How the Lightning Network is Revolutionizing Bitcoin
September 2, 2021
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The Lightning Network is a payment protocol that sits above the main Bitcoin blockchain enabling faster and cheaper payments. Lightning transactions are secured by the main Bitcoin blockchain but need not be publicly confirmed by the blockchain. How does that work, exactly? In this article, we break it down.
Bitcoin was designed to serve as digital cash, allowing individuals to instantly and cheaply transfer currency to one another. However, as it has grown ever more popular its infrastructure has struggled to cope with demand, making bitcoin payments slow and expensive.
The Lightning Network offers a solution, counteracting inefficiencies associated with Bitcoin’s proof of work system and allowing bitcoin to be transferred at a microscopic fraction of the cost of transacting on the main Bitcoin blockchain. Lightning transactions are also instant, instead of taking upwards of ten minutes on-chain.
A brief proof of work refresher
Proof of work is a consensus mechanism that enables all network users to know a crypto transaction is valid and prevents the same money from being spent twice, but this process is slow and expensive.
All bitcoin transactions are stored in a public ledger called a blockchain. Individual transaction records are known as ‘blocks’, and each of these is registered on the blockchain through the use of cryptography. Cryptographic records are secured through the use of mathematical equations solved by powerful computers.
On a proof of work system, these computers – known as ‘miners’ – compete to solve these equations, thereby creating a new block and earning a miner’s reward.
Bitcoin transactions take an average of 10 minutes to be confirmed on the blockchain, and only seven transactions can be processed per second.
These difficulties have contributed to an incremental rise in transaction fees over the years. When Bitcoin was first invented in 2009, transaction fees cost a fraction of a cent, but as its popularity has grown, fees have skyrocketed along with it. At times they have exceeded $5. At the peak of the 2017 bull market, they even exceeded $50. This represents a major hurdle to Bitcoin’s chances of being adopted as a currency suitable for small everyday payments.
Lightning-fast transactions & tiny fees
This is where the Lightning Network comes in. It promises to greatly increase the speed of transactions while slashing fees. The Lightning Network currently has a maximum throughput of 25 million transactions per second. This compares with on-chain’s throughput of seven transactions per second. This rate is set to increase as the network grows, unlike the throughput of on-chain transactions that decreases as the network grows and becomes more congested. While Bitcoin transactions currently cost around $3, transactions using the Lightning Network cost around one Satoshi, equivalent to a tiny fraction of one cent.
The beauty of the lightning network is that users don’t need to get into its complicated workings to benefit from it. They can simply use a Lightning Network enabled wallet like the Wallet of Satoshi and begin making bitcoin micro-transactions right away to other Lightning-enabled wallets.
How it works
The Lightning Network operates by enabling two or more bitcoin holders to open private payment channels. The parties in the channel can then set up nodes that send payments via the quickest route possible. A node operator will pick up a small fee for the transaction.
The way these private payment channels work – in relation to the public Bitcoin blockchain – is analogous to the way service contracts work in a professional context. For example, if you sign an employment contract, it is unlikely that a court will ever need to see it. However, all parties to the contract know they could go to court at any time if a dispute were to arise. Therefore, the privately drawn contract is enough to serve as a binding legal agreement.
When two or more people decide to set up a private payment channel on the Lightning Network, they first agree to deposit a certain amount of bitcoin into a multi-signature address. This multi-signature address is a wallet that requires both parties’ private keys in order to validate incoming and outgoing transactions.
If two people each deposit two BTC into the wallet, this registers on the main Bitcoin blockchain as a wallet containing 4 BTC. However, both parties know how much they individually have put in, and would keep a private record of their transactions. They can then send further payments back and forth within this payment channel.
On the main Bitcoin blockchain, nodes must approve transactions, but this does not need to be done on the Lightning Network. This eliminates a great deal of the time and computational power that is normally required for Bitcoin payments.
To ensure trust, the parties can construct a transaction that would close the channel and send the appropriate amount of BTC to both individuals, reflecting the amount they each hold in the shared wallet. This final transaction would be recorded on the public Bitcoin blockchain.
This is how the Lightning Network operates between two individuals, but it is also possible to create ‘chains’ of payment channels between larger groups of people. These chains connect all users’ assets and enable quick payments to be made between any two members of the group.
The Lightning Network is paving the way for Bitcoin to be used in small everyday transactions, ultimately helping it to reach wider mainstream acceptance.
Benefits of the Lightning Network
Here are just a few of the potential benefits of the lightning network:
Enables Bitcoin users to rapidly send and receive payments without waiting for the main blockchain to finalize the laborious proof of work process.
Lowers transaction fees to just a tiny fraction of a cent.
Maintains a high degree of security through pre-signed transactions that can be brought onto the main Bitcoin blockchain.
Create multiple payment channels for the purpose of enabling quick, stress-free payments between members of a group.
Progress since the 2018 launch
The Lightning Network has come a long way since its initial launch in 2018. A key milestone was achieved last year, when the maximum size of payment channels was removed. Lightning Network developers had originally set a maximum receiving limit of 0.16777215 BTC and a maximum payment limit of 0.04294967 BTC.
In 2020, however, it was announced that these limits would be abolished, so that clients can have larger channels on the Lightning Network. The option of creating larger payment channels (lightheartedly named “Wumbo” channels by developers) greatly improved the utility of the lightning network for consumers and businesses.
There is no doubt that the Lightning Network could be a game-changer for Bitcoin. As technology advances and developers find new ways to increase its accessibility, the Lightning Network is emerging as a key driver behind Bitcoin’s mainstream adoption.
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