Group Co.
When Bitcoin Generates Sustainable Income
Traders Magazine Online News, July 18, 2019
Today trillions of money are trapped in negative yield assets (https://www.marketwatch.com/story/amount-of-global-debt-yielding-less-than-0-approaching-10-trillion-2019-03-22), thanks to the “success” of central banking. What if your Bitcoin holding can generate sustainable income unrelated to lending to short seller or funding other speculations?
Currently the shortest plank on Bitcoin’s barrel is the lack of scaling. In other words, we can’t conveniently buy coffee with Bitcoin. Among many proposed solutions to this scaling issue, Lightning Network (https://en.wikipedia.org/wiki/Lightning_Network) stands out as an open source trust-free second-layer on top of Bitcoin’s blockchain that makes instant and low cost micropayment with Bitcoin possible. The regular Bitcoin payment is like using a check: slow but sure, suitable for low frequency high value transactions. Lightning Network is similar to credit card: fast and instead of settling every single transaction, you settle a bunch of them after a certain period of time. Unlike credit card, which depends on centralized credit card companies to facilitate transactions, Lightning Network is decentralized and relies on Hash Time Locked Contract (yep you can code smart contract on Bitcoin) to be trust-free. Check it out for a visualization of the current topology of Lightning Network here https://1ml.com/visual/network.
Every Lightning Network user will run a node, deposit some Bitcoin into her node, and connect to the instant payment network through other existing nodes. Let’s say user A wants to pay B some Bitcoin with Lightning but they are not directly connected. If both A and B are connected with C, then A can pay B by routing her payment through C. To incentivize C’s participation, A may choose to pay C a small “routing fee” for her help. In fact, each user will choose how much routing fee her node charges when settling up her node before connecting to other nodes. In this way, Bitcoin deposited into a Lightning Network node will generate a sustainable income by helping other users transact. You may ask instead of paying C, why not connecting A and B directly? Because opening a new direct connection requires depositing some amount of Bitcoin and paying the blockchain transaction fee. So utilizing several direct connections along with indirect routing makes more economic sense than connecting directly with everyone you transact with.
Naturally, a node with large amount of deposit and numerous connections will serve as a “payment hub” and generate considerable income from collected routing fee. Looking around, reputable cryptocurrency exchanges are among the best candidates for maintaining such hub: first they have tremendous Bitcoin holding in the form of users’ account balance; second it is easy for them to expand by connecting with existing users. Recently one of the largest cryptocurrency exchanges, Bitstamp, announced the opening of its Bitcoin Lightning Network node (https://www.bitstamp.net/lightning-network-node/) and invited its users to connect. If cryptocurrency exchanges can earn routing fee by depositing users’ balance into a Lightning Network node, we can expect market competition will make exchanges pay interest on users’ Bitcoin balance.
One root of modern banking was goldsmiths who lent out their clients’ deposit for an interest, which made gold an income generating asset and eventually created the gold standard monetary system. If Lightning Network succeed in making Bitcoin a digital currency for micropayment at Starbucks, we may witness crypto exchanges turning into Bitcoin “banks” and making Bitcoin the income generating digital gold.
“The past does not repeat itself, but it rhymes.”
Zhong Zhang is Senior Economist at Bates White Economic Consulting.
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