[Lightning-dev] An Argument For Single-Asset Lightning Network

Tamas Blummer tamas.blummer at gmail.com
Fri Dec 28 22:25:20 UTC 2018


Hi ZmnSCPxj,

You are right that an exchange can not simply embed the option into the offer price as there is no payment in case the offer is not taken,  so nothing would pay for their hedging costs.

This however is not a unique situation, but people deal with it frequently. Every offer has a timespan within which the market maker can not back out, and in your language writes a free option. 
That timespan might be very short on an electronic trading platform or rather long in trade finance. Bid-ask spreads of the offer reflect that and those making the offers manage or at least limit the market and liquidity risk of outstanding offers.

Just because there is no trustless automated solution in sight, we should not assume things will not exist. In contrary, this imperfection will invite people offering a service for profit.

Tamas Blummer


> On Dec 28, 2018, at 22:22, Tamas Blummer <tamas.blummer at gmail.com> wrote:
> 
> Hi ZmnSCPxj,
> 
> Making an asset swap offer using HTLC ties up funds and the offer may be taken up-until  the timelock expiry.
> Therefore making such an offer implies both opportunity cost and a premium for optional exercise.
> 
> There is no mechanism in LN to require compensation for above costs, therefore you imply that no sane person would make such an offer.
> 
> I think, that instead exchanges will still make such offers but with an exchange rate between the assets that compensate them for the cost they incure by making the offer.
> Exchanges will also limit the quantity of outstanding offers, so they can manage the risk of options written. This might lead to making offers only to known traders or to those,
> who pay for receiving an offer with a regular LN payment in-advance.
> 
> Tamas Blummer
> 
> 
> 
>> On Dec 28, 2018, at 04:34, ZmnSCPxj <ZmnSCPxj at protonmail.com> wrote:
>> 
>> Good morning Tamas,
>> 
>>> Although there is no escape from above reasoning, a market maker could still be profitable as long as the option is worth less than the bid-ask spread.
>>> Therefore the issue does not mean that LN cross asset exchange is not feasible, but that there is lower bound on bid-ask spread, that of the option premium.
>> 
>> The option premium cannot be charged in the not-exercised branch.
>> This is effectively a premium-free option.
>> This means that rational entities who know of this technique will create options "for free" until the exchange runs out of liquidity.
>> This is because, even if the exchange rate does not go beyond the bid-ask spread, the not-exercised branch is free of charge.
>> 
>> Since all their liquidity is tied up in premium-free American Call Options, exchange nodes cannot usefully bridge between a BTC Lightning Network and any other asset.
>> Routing attempts will usually fail.
>> In a very practical sense, it would not be possible to create a multi-asset LN.
>> 
>> 
>> --
>> 
>> I had long ago figured out that HTLCs can create American Call Options (more than a year ago).
>> The problem was that they tied up the assets involved into the contract, so I never bothered to publish this insight.
>> However, on LN, HTLCs are created "for free" with no payment, which is a significant advantage to the user of an American Call Option, who would be quite willing to tie up their funds in HTLCs since the not-exercised branch of the American Call Option formed was free of premium.
>> Their only cost is opportunity cost, and on the LN, with tiny tiny tiny fees, opportunity cost of having the funds free is very small.
>> One can say that the opportunity cost is the premium paid, but note that it is not paid to the exchange, since the exchange itself is also forced to tie up its other asset into another HTLC (meaning it also pays the opportunity cost).
>> 
>> What I suspect will happen is that the LN on the weaker asset (i.e. less popular, fewer users, etc.) will find itself unable to be paid by the LN on the stronger asset.
>> This will weaken the weaker asset even further (users will leave it for the stronger asset).
>> This creates a shift in exchange rate, which is precisely what the American Call Options are waiting for.
>> These American Call Options drain funds from the exchange, until the exchange stops being profitable and stops operating as an exchange, again further weakening the weaker asset as it is now even harder to pay from the stronger asset network to the weaker asset network, and so on.
>> 
>> 
>> Regards,
>> ZmnSCPxj
> 



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