Skip to content

Ark liquidity

When users perform operations that require on-chain bitcoin—like refreshes, offboards, and Lightning payments—the Ark server must deploy bitcoin upfront while waiting to sweep equivalent amounts from spent VTXOs after they expire. This is known as liquidity, and it creates ongoing capital requirements on the Ark server that fundamentally shape the protocol's economics and fee structures.

Unlike Lightning, where users are ultimately responsible for their own (channel) liquidity, Ark shifts the liquidity management burden entirely to the Ark server, relieving users of this complexity (although they'll still need to cover the liquidity costs).

Diagram of how liquidity works

Simplified example of Ark liquidity in action: Users refresh expiring VTXOs. The server deploys 10 BTC immediately to fund new VTXOs, but must wait for the old round's timelock to expire before reclaiming the 10 BTC from the forfeited VTXOs—creating a temporary capital requirement.

Liquidity-requiring vs liquidity-free operations

Liquidity-requiring operations

These operations require Ark servers to deploy bitcoin upfront (while waiting for spent VTXOs to expire before sweeping equivalent amounts):

  • Refreshes: The most common liquidity operation. Users forfeit old VTXOs in exchange for new ones with fresh expiry times.

  • Offboarding: Moving bitcoin back on-chain via a cooperative withdrawal from the Ark server.

  • Lightning payments: The server delivers bitcoin payments through the Lightning Network, via the Lightning gateway.

Liquidity-free operations

  • Ark payments: Payments between Ark users happen out-of-round and require no liquidity—they simply extend existing transaction trees.

  • Unilateral exits: Users broadcast their VTXO's pre-signed transactions, requiring no server involvement or liquidity provision.

Liquidity costs and economics

To provide liquidity for Ark users, servers must maintain a bitcoin treasury—a reserve of bitcoin ready to deploy for user operations. This creates an economic trade-off that's fundamental to understanding liquidity costs.

The opportunity cost principle

The bitcoin in an Ark server's treasury could potentially earn returns if deployed elsewhere—such as in Lightning channels to earn routing and liquidity fees, or lent out through bitcoin lending platforms. When an Ark server locks up bitcoin to provide liquidity on Ark, it foregoes these alternative earning opportunities. This foregone earning potential is called the opportunity cost.

Ark servers earn revenue primarily through payment and liquidity fees. Servers will naturally try to ensure their total fee revenue equals or exceeds what they could earn elsewhere, otherwise they become uncompetitive with other bitcoin investment opportunities.

Ark opportunity costs are bitcoin-denominated

Ark servers must refer to market rates for bitcoin-denominated returns—these will look quite different from the USD market.

How liquidity costs are calculated

Liquidity costs depend on three factors:

  1. Amount: The bitcoin value being refreshed or offboarded
  2. Expiry period: How long until the spent VTXO expires and becomes claimable
  3. Opportunity cost: The server's bitcoin-denominated cost of capital (expected annual return on bitcoin holdings)

The formula is: amount × (expiry_delta ÷ 365 days) × opportunity_rate = liquidity_cost

Example

Napkin math

These are rough calculations to give you a sense of scale—actual fees will be different when Second's Ark server goes live, and will fluctuate according to market conditions.

A user refreshes a 100,000 sat VTXO that has 5 days until expiry, assuming the opportunity cost is 5% annually:

100,000 sats × (5 days ÷ 365 days) × 5% = 68 sats liquidity cost

Refreshes also require on-chain fees

Refresh operations also require on-chain transaction fees. If 100 users refresh in a round and the bitcoin network charges 20,000 sats for the transaction, then the on-chain cost per user is around ~200 sats. So the total refresh cost in the above example would be around 268 sats (68 + 200) to refresh 100,000 sats (0.27%).

VTXO age affects costs

  • Fresh VTXOs: Recently created VTXOs have higher refresh costs because servers deploy liquidity for longer periods.
  • Old VTXOs: VTXOs approaching expiry cost significantly less to refresh since servers only deploy liquidity for shorter periods.

Ark fees must reflect these server costs, naturally incentivizing users to refresh closer to expiry while still allowing earlier refreshes for those who prefer immediate security.

Ark's capital efficiency

Ark achieves high capital efficiency through two key factors:

  • Precise liquidity usage: Users consume exactly the amount of liquidity they need for their specific operations, when they need it, with no pre-funding required. This differs from Lightning, where channels must be pre-funded with capacity by either the user or their LSP.

  • No behavior prediction required: Servers deploy liquidity on-demand as users perform operations, eliminating the need to predict user behavior or pre-allocate capacity. Lightning requires predicting user payment flows to size channels appropriately, while Ark dynamically responds to actual usage patterns.

Managing liquidity constraints

We expect it'll be unlikely that servers run out of liquidity—if they're generating consistent bitcoin returns, capital allocators will be interested in funding them. If there's no interest, it suggests the server is underpricing liquidity fees.

However, as liquidity constraints are still a possibility, servers should prepare for this scenario by anticipating shortages before they happen. Since all VTXO expiration information is known in advance, servers can see liquidity demands coming and plan accordingly.

When approaching constraints, servers should calculate exactly how much bitcoin is required for urgent requests—refreshing or offboarding VTXOs that are about to expire—and reserve sufficient liquidity to cover these critical operations. They can then decline non-urgent requests, such as early refresh requests that would push liquidity below required minimums.

Servers that experience frequent liquidity shortages will see their reputation damaged and revenue decline as users seek alternatives. As always, users retain the option to unilaterally exit regardless of a server's liquidity status.