An Argument For Single-Asset Lightning Network

Summary:

In a recent discussion on the Lightning-dev mailing list, it was identified that failing to route payments purposely can be used to opt out of a previously agreed exchange of two different assets. This is not an issue with same asset exchanges, but for cross-asset exchanges, there is a lower bound on bid-ask spread, that of the option premium.The use of hashlocked timelocked contracts (HTLCs) prevents implementation of seamless currency conversions in current designs of Lightning Network. HTLCs allow cross-system trades to be performed, but they can also be used to construct American Call Options, which can be "purchased" for free (gratis), potentially earning money in a completely risk-free manner. Abusing this ability means that any Lightning Network node advertising cross-asset on-Lightning exchange will find large amounts of its liquidity tied up in stalled forwarding payments (in reality, American Call Options) with a risk of monetary loss in case of large fluctuations in exchange rate.HTLCs can be used to enforce trades across different cryptocurrency systems, allowing routing of payments across different channels. Each channel is its own cryptocurrency system. However, due to UX concerns, there is no cost incurred in merely setting up HTLCs for routing. By using the low-level HTLCs provided as primitives by Lightning Network, one can set up equivalent straddles by constructing their own cross-chain payment to themselves with some other node, for the same amount. This can possibly provide a hedge for a single node, although it cannot scale to all participants.The use of Lightning Network to support multiple assets with each channel having a single asset, could lead to some nodes advertising themselves as providing exchange capability. This means taking one asset on one channel and exchanging it for another asset on a different channel. If an individual advertises themselves as such an exchange entity, and a payment is being made to someone who only accepts WJT but the payer has only bitcoins, they can exchange the bitcoins for 1 WJT through a process that creates an American Call Option with expiration of 1 day from now.In this scenario, the American Call Option is premium-free and even if the expiration is very near, rational entities will still construct such options. Extreme volatility may occur in short time frames, especially in the realm of digital assets. It is strongly likely that, if cross-asset exchange nodes on Lightning Network exist, they will be exploited to create risk-free American Call Options. They will find that significant liquidity will be tied up in such American Call Options, and find that they will lose funds especially at times of volatility.Solutions to mitigate this issue have significant drawbacks - requiring payment for HTLCs would make routing failure non-free, increasing exchange node fees would increase friction in crossing assets, and limiting the timelock of cross-asset swaps would also increase friction in crossing assets and centralize the weaker asset around exchanges. This implies that a multi-asset Lightning Network may not be economically viable and it would strongly prefer having a single asset across the network.

Updated on: 2023-06-02T16:05:00.183559+00:00