Credit Limits beyond Full Collateralization in Decentralized Micropayments: Incentive Conditions

TL;DR

This paper explores conditions under which decentralized micropayment systems can extend credit limits beyond full collateralization, balancing liquidity efficiency and strategic default deterrence.

Contribution

It characterizes incentive conditions for non-custodial micropayments to operate with under-collateralized credit, supported by a prototype implementation.

Findings

Credit limits can exceed full collateralization under certain incentive conditions.

A prototype demonstrates low on-chain overhead for credit-limit-based micropayments.

Trade-offs between capital efficiency and enforcement are clarified.

Abstract

In decentralized non-custodial micropayments, the central challenge is not whether payments can be executed directly, but under what conditions such systems can offer credit limits without requiring full collateral backing. Existing approaches typically tie available credit to posted collateral, causing liquidity requirements to scale with transaction volume and settlement exposure and limiting the practical usefulness of credit-based micropayments. This paper characterizes the incentive conditions under which credit-based non-custodial micropayments can operate beyond full collateralization while remaining incentive compatible. We model repeated buyer--merchant interactions under public monitoring and identify the roles of bounded exposure, verifiable settlement outcomes, and continuation value in deterring strategic default under non-custodial execution. The resulting characterization clarifies the trade-off between capital efficiency and the enforcement conditions required to sustain under-collateralized credit expansion without custodial trust. As an illustrative application-layer instantiation, an Arbitrum Nitro prototype provides execution-level evidence that the settlement, commitment, and incentive-enforcement paths of a credit-limit-based design can be realized with low on-chain overhead.