Everyone has come across the Chinese saying British misattribution: “May you exist in captivating times,” and how it’s thought of as a curse. It feels profound, akin to a quote made for edgelords over the age of 80.
But have you ever pondered the alternative? As per the Anglo-Saxon Chronicle, there were close to two hundred years during which very little occurred. Vivian Mercier famously described Waiting for Godot as “a play in which nothing occurs, twice.” But nothing happening 191 times? I’d prefer interesting times every single day.
And that’s precisely what we have at present. Tether, along with their stablecoin USDT, are arriving at Lightning. We’ve had numerous discussions lately about how Lightning is the universal language of the bitcoin economy and how bitcoin functions as a means of exchange (and it genuinely does; check our report).
These two arguments now appear to be aligning. Thanks to Lightning acting as a universal language, it transforms bitcoin into a compatible asset with various adjacent technologies, including USDT. And USDT will supercharge bitcoin into fresh use cases, new markets, and new challenges on a scale that the Lightning ecosystem has yet to witness.
Given the option, I’d prefer to leap headfirst into the unfamiliar rather than lounge on the couch for the afternoon. All the exciting experiences await in the unknown. (Image: pxhere)
Given the option, I’d choose to leap headfirst into the unfamiliar rather than lounge on the couch for the afternoon. All the exciting experiences await in the unknown. (Image: pxhere)
USDT on Lightning is an uncharted territory. Captivating times indeed. So let’s contemplate what it signifies for USDT to integrate with Lightning and for Lightning to facilitate USDT — the possibilities, the hazards, and the countless open questions.
Lightning was initially designed to enhance the throughput of the bitcoin blockchain, so bitcoin was intended to be its sole cargo. Taproot Assets is a new protocol that facilitates the transmission of fungible assets (e.g., stablecoins) over Lightning as hashed metadata utilizing the same infrastructure employed for processing bitcoin transactions.
The process is relatively straightforward for anyone familiar with Lightning. The recipient creates an invoice that queries edge nodes (i.e., the nodes connecting users to the broader network) for exchange rates between bitcoin and the asset in question — USDT in this instance. Once the user agrees to an edge node’s exchange rate, they create an invoice for the payment and send it to the payer. The payer transfers the asset to the edge node on their side, the edge node converts everything into a standard-looking bitcoin transaction, the transaction moves through routing nodes across the network as usual, and then the edge node on the recipient’s end converts the payment back into the original asset (USDT) and sends it to the recipient.
Taproot Assets harnesses the flexibility of Lightning and bitcoin, enabling users to transfer new types of assets across the network, utilizing bitcoin as the universal medium of exchange. One outcome of all nodes communicating over Lightning is that any routing nodes between the edge nodes only perceive BTC in transit. Lightning instructs them on how to move BTC, and that’s the extent of their knowledge. Remarkable.
Nevertheless, there’s more than just technical details to consider. USDT is, after all, a significant means of exchange. Tens of billions of USDT worth moves daily across millions of transactions. Its daily trading volumes are comparable to the Brazilian real and the Indian rupee. This is noteworthy. So what implications does Lightning hold for USDT, and what does the inclusion of USDT signify for Lightning?
… for Bitcoin
To this point, much of the strategy for incorporating bitcoin into commerce has concentrated on promoting as many people as possible and expanding the circular economy one individual at a time. This approach may have reached the limits of its scalability. The circle has dramatically expanded in the last fifteen years, yet it remains constrained, and we must think in terms of millions simultaneously.
Now that USDT and BTC are natively compatible on Lightning, the circle has developed tangents. With USDT on Lightning, each participant in a transaction — the payer and the recipient — can decide whether to utilize BTC or USDT on their respective ends, independent of each other’s choices. A customer might pay with BTC, while the merchant accepts USDT. Alternatively, the customer could pay in USDT, and the merchant could receive BTC. They both could also employ the same asset. It simply does not matter. Once both assets are native to Lightning, they become automatically and frictionlessly interchangeable. Everyone is free to choose either bitcoin’s benefits as a means of exchange, nurtured from the ground up by the users, or USDT’s advantages as an asset with a price steadiness comparable to US monetary policy and Tether’s liquid reserves.
Lightning and, consequently, bitcoin stand to gain millions of users and billions in spending power. This marks a qualitative advancement in bitcoin’s utility. The new use cases will benefit bitcoin more than a heap of orange pills. It also has the potential to create a quantitative explosion for Lightning. Many of those new users might remain unaware that they’re utilizing Lightning, thanks to its effectiveness as the common language.
of the bitcoin economy. Yet, we experienced Lightning enthusiasts understand. This is the goal we have been striving for.
After mentioning that Lightning would simplify USDT access for American users, it’s important to note that USDT will simultaneously ease their usage of Lightning. American tax policy categorizes BTC as an equity, making every transaction a potentially complicated series of tax implications. However, if US citizens can utilize Lightning with an asset that incurs no capital gains, they can enjoy many of Lightning’s benefits without encountering one of its specific regulatory challenges.
…for Tether
Tether generally issues USDT on recognized blockchains that have gained notable market traction, and they hold no desire to develop their own. USDT is presently offered on Algorand, Celo, Cosmos, Ethereum, EOS, Liquid Network, Solana, Tezos, Ton, and Tron. It’s important to note that all these are proof-of-stake (PoS) blockchains (with the exception of Liquid, which employs a federation), thus they are inherently more centralized compared to bitcoin.
These blockchains also encounter varying compromises. Although Ethereum is comparatively decentralized for a PoS blockchain, its transaction fees are famously high. In contrast, Tron is more affordable. Perhaps that explains why, according to one assessment, nearly seven times more monthly active retail USDT users prefer Tron over Ethereum and transfer eight times more retail volume on Tron. Yet, Tron is significantly centralized, creating a potential bottleneck for USDT. Should Tron fail, Tether would likely forfeit roughly half of its overall capacity across all blockchains. That’s quite a hit. By enabling USDT transactions through Lightning, which is inherently decentralized, Tether reduces its reliance on inexpensive, centralized blockchains.
Moreover, Lightning could enhance the convenience of USDT usage within the US market. US exchanges often restrict USDT transactions to specific blockchains. For instance, Coinbase states “Coinbase solely supports USDT on the Ethereum blockchain (ERC-20). Please do not send USDT via any other blockchain to Coinbase.” Lightning provides major exchanges such as Binance, Coinbase, and Kraken (which already support Lightning) a decentralized option for USDT transactions to present to their users.
The new US administration has proposed onshoring the entire stablecoin sector and indicated that regulating it is their “top priority.” In simple terms, they will be closely monitoring every development. As long as stablecoins like USDT maintain a dollar peg, those who govern the dollar and derive profit from it will strive to exert control over the stablecoins as well.
Regulators appear to believe they can enhance freedom through regulation. This impulse is innate to them. However, it follows that as USDT becomes more functional on Lightning and Lightning becomes increasingly useful for transferring USDT, we will all draw more attention from regulators. It’s hard to predict how much they’ll actually be able to intervene or what strategies they’ll pursue, but it likely won’t be enjoyable. Regulation inevitably introduces friction.
One domain likely to experience regulatory focus is the edge nodes. Traditional centralized exchanges often must adhere to KYC/AML obligations in numerous jurisdictions. If the edge nodes automatically exchange USDT and BTC while forwarding payments, they may closely resemble conventional exchanges to regulators, who typically oppose decentralization. 🙄
What’s the Cost? What’s the Value?
While Lightning brings considerable advantages to users and USDT alike, it’s not universally the ideal solution for every payment involving USDT. Lightning users expect minimal fees, and so do USDT users utilizing centralized blockchains and custodial exchanges. However, integrating a second asset into Lightning introduces essential financial factors that all parties—including routing nodes, users, and especially edge nodes—must take into account.
Initially, the edge nodes are fulfilling the usual roles of Liquidity Service Providers (LSPs)—ensuring that users are connected to the network with sufficient channels and liquidity for seamless payments—in addition to asset conversion. This conversion represents a valuable service that warrants compensation and also carries risk (refer to further details below).
Secondly, USDT is likely to dramatically increase transaction volumes, indicating that LSPs and routing nodes will need to maintain greater liquidity on the network to process those payments. Unlike custodial exchanges that merely need to update their internal ledgers, these nodes must comply with the economics of liquidity allocation, which are amplified in this scenario.
Will Lightning effectively compete with centralized blockchains like Tron for USDT transactions? The response will likely mirror the answer to most inquiries about aligning technologies with usage scenarios: every technology possesses distinct strengths and vulnerabilities, making it suitable for certain situations but not others. As always, the market will determine the optimal solution. However, since the technology was not specifically designed for this use case, price discovery will be a gradual process involving trial and error.
Free Call Options? Oh dear.
Edge nodes confront the danger of the “free-call-option dilemma,” which is compelling enough to warrant its own examination here. This represents a new risk and is intrinsic to any scenario integrating two assets in a single Lightning transaction.
Lightning transactions must be finalized within a specific timeframe to ensure settlement, or the invoice automatically cancels. This timeframe is the “T” in HTLCs — hashed, time-locked contracts.
When the edge nodes place bids with their exchange rates for a USDT↔BTC transaction, they formulate their bids based on factors such as their present liquidity status and the spot price. However,
The individuals possess a timeframe between approving the edge node’s proposal and the termination of the HTLC to finalize the transaction. Exchange rates can fluctuate within that timeframe. If I commence a USDT transaction at a specific rate, I can wait until the rate shifts in my favor before I disclose the preimage to finalize it. If the rate shifts unfavorably, I simply refrain from releasing the preimage. In such a scenario, the edge node might pursue a channel closure to reclaim their funds, but this is a slow (and thus expensive) procedure. If it adjusts in my favor, the edge node is liable for the difference. In one case, I lose nothing. In the other, I profit from the edge node.
Transactions encompassing any assortment of assets on Lightning provide the user a call option. Conventional financial entities mitigate their downside risk in selling call options by incorporating the risk into the price. These options can become quite costly for unprepared edge nodes. Just consult Kilian and Michael at Boltz, who initially highlighted this entire matter to my attention and graciously explained it for all of us in the ecosystem. An alternative is for the edge nodes to incorporate the call option into their quotes, much like traditional financial institutions. Intertemporal arbitrage is excellent work if you can secure it.
Users aren’t the sole source of concern for edge nodes either. If a routing node fails to transmit the preimage — whether intentionally or due to a malfunction — the edge node could still bear responsibility. At least with routing nodes, it may be possible to implement some type of reputation system to facilitate route selection. However, a reputation system for end users might prove impractical as new users will continually join the network.
The complimentary call options have never posed an issue for Lightning until now because the network has only dealt with a singular asset: bitcoin. If the problem of free options became severe enough, one could envision multiple parallel, single-currency Lightning Networks developing. One for bitcoin. One for USDT. Another for … If bitcoin is excluded from the equation, we will forfeit the advantages of bitcoin interoperability. We might even find ourselves regretting introducing USDT onto Lightning in the first instance.
Bitcoin was always intended to be groundbreaking. Disrupting flawed fiat is the entire objective and always has been. We’re in it for the revolution. We recognize that alteration and disruption was never going to be a seamless journey.
However, change is a positive development. Progress is merely a form of change that people embrace. We welcome USDT on Lightning because we perceive the opportunity. It can signify progress for USDT users, for Lightning, and for bitcoin.
Like any transformation, though, it’s going to necessitate thoughtful consideration, preparation, keen instincts, and swift responses. You don’t enter uncharted territories without the appropriate gear and some skills. Anyone engaged in the Lightning liquidity sector will confront new challenges, but also stands to achieve substantial benefits.
Tether stands to acquire an economical, decentralized distribution framework and enhanced access to the crucial US market. Lightning stands to gain a substantial influx of liquidity and users. Bitcoin will be inherently interoperable with USDT. That’s why there’s such enthusiasm.
However, regulators are observing. And edge nodes will only provide the necessary conversion services if doing so is lucrative, not detrimental. Thus, let’s approach this transformation as we do all new advancements in Lightning: through careful contemplation, meticulous design, fortifying our code, preparing the market, and maintaining focus on our ultimate aim, which is to achieve the universal bitcoin economy.
This is a guest article by Roy Sheinfeld. Views expressed are entirely his own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.