Inbound liquidity is an important resource in the Lightning Network. Galoy Research found an error and developed a new business model. It is amazing how their clever solution turned a problem into a million dollars. The case is like reading a detective story. Let’s dive in.
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Liquidity Leechers and Inbound Liquidity
In the article “Galoy research: Structures of Inbound Liquidity Fees that are Self-Balancing,” the company describes the problem to then lay on us the solution. Galoy were the original creators. Bitcoin Beach Wallet, Bitcoinist describes here. The team discovered this irregularity:
“Galoy CEO Nicolas Burtey noticed that the onchain hot wallet was being depleted by a subset of users. These users consistently sent offchain bitcoin to the Bitcoin Beach Wallet only to withdraw it again onchain.”
The company had to “use submarine swaps to replenish our onchain wallet and regain some inbound liquidity.” The thing is, “inbound liquidity is a valuable resource on the Lightning Network. The “liquidity leechers” were using Bitcoin Beach Wallet as a less expensive alternative to a service like Loop from Lightning Labs.”
What does Loop do to manage Inbound and Outbound liquidity?
The service’s official website describes Loops as “the easiest way to manage inbound and outbound liquidity on the Lightning Network”. This service offers two sides. On the one hand, “Loop In enables typical users to “refill” their Lightning wallets when funds are depleted”. Loop Out, on the other hand, is designed for:
“Merchants, services, and users who primarily receive funds via Lightning, Loop Out serves as a bridge, allowing funds to be sent out of the Lightning Network to “on-chain” destinations like exchange accounts or cold storage systems.”
Instead of trying to catch the people who were “using Bitcoin Beach Wallet as a less expensive alternative to a service like Loop,” Galoy developed a product for them.
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The Dynamic Fee
The adventure continues in the following article. “Nicolas and Galoy data scientist José Rojas Echenique set out to diagnose the issue and try to find an appropriate solution”. The duo “first looked at historical data to get a better sense of the problem”. Surprisingly, they found out that “the price of inbound liquidity is roughly similar, no matter how you get it.”
Here’s where the product appears:
“They then looked for a solution that would charge this roughly similar market rate across the full range of use cases – including those using Bitcoin Beach Wallet as a loop out service. A dynamic fee structure was created.As described in this report) that charges each user a fair amount based on how they are using the service.”
Instead of excluding “those using Bitcoin Beach Wallet as a loop out service,” the company included them. The company set a price for the service, and it was pushing. You can see how it works Actual report describe this “dynamic fee structure”?
“From the perspective of user experience, this approach trades high fees for simplicity. It does not account for the balancing effects of a user’s previous or future transactions, and therefore over-charges users.”
“A smoother dynamic fee formula would take into account a user’s previous transactions, and charge users less if their current transaction balanced their previous transactions.”
Similar Business Operation as Always
In three simple steps, you can transform a problem into a product. Back to the article, Galoy states their approach’s value proposition:
“By solving the issue with fees, Bitcoin banks and other Lightning services can continue business operations as usual vs. attempting to detect and regulate actors who use their liquidity for looping.”
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And, to close it off, the company summarizes the product’s advantages. “The result? An automated solution for Bitcoin banks, a good user experience for end users, and the right fees for all.”
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