Bitcoin’s Lightning network operates on top of the Bitcoin blockchain. For layer 2 to function and deliver global, instant, and zero-fee transactions, nodes must join the network and provide liquidity, otherwise known as capacity.

Lightning network capacity is the liquidity function of the network. With more liquidity, the network can send a higher volume and value of total payments.

Below is a visual showing the Bitcoin blockchain on Layer 1 (bottom). Next, you see the second layer, the Lightning Network. This illustrates the network's Peer-to-peer (P2) connectivity function and how nodes connect to send payments. The orange represents nodes, and the lines are the connectivity (channels) between the nodes.

What does increased Lightning network capacity mean?

As Lightning Network capacity increases, the network typically increases its average channel size. You can find that data live here on Bitcoin Visuals.

I want to point out the fact that the dollar value of Bitcoin does not purely drive increased channel size at any certain time. While volatility has been high, the average channel growth has not deviated from volatility.

Here are the average channel sizes comparing 2021 to 2022, nearly a 100% increase:

• November 2nd, 2021 - 2,873,777 sats ($61,121 per btc price)
• November 2nd, 2022 - 5,892,074 sats ($20,162 per btc price)

July of 2021 is when capacity within the Lightning network began moving upward at a parabolic rate. In April of 2021, Bitcoin was at $63,000, and by July of 2021, the price had fallen below $30,000. November 9th, 2021 we hit the Bitcoin ATH of ~$68,000, and since then capacity has continued on a strong upward trajectory.

The motivation and incentive to add capacity

Even with price volatility, the average channel size continues to increase. One of the motivations of Lightning node runners is to become a reliable node and a routing hub within the network. 

Node runners collect fees for routing payments successfully. As nodes increase their reliability, they earn trust within the network as high-quality nodes. You can view insights into the top-performing nodes on Lightning Terminal.

As node runners create value within the network, there is an incentive to sell inbound capacity to new peers coming onto the network. This is done through tools like Amboss Magma or setting up liquidity ads in core lightning.

Two potential incentives to open new larger channels

• A larger channel capacity creates a higher probability of a channel being capable of routing more payments than a smaller channel. The less a channel has to rebalance, the lower operational costs node runners have to pay.
  
• Larger channels today that provide value have an opportunity within the lightning implementations algorithm to be the chosen path either based on price, payment success, or other factors.
  • We also do not know the algorithms of tomorrow, but they likely will favor age in some way, shape, or form.

While the first point is generally understood to be true, the second is not 100% clear as of this writing. CLN at the time of this writing uses probabilistic payments (learn more in section 4 of this MIT documentation) - not all lightning implementations have this functionality yet.

Can lightning channel capacity be used for more than payments?

The short answer is yes. Over time, I see a world where institutions may set up a node and never actually make a payment themselves. 

With advancements like Taro, the capability for node runners to help transfer issued assets on the bitcoin blockchain becomes a possibility.

Taro enables the ability to embed asset metadata within an existing output. This means the ability to move assets around on top of the lightning network. 

I foresee that capital allocators will spin up nodes to leverage portions of their Bitcoin treasury to earn yield by routing whatever assets are on top of the lightning network. Time will tell if this comes about. The incentive is there. It also must be stated that endpoints of transactions will be regulated; sending and receiving nodes will be regulated as they send assets with varying values. 

Concluding

Lightning capacity is the backbone and liquidity between nodes within the Lightning network. Every new node joining the lightning network must provide liquidity to spend. Local capacity is for spending; remote capacity is for receiving. 

Capacity has the potential to be leveraged to route assets with the Taro protocol. While still in the alpha testing stages, established nodes likely will benefit from the protocol going live as they are reliable routing nodes on the network.

Thanks for reading!

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