What Is The Lightning Network?
The Lightning Network (LN) is a highly efficient payment protocol exclusive to Bitcoin, launched in 2018.
Designed to prevent the blockchain from overloading due to slow transaction speed (~10 min) and higher fees ($5 to $30).
Instead, the lightning network circumvents these limitations with an off-chain layer-2 solution: payment state channels.
This scalability solution serves two purposes:
- Make the Bitcoin blockchain practical for small, everyday payments
- Offer users an efficient alternative to process Bitcoin payments when the main network is too busy
The Lightning Network has developed at least 13,000 nodes and achieved over 4,500 BTC of total transaction capacity.
“The Lightning Network (LN), a second-layer protocol built on top of the Bitcoin blockchain, is an innovative digital payment solution that offers increased convenience, speed, and cost-effectiveness to consumers and businesses alike.”
Dasaklis, T. K.
How Does the Lightning Network Work?
The Lightning Network is based on payment state channels, which use a combination of cryptographic methods to secure transactions outside the blockchain.
They resemble Ethereum smart contracts, except there are no transaction fees in between. Instead, there are only Bitcoin fees when opening and closing a channel (the first and last “state”).
The lightning network also uses a multi-signature Bitcoin address where two parties (or nodes) can sign free private transactions as many times as the balance allows, and in both directions:
- First, the client node uses the Lightning Network to fund the payment channel for the business node (for example, a $500 Bitcoin balance for a restaurant). This incurs the first Bitcoin fee.
- Every time the client node buys from the business (e.g. a $50 lunch), that’s a “free transaction” that updates the payment state (in this case, the balance is now $450 and $50 for the client and business).
- When the client node runs out of balance, they can add funds without closing the channel to keep transacting. There’s no upper limit, but every top-up does incur network fees.
- Eventually, either node may decide to cash out or stop doing business. That’s when the last state is broadcasted to the blockchain to settle both wallet balances. This incurs the second Bitcoin fee (assuming no top-ups were needed).
Repeating this process with every new merchant would be impractical. Instead, channels from other nodes act as one combined payment channel (the Lightning Network) that anyone can access. For this to work:
- The requesting node has to “find” the last node through the others (Lightning network finds the path involving the fewest nodes possible)
- The last node has enough balance to transact on the first one’s behalf
Challenges the Lightning Network Aims to Solve
The Lightning Network solves the scalability problem of Bitcoin and speed up its adoption:
- Instant payments: The average Bitcoin transaction takes 10 to 60 minutes to confirm.
- Micropayments: Outside the lightning network, Bitcoin fees start at $0.50 to $30 depending on the network volume, and they increase with bigger payments.
- Security: Scalability often involves security trade-offs, such as custodial wallet services.
The Benefits of Lightning Network
The Lightning Network is catching up with the network size of Bitcoin due to its advantages:
- Efficiency: Payments are near-instant with fees under $0.001
- Scalability: As more nodes create more channels, users can access more service providers without manually setting every channel.
- Control: Both parties can freely close the channel anytime without the others holding the balance indefinitely.
Dasaklis, T. K., & Malamas, V. (2023, August). (PDF) a review of the Lightning Network’s Evolution: Unraveling its present state and the emergence of disruptive digital business models. ResearchGate.
https://www.researchgate.net/publication/372850756_A_Review_of_the_Lightning_Network’s_Evolution_Unraveling_Its_Present_State_and_the_Emergence_of_Disruptive_Digital_Business_Models
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