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Want a Yield on Bitcoin? There Are Opportunities on Lightning
United States treasuries yield what the world considers to be a risk-free rate. Whatever that rate may be, whatever amount of money you put in, you’re guaranteed to get that rate of return. Promised and backed by the full trust and confidence of the United States government.
Since there is low risk, US treasuries are home to trillions of dollars of peoples’ savings. Millions of people and countless governments have opted to buy and hold US treasuries in an attempt to preserve their relative wealth.
However, the risk-free nature of the US treasuries are not as free from risk as we originally thought. The USD is slowly losing its status as the world’s preferred store of value. This trend begs the question, what happens if the USD loses its world reserve status? What will be the next world reserve currency, and where will that risk-free yield come from?
Earning Yield on the Bitcoin Lightning Network
As it turns out, there is money to be made on the Bitcoin lightning network. It’s not hand-over-fist levels of money, instead it’s a rate of return that is comparable to historical rates yielded by treasuries.
Someone choosing to provide liquidity on the lightning network can earn a risk-free rate of between 2% and 4% APY on their BTC. Although this is not an eye grabbing rate of return, we should double click on the “risk-free” part and dive into what exactly absolves providing liquidity of risk.
Lightning Liquidity is Risk-Free
The lightning network functions by knitting together channels. A channel is a bidirectional pipe through which satoshis may flow. Through a simple set of concepts around how these channels are set up and maintained, free and instant payments with BTC are made possible.
Both parties within the channel maintain their own records of how much of the BTC in the channel is theirs.
At no point in time does either party lose access or control of their bitcoin. In this sense, there are no third party custodians of BTC if channel operators set up their own nodes. Since there is no counterparty risk, there is no risk.
The caveat here is that a lack of knowledge on the lightning network can cause funds to be temporarily inaccessible.
One large side effect and problem of the design of the lightning network is that in order to receive satoshis to your local node, you need someone else to open a channel with you. This can be a challenge for new merchants or entities that will be receiving lots of bitcoin. This is known as the inbound liquidity problem.
So what if there was a way for a merchant to pay someone to open a channel with them? How much would they pay? It turns out that we’re discovering this rate in real time through various lightning liquidity marketplaces. The biggest one in terms of users and volume is the Magma liquidity marketplace built and provided by Amboss.
Introducing LiNeR
LiNeR, or “Lightning Network Rate” describes a rate of return earned by selling liquidity on the lightning network. A useful comparison is the amount that merchants currently pay to credit card providers. Anytime a customer swipes their credit card, the merchant is charged between 1% – 5% of the total value of the transaction.
This is the cost of providing convenient payment methods to the customer, and merchants all over the world pay it. So it makes sense that LiNeR rates sit competitively between 0% and 3%. If merchants wish to provide free and instant bitcoin transactions to their customers, they will either need to figure out their own inbound liquidity, or pay liquidity sellers on a marketplace like Magma.
Although bitcoin is not at the scale of billions of daily active users, figuring out how to make lighting payments reliable is imperative to the success of bitcoin’s use as a medium of exchange. LiNeR addresses this by providing a way for people to profit off of solving the inbound liquidity problem.
These sort of liquidity marketplaces create incentives for people to load their bitcoin onto the lightning channel, strengthening the overall fidelity of the network and increasing confidence in individual payments.
Yield Farming your Bitcoin
In general, it is not recommended to lend your bitcoin to others. The phrase “Not your keys, not your coins” comes to mind. Why would you risk taking a total loss on your bitcoin in exchange for a 5% APY?
Plenty of people do it, but have been burned by Celsius, FTX, or other companies offering high rates of return on BTC. This is another reason why LiNeR is so attractive, as users don’t need to part with the custody of their BTC in order to earn a rate of return.
Even when they’ve opened the channel, the BTC is still in their possession. Even if the BTC slides from one side of the channel to the other, the total balance of BTC on the node remains the same. This is the beauty of the lightning network. It allows node operators to always be in control of their BTC.
The Basis for a Reserve Currency
While this may be a grandiose statement, early speculation on LiNeR and the lightning network more generally says that this forms the basis for Bitcoin becoming a world reserve currency. Optimistically, LiNeR makes the lightning network more robust and brings the whole network closer to being able to guarantee that payments will be able to be sent, regardless of size or destination. That is at least, the ultimate best-case-scenario for the lightning network.
At the end of the day, if bitcoin wishes to become the global reserve currency, it’ll need to solidify its status as a store of value, but also as a medium of exchange and unit of account. Without a high-functioning lightning network with robust and lucrative incentives, bitcoin fights a losing battle in being a reliable medium of exchange.
