the LSP’s initial capital deployed is idle, not earning a return.
That being said there are a few business models being considered and implemented, with more to come.
Subscription - as the name suggests, a user pays a monthly subscription fee to the LSP in return for inbound liquidity. While on the surface this looks like a good proposition, one of the drawbacks with this approach is that subscriptions don’t adjust to usage patterns.
Leasing - those who have excess coins to spare have the ability to lease it via smart contracts at an agreed rate to users seeking inbound liquidity. Lightning Lab’s Pool product offers such functionality allowing bidders to submit offers to lenders. Those with the highest bids (i.e. offering the highest yield for the lender) would win the bid.
Similarly to subscriptions, a notable drawback to this approach is that it is difficult to adjust to usage patterns.
Routing fees - LSPs charge a fixed routing fee (usually 1-2 sats) + variable % on each transaction they successfully route. This perhaps is one of the most fitting models as it adapts to usage patterns and it’s super cheap for users. The problem arises in that the routing fees are currently too low. Over time however as the network grows, the routing fees would increase as will the volume of transactions on the network, making it a much more viable revenue option for LSPs.
One off payment - ZeRoFeeRouting was one such example offering zero fee routing for a one off opening fee (roughly 8000 sats) for 2,000,000 inbound liquidity. Note that zero fee payments only applied from and to ZeroFeeRouting’s node, users would still have to pay for channel hops for their payment to go through successfully, albeit very small amounts. One advantage of this approach is that it streamlines the onboarding process and user experience, potentially making it more attractive to mainstream users. However, for a novice user who anticipates being able to transmit free payments across the network, it could be a bit misleading. Additionally, as the network expands and fees inevitably rise, it remains uncertain whether this model will be sustainable, especially if it is offered to merchants and businesses.
Future of LSP
Lightning is continuously evolving and so are LSPs. This is an attempt to describe how dynamics would change for Lightning Service Providers, as the network grows and empowers more users to be self sovereign.
Continuous Growth
As the Lightning Network continues it’s upward trajectory an increasing number of LSPs has begun to emerge and will continue to be integrated with other Lightning-based applications. Keeping aligned with the ethos of Bitcoin, a non-custodial future is the ultimate goal, and LSPs represent a crucial component in making that vision a reality.
The trend for continued growth on Lightning is reinforced by a recent report from Block Inc., which surveyed 9,500 individuals in 14 different countries. The report revealed that a significant number of respondents view Bitcoin as a payment instrument for activities such as purchasing goods and services, or transferring funds to their families, in accordance with the currency's original vision. Among the report's other findings are the following:
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Lower-income respondents ranked purchases/payments as the primary reason to buy Bitcoin.
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Respondents from China felt strongest about Bitcoin as a means of transaction.
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Higher-income participants ranked purchases/payments second, slightly behind investment return.
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Asia claims the highest level of optimism about Bitcoin's future.
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Bitcoin adoption is significantly higher in countries like Argentina with high inflation.
Short to mid term there is a potential for Custodial financial solutions to emerge which would allow users to put their BTC as liquidity on the Lightning network and start earning routing fees without managing a node or liquidity management. How successful this would be remains to be seen.
Exchanges adopting Lightning
It would come as no surprise to anyone to see more exchanges follow in the footsteps of Bitfinex and Kraken and adopt Lightning. Recently we have seen that both Coinbase and Binance have indicated their intentions of integrating the Lightning network, something we covered in a recent article.
This will provide a use case for LSPs in that exchanges can offer instant withdrawals and deposits for arbitrage and immediate trading needs of their users.
Wallets
As more and more users discover Lightning, adoption of wallets will skyrocket. Such dynamics will provide opportunities for Wallets to add new revenue streams by renting liquidity to their user base. LSP’s can facilitate the outsourcing of routing in order to improve the payment reliability and user experience, whilst the wallet provider maintains control of their node.
Point of Sale (PoS) and Merchants
Point of Sales will also benefit - ideally in a self custodial form instead of using a payment processor, but that is at least a few years away.
Lightning does present liquidity and routing challenges for new merchants who are not able to receive payments. However, adopting a LSP solution can help their business tremendously.
A lot of work needs to be done to improve the UX on Lightning and to provide more liquidity in order to accommodate for onboarding the next billion users, but the good news is there are no shortage of companies who are working on making that self-custodial future possible!