If you have been in the bitcoin space for a while, you must probably have heard about the Lightning Network. But for those who are pretty new in the crypto space and still trying to find their footing, today’s post will explain everything you need to know about the Lightning Network.
For starters, the Lightning Network is a second layer added to the Bitcoin blockchain. This second layer allows for a seamless off-chain network. What we mean by off-chain transactions are transactions between bitcoin users who aren’t on the blockchain network. The second layer we are talking about houses multiple payment channels between parties or bitcoin users.
Simply put, a Lightning Network payment channel is essentially a two-party transaction method where parties are allowed to make and receive payment seamlessly from one another. The second layer improves the scalability of blockchain applications by managing transactions outside the blockchain network, which is layer one, while still leveraging the mainnet’s robust decentralized security architecture.
Scalability is one of the most significant barriers that have restricted the widespread adoption of cryptocurrencies. Should we ever attain full scalability in the crypto space, then a blockchain network should handle millions to billions of transactions per second.
Thanks to the Lightning Network, bitcoin users will enjoy low fees by transacting and setting off-chain. This will give rise to new bitcoin use cases like instant micropayments that will close off the arguments of whether you can buy coffee with crypto. Another exciting thing about the Lightning Network is that it will speed up processing time while reducing expenses related to the Bitcoin blockchain.
While the Lightning Network technology is a welcome development in the bitcoin world, the technology is still struggling to resolve specific issues. Not just that, it has also given rise to multiple problems, including the case of low routing fees as well as malicious attacks. For instance, users of Lightning Network have to pay a small fee to open and close a payment channel. On top of that, there are also routing costs that go towards nodes for validating transactions.
Now the big question is, if the routing fee is so negligible, why would a node want to validate said transaction?
The simple answer is that miners do not often validate smaller transactions, and that’s because they will earn lower fees for authenticating insignificant transactions. To this end, bitcoin traders pay a small routing fee and may have to wait for some time before the transactions are validated.
In terms of malicious attacks, a bad actor could simply create multiple payment channels and close everything at once. Since those channels still need to be validated, they will get in the way of the legitimate ones, resulting in congesting the network. And once the network is congested, the attacker can simply pull funds before legitimate parties get any wind of the situation.
The Lightning Network was the brainchild of two researchers, Joseph Poon and Thaddeus Dryja, who proposed the idea in a 2015 paper titled “The Bitcoin Lightning Network.” Their research was based on previous discussions of payment channels created by Satoshi Nakamoto, the genius behind Bitcoin. Satoshi Nakamoto described payment channels to a fellow developer Mike Hearn, who published their conversation in 2013.
The Bitcoin Lightning Network paper’s abstract described an off-chain protocol made of multiple payment channels. With these payment channels, two parties can seamlessly transfer value without any kind of congestion to the mainnet, and that’s because the channels exist off-chain. For those who have no idea, off-chain transactions are designed to resolve bitcoin’s scalability problem.
Dryja and Poon went on to explain that Visa peaked at 47,000 transactions per second during the holidays in 2013. For bitcoin to reach anywhere close to Visa’s transactions per second milestone, it would have to manage eight gigabytes worth of transactions per block. Trust us when we say this isn’t close to the capabilities of the current blockchain. While bitcoin was only able to handle seven transactions per second initially, and that’s assuming that those seven transactions were around 300 bytes each, things have changed remarkably as of today.
More so, bitcoin’s blocks only had a one-megabyte transaction limit at the time, so there wasn’t any chance for the network to handle nearly 47,000 bitcoin transactions in a single block. But good enough, the coming of the Lightning Network’s off-chain payment channels will resolve the issue of scalability on the Bitcoin Network as the channels make it possible for multiple smaller transactions to exist without any issue of congestion on the network.
Precisely in 2016, the duo of Dryja and Poon launched Lightning Labs in conjunction with a few contributors. This company was charged with bringing the Lightning Network to fruition. Even though team members were changed multiple times, the company still worked around the clock to make the protocol compatible with the core bitcoin network.
Thanks to Bitcoin’s SegWit-based soft fork that happened in 2017, the network experienced a breakthrough that made it possible for more transactions to fit in each block. This singular event resolved the longstanding Bitcoin bug, transaction malleability. The bug allowed users to fake transactions, manipulate the network and keep bitcoin in their wallets.
Using pre-launch testing, developers were able to build apps on the Lightning Network without any hassle. Apps built on the Lightning Network included simple use cases such as wallets and gambling platforms, which took advantage of the power of the Lightning Network’s microtransactions.
In 2018, Lightning Labs eventually launched a beta version of the Lightning Network implementation into the bitcoin mainnet. During this period, notable personalities like Jack Dorsey, the founder of Twitter, partnered with the project. For example, Jack Dorsey hired the services of developers who will focus on the Lightning Network development. He also plans to integrate the technology into Twitter sometime in the future.
The Lightning Network protocol allows for the creation of peer-to-peer payment channels between two parties, for instance, between a customer and a coffee shop. Once created, the channel makes it possible for parties to execute unlimited amounts of instantaneous and inexpensive transactions. The Lightning Network works as its own little ledger, where users can pay for even smaller goods and services like coffee without causing any issue on the bitcoin network.
To create a payment channel, one party has to lock a certain amount of Bitcoin into the network. Once the bitcoin has been locked in, the other party can invoice payment amounts as it relates to the transaction. If the customer wants to keep the channel open, they can continue to add bitcoin consistently.
By leveraging the power of the Lightning Network channel, parties involved will be able to transact with one another seamlessly. Compared to everyday transactions on the bitcoin blockchain, some transactions are handled pretty differently. For example, when two parties open and close a channel, the entire process is only updated on the main blockchain.
With Lightning Network, the parties involved can seamlessly transfer funds between each other without any intrusion from the main blockchain. And this doesn’t come to us as a surprise, especially considering that all transactions with a blockchain don’t need to be approved by all nodes. With this scenario, you can easily understand why the Lightning Network will remarkably speed up transaction times. Lightning Network nodes that are designed to route transactions are formed by combining individual payment channels between interested parties. To this end, the Lightning Network is the result of several payment systems being linked together.
Eventually, when both parties agree to complete transactions, they can close off the channel. Once that’s done, all the information on the channel is then consolidated into a single transaction and forward to the bitcoin mainnet for recording. Consolidation is a means of ensuring that dozens of small transactions spam the network at a time. This goes a long way to simplify them into a single transaction that requires less time and effort for nodes to validate. Without payment channels, there is every likelihood that smaller transactions will impede bigger transactions, causing congestion on the network as the nodes will have more transactions to validate.
Let’s say, for instance, Anna visits a local coffee shop daily and would like to make payment in bitcoin. She can choose to make a small transaction for each coffee cup. Unfortunately, the transaction can take an hour or more to validate because of bitcoin’s scalability problems. In addition to that, Anna would still have to pay the Bitcoin network’s high fees, even though she is only making a small payment. Small transactions are great with traditional payment methods like cards, and that’s because companies like Visa have the infrastructure to process over 240,000 transactions per second. On the flip side, bitcoin on a typical day can only validate seven TPS.
Thanks to the Lightning network, Anna can now set up a payment channel with the coffee shop, with each coffee purchase subsequently recorded within that channel and payment made. With Lightning Network, each transaction is instant, cheap, and possibly free. Once the bitcoin used to set up the channel has been spent, Anna can decide to close the channel or top up the bitcoin to keep the channel open. Should she decide to close the channel, all the transactions executed on that channel are recorded on the main bitcoin blockchain.
For those who have no idea, the Lightning Network creates a smart contract between two consenting parties. The rules guiding both parties are then coded into the contract upon setting up a channel. And just so you know, the contract cannot be broken. Using a smart contract code ensures that the contract fulfillment is automatic. Not just that, it also means that all parties agree to the initial rules encoded within the smart contract. Every successful transaction will mean that all requirements have been met. Once validated, the Lightning Network is set up in such a way that it anonymizes every transaction executed within the channel. With this, others can only see the total transfer value and not the parties involved.
The Lightning Network makes it possible for anyone to execute transactions without any type of restrictions outside the blockchain. And that’s because off-chain transactions have all the infrastructures and can be trusted to enforce the blockchain, especially considering that they end up on the mainnet once payment channels are closed. To understand how Lightning Network works, it is important you always see the mainnet as the arbiter of all transactions. So while off-chain protocols have their own unique ledger, the ledger will always find its way back to the mainchain, which is the very core that powers the Lightning Network’s design.
Some of the most significant advantages of the Lightning Network include cheaper and lightning transactions. This makes micropayments possible in a way never imagined on the bitcoin blockchain network. Without Lightning Network, users will have to pay exorbitant fees for making simple transactions. More so, they will have to wait for hours for their transactions to be validated. Longer wait times on the traditional bitcoin network occur because miners prefer to validate larger transactions since they will earn larger rewards.
The Lightning Network is connected to the bitcoin blockchain and functions as an existing layer on top of it. Thanks to its connection to the bitcoin blockchain, the Lightning Network will benefit from Bitcoin’s security protocols. Using this protocol, bitcoin users can use the primary blockchain for bigger transactions or switch to the Lightning Network’s off-chain for micropayments without compromising on safety. The Lightning Network payment channels also make it possible for users to execute private transactions as others cannot take a peek at every individual transaction.
Besides the Lightning Network, crypto enthusiasts have also been experimenting with atomic swaps. For starters, atomic swap is a brilliant process that allows users to swap one crypto asset for another without using a third party or an exchange. Atomic Swaps are pretty more important than exchanges since they make the process of swapping almost instantaneous with little or no transfer fee to worry about.
One of the major disadvantages of the Lightning Network is that users have to get a wallet that is compatible with the Lightning Network. Even though finding a wallet that is compatible with the Lightning Network is easy, users will have to fund the wallet using a traditional Bitcoin wallet. And just so you know, the very first transaction from the traditional to the Lightning Network wallet costs a fee. Given this scenario, users will lose some bitcoin in the process of interacting with the protocol. Once users have funded their Lightning Network wallet, users will have to lock up their bitcoin to set up a payment channel.
Sending bitcoin between wallets can be pretty annoying and expensive, which can be quite off-putting to new users. That said, some wallets are designed to handle both on and off-chain payments without paying any type of fees. With this, you can be sure that the Lightning Network will improve in terms of convenience over time.
If either party in the payment channel decides to pull out some funds, they have to first close the channel and receive the bitcoin back before using the funds. Keep in mind that when using the lightning network, it isn’t possible to take out a bit of money and leave the channel open. More so, to open or close a channel, each party has to make an initial transaction called a routing fee. While opening a channel is pretty easy, all of these additional payments make the process a little more expensive for users.
One of the most significant problems with the Lightning Network is the increasing cases of offline transaction scams. Here is what we mean. If one party in a payment channel decides to close the channel when the other party is offline, the former can decide to steal the funds. When the other participant decides to come online, it will be too late to do anything as the other party can decide to stay offline, making it impossible to contact them.
Another thing you should never forget is that the Lightning Network suffers from bugs like stuck payments, which are essentially outgoing transactions that don’t see verification. Even though the bitcoin network will refund a stuck payment, the process can take some days as valid transactions are given more priority over stuck ones when it comes to authentication.
At the end of the day, even if the Lightning Network is able to resolve all of these issues, there is still the issue of regulators to worry about. Given the complicated tech behind the Lightning Network, we know for sure that regulators will have a hard time understanding Lightning Network. This will make it super challenging to put in place proper regulations. And if regulators struggle with this aspect, it means that mainstream crypto users will also struggle to use the Lightning Network.
Even if regulators were to understand the operations of the Lightning Network, they might find a way to block the Lightning Network, citing its anonymity. Since they can only see finalized transactions, regulators may be put off by the anonymous transaction feature of the Lightning Network.
Despite the many shortcomings of the Lightning Network, we are still seeing an increase in adoption. According to DappRadar, over $110 million worth of bitcoins is currently locked into the Lightning Network. This is basically from people using the Lightning Network for payment of goods and services, gambling, utilizing apps, and more.
Some apps are essential for network usage. By this, we mean apps such as Lightning Network compatible wallets. Since the Lightning Network is a separate protocol from the Bitcoin mainnet, it will require a different type of wallet so users can be able to create payment channels. Traders can take advantage of the Lightning Network via optimized wallets. And should the Lightning Network continue to appeal to the broad crypto community, then it is only a matter of time before wallet developers start building wallets with Lightning Network support. Also, dedicated users of Lightning Network can also become a node, speeding up the entire transaction process.
Let us also add that development on the Lightning Network has been expanded to function as a layer-two solution on various projects. Also, many crypto exchanges are beginning to support the protocol, allowing users to enjoy all of the perks offered by the Lightning Network. Exchanges that have integrated the Lightning Network usually allow users to withdraw smaller amounts of Bitcoin instantly and cheaply. Without Lightning Network, users will have to endure high transaction fees as well as wait times due to bitcoin’s technology.
The Lightning Network has also resulted in the launching of Watchtowers, a third-party protection service featuring various specialized nodes. While it’s no secret that some nodes go offline from time time, leaving payment channels susceptible to offline transaction scams, a participant can simply pay a small fee to a watchtower instead of just leaving the payment channel unattended to. Doing this will prevent any type of scam as the watchtower will keep an eye on the channel. Suppose a watchtower sense any type of malicious activity, such as a party trying to close the payment channel. In that case, the watchtower will automatically freeze the fund and refund them to the offline user. Also, the watchtower will penalize the other party by simply removing their funds from the channel.
The Lightning Network promises to revolutionize the payment process on the bitcoin network, especially when dealing with micropayments. Not only will it make micropayments almost free, it will also make transactions quick and hassle-free. With the Lightning Network, you can kiss goodbye to cases of congestion on the Bitcoin network. While the Lightning Network has its many challenges, we are sure that most of the issues will be resolved as technology advances.
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