What is the Lightning Network?

In 2009, Satoshi Nakamoto created Bitcoin, the first-ever blockchain, and its BTC cryptocurrency. Upon its inception, BTC drew the interest of global markets, and today, countless merchants all around the world accept it as a payment method.

But there are limitations to payments with cryptocurrencies like bitcoin. Transactions are only finalized once they are included in the next block in the blockchain. The time to mine a new Bitcoin block is around 10 minutes, which means that it will take at least 10 minutes for an initiated transaction to be complete. To be doubly safe, merchants and exchanges usually require a couple of blocks to be added to the blockchain after the one containing your transaction, thus further extending the time before your transaction is truly complete.

To mitigate this issue, Bitcoin developers are looking into so-called layer 2 scaling solutions. These are aimed at scaling the blockchain and increasing its transaction throughput. This article discusses the Lightning Network, one of Bitcoin's most popular layer 2 solutions.

Lightning Network Essentials

• The Lightning Network is Bitcoin’s layer 2 scaling solution.
• The Lightning Network utilizes off-chain payment channels to lighten the load of the blockchain.
• Transactions are processed within payment channels.
• Only the initial and final balances of the transactors are written to the blockchain.
• The Lightning Network reduces fees and increases the transaction throughput.

History and background of the Lightning Network

Soon after its creation, the Bitcoin network began growing quickly. Developers realized that a 1 MB block size and 10 minute block time only allow for 3-7 transactions per second. The first scaling solutions proposed were increasing block size and reducing block time. In essence, this is how Bitcoin Cash and Litecoin were created.

Then came SegWit. At first, it was intended to fix transaction malleability—it prevented people from modifying transaction IDs by changing signatures. While it was not the primary intention, SegWit laid the foundation for the development of the Lightning Network.

In 2015, Thaddeus Dryja and Joseph Poon published a whitepaper with their idea for the Lightning Network. They envisioned it as an external layer on top of the Bitcoin blockchain. This layer would be able to pass transactions back and forth between users before adding them to the underlying blockchain. But it would take several years before the Lightning Network would reach the public.

Basics of payment channels

To understand how the Lightning Network functions, let us first take a look at a simple payment channel between two individuals. For example, Sarah and Jose transact on a regular basis, and because they do not want to waste too much money on fees, they decide to open a payment channel in the Lightning Network. To do so, they must first open a double-signed Lightning Network wallet. Then, they must each deposit a certain amount of BTC to this wallet, which they can then use in their channel.

Let us say that each of them deposits 2 BTC. Afterwards, they can engage in unlimited transactions within their payment channel, with the total balance of the channel consistently amounting to 4 BTC. In other words, transactions between Sarah and Jose are only redistributions of the BTC in their shared wallet. Each transaction re-allocates ownership of the funds transferred.

Sarah and Jose can keep their payment channel open for any amount of time. But as long as their payment channel remains open, they cannot use the BTC in their double-signed wallet outside of their payment channel. This would only be possible once they close their payment channel. When that happens, the final balances of their payment channel are broadcast onto the Bitcoin blockchain.

By using the Lightning Network, Sarah and Jose avoid having to wait for a new block in the Bitcoin blockchain for each transaction to reach practical finality. Moreover, they also avoid mining fees for each of the transactions between them.

Lightning is a web of payment channels

Payment channels alone are quite limited, since they only allow transacting between two people. If you wanted to send money to Jose, you would have to have a payment channel opened with him.

So, if you want to transact with Jose, the Lightning Network makes it possible to send BTC even if you do not have a channel open directly with him. The network routes your transaction through other channels to find Jose. How quickly and efficiently this happens depends on how well connected you are. Usually, all you need is to open a channel with a popular node (someone who has a lot of payment channels).

Lightning goes live

After going through a beta testing phase in 2018, the Lightning Network eventually reached the public. Much improved and polished, it is now available to everyone, through many different apps that offer a simple interface to the everyday user. Though some still warn of potential quirks and bugs, projects, such as the Lightning Torch (a passing of an ever increasing amount of BTC through the network by members endorsing its use) demonstrate the potency of this layer 2 solution.

Lightning Network appears to be a promising way forward for the Bitcoin network. Aside from scaling the network and increasing its throughput, it also reduces the fees. Another feature that benefits greatly from the Lightning Network is called atomic swaps. In theory, these  will enable currencies to be exchanged among different blockchains, say Bitcoin and Litecoin.

Widespread adoption of the Lightning Network could solve many of Bitcoin’s limitations. In this case, the Bitcoin protocol would be able to live up to its true potential. Not only would it finally be on par with the world’s leading payment service providers, like Visa and Mastercard, but it could even surpass them, with a potential throughput of millions of transactions per second.