On HTLCs and arbiters

This is another attempt and conveying the same information that should be in Lightning and its fake HTLCs. It assumes you know everything about Lightning and will just highlight a point. This is also valid for PTLCs.

The protocol says HTLCs are trimmed (i.e., not actually added to the commitment transaction) when the cost of redeeming them in fees would be greater than their actual value.

Although this is often dismissed as a non-important fact (often people will say "it's trusted for small payments, no big deal"), but I think it is indeed very important for 3 reasons:

1. Lightning absolutely relies on HTLCs actually existing because the payment proof requires them. The entire security of each payment comes from the fact that the payer has a preimage that comes from the payee. Without that, the state of the payment becomes an unsolvable mystery. The inexistence of an HTLC breaks the atomicity between the payment going through and the payer receiving a proof.
2. Bitcoin fees are expected to grow with time (arguably the reason Lightning exists in the first place).
3. MPP makes payment sizes shrink, therefore more and more of Lightning payments are to be trimmed. As I write this, the mempool is clear and still payments smaller than about 5000sat are being trimmed. Two weeks ago the limit was at 18000sat, which is already below the minimum most MPP splitting algorithms will allow.

Therefore I think it is important that we come up with a different way of ensuring payment proofs are being passed around in the case HTLCs are trimmed.

Channel closures

Worse than not having HTLCs that can be redeemed is the fact that in the current Lightning implementations channels will be closed by the peer once an HTLC timeout is reached, either to fulfill an HTLC for which that peer has a preimage or to redeem back that expired HTLCs the other party hasn't fulfilled.

For the surprise of everybody, nodes will do this even when the HTLCs in question were trimmed and therefore cannot be redeemed at all. It's very important that nodes stop doing that, because it makes no economic sense at all.

However, that is not so simple, because once you decide you're not going to close the channel, what is the next step? Do you wait until the other peer tries to fulfill an expired HTLC and tell them you won't agree and that you must cancel that instead? That could work sometimes if they're honest (and they have no incentive to not be, in this case). What if they say they tried to fulfill it before but you were offline? Now you're confused, you don't know if you were offline or they were offline, or if they are trying to trick you. Then unsolvable issues start to emerge.

Arbiters

One simple idea is to use trusted arbiters for all trimmed HTLC issues.

This idea solves both the protocol issue of getting the preimage to the payer once it is released by the payee -- and what to do with the channels once a trimmed HTLC expires.

A simple design would be to have each node hardcode a set of trusted other nodes that can serve as arbiters. Once a channel is opened between two nodes they choose one node from both lists to serve as their mutual arbiter for that channel.

Then whenever one node tries to fulfill an HTLC but the other peer is unresponsive, they can send the preimage to the arbiter instead. The arbiter will then try to contact the unresponsive peer. If it succeeds, then done, the HTLC was fulfilled offchain. If it fails then it can keep trying until the HTLC timeout. And then if the other node comes back later they can eat the loss. The arbiter will ensure they know they are the ones who must eat the loss in this case. If they don't agree to eat the loss, the first peer may then close the channel and blacklist the other peer. If the other peer believes that both the first peer and the arbiter are dishonest they can remove that arbiter from their list of trusted arbiters.

The same happens in the opposite case: if a peer doesn't get a preimage they can notify the arbiter they hadn't received anything. The arbiter may try to ask the other peer for the preimage and, if that fails, settle the dispute for the side of that first peer, which can proceed to fail the HTLC is has with someone else on that route.