Are you using your capital efficiently? A deep dive into what the Lightning Network enables for traders

What are futures?

In cryptocurrency markets there are two main market types, Spot markets and Derivative markets. Spot markets are relatively straightforward, a trader sets the price at which they want to buy or sell an asset (e.g. Bitcoin for USD). If another trader is willing to trade, the exchange occurs with each trader physically owning the said asset.

Contracts expire, but perpetuals do not.

To enable derivatives markets for illiquid assets, economist Robert Shiller proposed the idea of perpetual futures in 1992. Based on Shiller’s idea, Bitcoin derivatives exchange, BitMEX, implemented a perpetual futures contract for Bitcoin in 2016. The perpetual contract is a futures contract without an expiry date, allowing traders to hold Bitcoin exposure indefinitely without paying the extra costs to roll-on or ‘refresh’ a futures position onto a future dated contract. Today, perpetual markets are the most liquid markets in the cryptocurrency world. They facilitate many trillions of dollars worth of volume (last quarter the top 9 derivatives exchanges processed $5.6 trillion in BTC perpetual trading volume) and continue to become more and more popular. Arguably, they’re the most popular cryptocurrency product to date.

The arbitrage trade

So now you know what perpetuals are, and you know that their price is encouraged to move towards (converge) the index price over time. So what is the significance of this for traders, and how does it apply to crypto? Well sometimes there’s an arbitrage opportunity here called the ‘cash and carry’ or ‘basis’ trade, and it relies on convergence.

So how does the Lightning Network help traders?

The Lightning Network offers an off-chain transaction model for Bitcoin that enables:

  • Instant Transactions. Instant transactions without relying on block confirmation times and using a security model enforced by the Bitcoin Blockchain, but without posting transactions to it.
  • Fee reduction during busy times. Lightning Network transactions are settled off-chain, so it has exceptionally low fees (sometimes 0), making micropayments possible in real-time.
  • Scalability. The Lightning Network is capable of sending billions of simultaneous bitcoin transactions per second across the network.
The Lightning Network is taking us to new places (Image:

Arbitrage trades using Lightning

Lightning is not changing the type of trade, it’s changing HOW it’s traded. Let’s use the same cash and carry trade from above to demonstrate what changes if exchanges supported Lightning.

The Lightning Network can benefit every trader

The Lightning network enables different things for different people. But for traders in particular, it allows them to execute faster, manage counterparty risk more effectively, and utilise their entire trading balance. In the case of derivative traders, using Lightning for Bitcoin settled positions may enable them to manage their risk more carefully and potentially help them avoid being liquidated when they don’t have enough margin to cover their position. The most important aspect is that Lightning brings these benefits to every trader, not just a select few with additional capital and access to a variety of third party providers that enable them to execute faster, safer, or better.



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