Lightning 201 Series:
Cryptocurrency markets are fundamentally different in market structure than traditional markets. One of the most unique things about bitcoin is the new market structure it creates. Unlike traditional exchanges, most successful bitcoin exchanges are a brokerage, custodian and clearing house all under one business. This is because when Bitcoin markets started, no institutional entities wanted to take on the regulatory and financial risk of working with bitcoin. This meant savvy cryptocurrency entrepreneurs had to innovate and figure out how to offer solutions to these problems themselves.
The problem that still plagues the cryptocurrency trading ecosystem is how capital inefficient it is to trade on different exchanges. Cryptocurrency markets are capital inefficient because top exchanges do not have shared custodians. This means you cannot share cryptocurrency collateral across exchanges. If you see a trading opportunity on Binance, but all of your collateral is on Coinbase, you need to issue a bitcoin transaction to transfer funds from Coinbase to Binance. According to Binance’s deposit policy, this will take roughly 10 minutes.
This is an eternity in the high frequency trading world and most likely your trading opportunity will be gone.
There is work being done to solve the fiat side of this problem. The Silvergate Exchange Network is a product that Silvergate bank is rolling out. Silvergate is banking these top cryptocurrency exchanges:
With the Silvergate Exchange network, you can now move fiat between any of these 4 exchanges instantaneously. This is great for increasing capital efficiency on the fiat side.
Unfortunately the most liquid markets — BitMEX, Binance, and Bitfinex — are not involved in the Silvergate Exchange Network. To be able to trade between Binance and Coinbase, you still need to pre-fund accounts on both exchanges. This effectively divides your working capital in half as you don’t know which exchange you will need access to your fiat capital.
One other solution to moving fiat collateral is transferring stable coins. Stablecoins have a “host” blockchain that they need to be transferred on just like a normal cryptocurrency. Let’s take USDC as an example — a stablecoin that was created by both Coinbase and Circle. USDC is an ERC20 token which means that the host blockchain is Ethereum. On average an Ethereum block is found every 15 seconds. Coinbase requires 35 confirmations for Ethereum and it’s associated ERC20 tokens. This means for your USDC to be available for trading on Coinbase, it will take 35 * 15 = 525 seconds, or 8.75 minutes.
Each exchange has a different deposit policy, but this is an eternity when it comes to taking advantage of trading opportunities. The orderbook will have changed significantly before you have successfully transferred your stablecoin to a different venue. You have the same speed problem as every native currency on the blockchain has.
With Lightning, capital can be transferred extremely quickly. We have previously discussed the amount of latency required to make a Lightning transaction. It takes roughly 1 second to transfer money from one entity to another. Optimizations can be made to make this transfer even faster. This is fast enough to plausibly be able to transfer money in between exchanges for a specific trade. Thus increasing capital efficiency of the cryptocurrency market.
This means you do not have to pre-fund collateral across every exchange you would like to trade at. You can issue a Lightning transaction and have your Bitcoin collateral be fully settled with the exchange in a matter of seconds and be available to trade. With this speed, you can increase your trading speed by two orders of magnitude. Since you can trade much quicker, you can re-use your capital to take advantage of different trading opportunities that exist. Your bitcoin is no longer unavailable for 10s of minutes while it is being transferred from one exchange to another.
Currently the Lightning network only supports Bitcoin and Litecoin but in the future it will support other assets such as stablecoins. This means that traders can take advantage of Lightning for arbitrage with all cryptocurrency assets.
For exchanges to facilitate high-frequency trading in cryptocurrency, they need to adopt Lightning as a withdrawal and deposit mechanism. For more information on what is required for an exchange to integrate Lightning check out our Lightning 101 for Exchanges blog post series. With higher frequency trading spreads will shrink across exchanges and liquidity will increase. More liquidity will attract more traders which will generate more revenue for your exchange.
All of our API services, for both Cryptocurrency APIs as well as Sports APIs, are built using Lightning technology and the Lightning Network. All API services are live on Bitcoin’s mainnet. Our fully customizable data service allows customers to stream as much or as little data as they wish and pay using bitcoin.
You can connect to our Lightning node at the url:
If you are a company or cryptocurrency exchange interested in learning more about how Lightning can help grow your business, contact us at [email protected].