Economics
Lightning Economics
P2P Payments
The Lightning Network leads as the overlay micro-payment network for Peer-toPeer (P2P) payments using Bitcoin, with strong potential to move into other layer-1 consensus protocols.
The emergence of so-called “Lightning Apps” (Lapps) creates the economic basis for processing transactions via decentralised applications on the LN. Lightning Service Providers (LSPs), whether centralized or decentralized, regulated or unregulated, or a mix of all, are creating new opportunities for transaction-based services such as P2P payments that can be offered by Lightning Nodes or lightning hubs.
Re-imagining how money flows over P2P systems in the future helps convey the potential of lightning payments and its ecosystem. There are many use cases for instant, high-volume, low-fee payments in cryptocurrency. Technological trends such as machine learning and artificial intelligence can be easily linked to lightning transactions. Metered payments for machine-to-machine (M2M) payments amplify the value proposition of the Internet of Things (IoT).
Furthermore, micro-payments are useful when streaming content over the Internet. Lightning-enabled cryptocurrencies allow for innovation in payments and make the streaming of money possible. The graphic below shows the Lightning Network in 3D and illustrates how a decentralized infrastructure with fluid transaction flows mesh.
In general, P2P networks can be distinguished on the architecture level. The first type refers to structured P2P networks, the second to unstructured P2P networks. Payment systems with a P2P messaging layer but a centralized settlement layer are structured. Payment systems with a P2P messaging layer and a decentralized settlement layer are unstructured.
The P2P setup of the LN can be better understood by bringing the distributed architecture of traditional payment networks to mind. In current mobile payment applications, individual devices can message directly with one another. This messaging layer represents a P2P network using a mesh topology. In a mesh network, users, devices, or nodes connect directly and non-hierarchically. However, within conventional mobile payment applications, users link bank accounts and card data to the network. Although the topology of traditional mobile payment applications is P2P mesh on the user interface level, the settlement layer remains centralized on the infrastructure level. Underneath, transactions are processed among financial intermediaries.
Technically, mobile payment applications are hubs with transactions including Person-to-Business (P2B), B2B (Business-to-Business), and Business-to-Person (B2P). Such hubs are structured hierarchically where transactions occur indirectly via the platform. Under the hood, current mobile payment applications use payment service providers (PSPs) and/or act as financial intermediaries, transferring money and holding funds of third-parties. From a regulatory perspective, no P2P transactions occur when the clearing and settlement mechanism is centralized.
In contrast, the Lightning Network is unstructured, whereby the messaging layer and the settlement layer are both decentralized. Other than fiat transactions, funds are controlled by users, not of financial intermediaries. In this regard, the LN constitutes a complete P2P network. Mesh topology is applied fully. Each node functions as a router. This routing layer allows nodes to cooperate with one another to efficiently route transactions through payment communication channels of intermediate nodes that pass data along.
The functioning of the LN can be further clarified by taking a closer look at the characteristics of traditional payment networks. Apart from central clearing houses or card schemes, which act as specialized financial intermediaries for settlements among banks and do not use P2P structures, traditional finance has always been familiar with P2P payments. The transaction flows of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) correspond with the P2P concept. In general, SWIFT uses P2P payments between banks for international transfers, as shown in the transfer message diagram below:
Key money transfer messages:
- MT 101 – Request for Transfer
- MT 103 – Single Customer Credit Transfer
- MT 202 – General Financial Institution Transfer
- MT 202 COV – General Financial Institution Transfer for Cover Payments
For clarity, SWIFT is a global network connecting banks for communicating messages about financial activities like money transfers. The SWIFT network links members for processing payment instructions and enables the secure movement of financial messages. As such, SWIFT is not a financial intermediary that provides centralized custody services to hold and move funds but instead is a general ledger with a centralized database that records transaction information privately as compared to a blockchain, which is a specific type of a distributed ledger with a replicated database shared publicly or privately. Via SWIFT, assets are held by banks and balanced based on individual agreements and reciprocal credits among correspondent banks.
Essentially, SWIFT offers payment communication channels for transactional data. In the widest sense, this non-custodial concept is reassembled when connecting Lightning Nodes among each other for communicating transactional data that give access to money. However, there is one major difference: Funds are held in payment channels over the LN and secured by the Bitcoin blockchain powered by multi-signature Bitcoin-based smart contracts to send transactions among peers.
Like SWIFT, the Lightning Network is global. Unlike SWIFT, however, participation is permission-less and only requires a Lightning Node and/or a wallet app on a smartphone. This technical framework means users can transfer their own funds among peers nationally and across borders without the need for a regulated financial intermediary go-between. Consequently, no financial license is required to participate if Lightning Nodes do not provide custodial services to hold and process funds or third parties.
Also, Real-Time Gross Settlement (RTGS) systems run on P2P rails. RTGS are special money transfer systems in which the transfer of money or securities from one bank to any other bank takes place on a gross basis at the national level. RTGS systems are operated by central banks transacting with high value payments, compared to the LN that is focused on micro-payments. The Schematic representation of how an RTGS payment is exchanged and processed in the network is shown below:
It goes without saying that central banks are state institutions. They capitalize on seigniorage through the issuance and control of fiat currencies with a focus on assisting financial intermediaries that offer custodial services. Therefore, they rarely have the intention of supporting private forms of money such as open-source cryptocurrencies running on decentralized networks that bring non-custodial solutions to the masses across borders. Nonetheless, major central banks have rapidly increased their research and development efforts in central bank digital currencies (CBDCs) in recent years, with P2P payments being discussed in-depth. In essence, these network principles apply to both centralized and decentralized systems, regardless of whether fiat or cryptocurrencies are used, regardless of whether permissioned or permission-less distributed ledgers are involved and regardless of whether large-value payments or micro-payments are processed.
