Good morning,

> On 3 Jan 2019, at 13:04, ZmnSCPxj <> wrote:
> Good morning Lawrence,
> While true, on Lightning, interest earnings are ***tiny*** enough that the 
> premium "paid" in this manner is minimal.
> Increase in alternative interest earnings for Bitcoin on non-Lightning 
> alternatives would also cut down the available liquidity on Lightning and 
> increase Lightning fees.

If the contract issuer and recipient are different people, the issuer would 
charge an option price or premium, x_p, which would depend on volatility. 

If the issuer and recipient are the same person, they are guaranteed a loss.

> Further, the current nature of cryptocurrency assets is highly speculative 
> and large swings in exchange rates in short time frames are typical.
> Thus the premium paid is minimal compared to the upside of the speculative 
> call option.

This would be reflected in the premium calculated by the contract issuer; x_p 
increases with volatility.

> Finally, the massive problem here is that the exchange, which enables 
> cross-asset swap, is itself obligated to lock the asset to be called in the 
> contract.
> In particular, the "premium" is ***not paid*** to the exchange node; instead, 
> the "premium", such as it is, is split between both the exchange and the user 
> of the American Call Option, and is paid as a temporary decrease in the 
> supply of both assets to the rest of the economy.
> The galling part is that it violates the principle of "initiator pays", since 
> the exchange, which passively advertises its service, does not initiate the 
> creation of the American Call Option yet is forced to pay for its existence 
> by locking its own assets.

The initiator pays an opportunity cost by depositing funds into the exchange.

> Given this, the logical consequence is that on-Lightning exchanges will 
> increase, probably greatly, their bid/ask spreads on Lightning compared to 
> custodial exchanges, increasing market friction on cross-asset payments on 
> Lightning.
> This means that rational payees may find it more lucrative to accept the more 
> popular asset, identify a "trustworthy" custodial exchange, and use the lower 
> bid/ask spread on such a trust-based exchange to get more of their desired 
> target asset compared to being paid on Lightning.
> The end result is the Lightning network primarily settling on the most 
> popular of the assets, i.e. Bitcoin.
> Regards,
> ZmnSCPxj
> Sent with ProtonMail Secure Email.
> ‐‐‐‐‐‐‐ Original Message ‐‐‐‐‐‐‐
> On Thursday, January 3, 2019 8:07 PM, Lawrence Deacon 
> <> wrote:
>> Do cross-asset lightning nodes do not offer premium-free American call 
>> options?
>> =============================================================
>> I would argue that cross-asset lightning nodes do not offer premium-free 
>> American call options for the following reasons.
>> Say I wanted to set up to purchase 1 WJT for P bitcoins at time t < T where 
>> t is the time I close the contract and T is the expiry time.
>> In order to set up the contract I must pay P bitcoins to the contract, 
>> incurring an opportunity cost of x_i1. Assuming we set up the contract at 
>> time t_0=0, this will be equivalent to the money I could have earned by 
>> loaning the currency at interest during the period t. 
>> I must also pay the issuer of the contract a premium x_p (in the case where 
>> I am both recipient and issuer, see further down).
>> If S(t) is the spot price at time t and K = S(t) - P then the payoff for me 
>> is as follows:
>> S(t) > P:        K  - x_p  -  x_i1 
>> S(t) < P:        -x_i1 - x_p
>> If x_i2 is the opportunity cost of paying 1 WJT to the contract for time t 
>> then the payoff for the other party (issuer) is as follows:
>> S(t) > P:        -K + x_p - x_i2
>> S(t) < P:         x_p  - x_i2
>> If x_p = 0 then the issuer is guaranteed a loss. Therefore no rational 
>> contract issuer will issue an American call option for free.
>> In the case where I am both recipient and issuer of the contract, to get the 
>> payoff we add the above payoffs:
>> S(t) > P:         -x_i1 - x_i2
>> S(t) < P:         -x_i1 - x_i2
>> This is a guaranteed loss.
>> Conclusion
>> ========
>> Lightning nodes do not offer premium-free American call options because 
>> whether or not the contract and issuer are the same person, setting up a 
>> premium free American call option using a HTLC guarantees a loss for one or 
>> both parties. Even if the opportunity costs were 0, then setting up a 
>> contract with myself would have a guaranteed 0 payoff.

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