Channel Setup (work in progress).
Basic Economics of Bitcoin LN (work in progress).
0. What is Bitcoin LN and Should I set up a Node?
In short, Bitcoin LN allows for small bitcoin transactions to be made more quickly and cheaply than on the Bitcoin block chain.
Bitcoin LN runs as a side chain to Bitcoin whereby nodes provide a service by locking a portion of their Bitcoin on the blockchain and then enter into an off-chain contract with another whereby they swap Bitcoin between each other in quantities up to that locked amount. At any time, either of the two nodes can end their relationship (known as a channel), and the locked bitcoin on the chain is split between them according to their final balance with each other.
A large network of these nodes makes it possible for anyone to transfer bitcoin via a series of node-to-node channels. For example, if I am connected with Johnny, I can push funds to Johnny and then through Johnny’s channel with Mary, in order to get funds to Mary.
I recommend the first ten minutes of this video by BTC Sessions in order to better understand Bitcoin LN.
Next, some Q&A on setting up a node:
Q: What does it cost to set up a node?
A: The direct cost is about €200 if you build a Raspberry Pi based kit. It’s not a cost, but you also do need to lock up Bitcoin in order to create Bitcoin Lightning channels. A good node will have at least ten channels with 2,000,000 sats (0.02 BTC) per channel. For reasons we’ll get into later, you’ll need to lock up about half of this amount in BTC to set up the channels. So, you’ll need 10 * 2,000,000 * 0.5 = 10,000,000 sats (0.1 BTC) to set up a decent channel. As of August 2021, this is about €3,300 worth of Bitcoin.
Q: Will I make money on BTC Lightning?
A: Probably not. I’ll detail this more in the basic economics section, but – at best – I think it may be possible to earn a small single digit return on your locked Bitcoin. More likely, you’ll lose money on the fees to set up channels. So, I don’t recommend doing this unless you are curious and value the learning.
Q: What are some of the risks of setting up a node?
A: It is possible that you lose the data supporting your channel if you don’t back it up properly. This can result in all of your locked Bitcoin being lost. As with any crypto protocol, there is a risk of bugs in the software resulting in loss of funds. The regulatory status of running a bitcoin node is not always clear, nor are necessarily the tax consequences. These are just some of the risks to consider and there are certainly more.
1. Notes on Hardware Setup
It’s possible to run a node on most computers, but you probably want to buy a dedicated one because a node requires decent storage space and will need to run 24/7 . The cheapest option is probably to buy a Raspberry Pi.
For software, there are a few options but the only one I considered was Umbrel.
In short, I set up my LN node using a Raspberry Pi and Umbrel. A few notes on how to do this:
a. Navigate to https://getumbrel.com/#start and click on the guide for Raspberry Pi 4.
b. The guide is very comprehensive and indicates what components you need to buy and how to flash the Umbrel software onto your Raspberry Pi. Don’t forget to additionally buy a 32 GB SD card (this is only mentioned later on in the Umbrel tutorial).
That’s it for this week, next week will be more on channel setup. Subscribe on Pinotio.com to get the weekly update.