Bitcoin transaction fees are so high that it is not practical to use Bitcoin for small everyday payments. Lighting Network was designed to address this very issue and to be used for instant micropayments with negligible fees. If you wish to learn more, please, continue reading.
The Lightning Network is the second layer of payment protocols running on the blockchain. Its purpose is to enable fast transactions between participating nodes and has been proposed as a solution to the scalability problem of Bitcoin. It is equipped with a P2P system suitable for micropayments. The operation of the Lightning Network also simplifies atomic swaps or atomic exchanges where crypto coins can be swapped without requiring any arbitrator, like a crypto exchange.
Bitcoin’s Scalability Problem
The problem with Bitcoin scalability is the limited speed at which the Bitcoin network can process transactions. This is due to the limited size and frequency of blocks on the Bitcoin blockchain and that all changes to the state of the blockchain are transmitted to this public ledger.
Every node of the Bitcoin ecosystem having to be aware of all the transactions that take place on a global scale can significantly undermine the network’s ability to handle every global financial transaction. Instead, it is desirable to process every transaction in a manner that does not sacrifice the inheritance and security provided by the network.
The Visa payments ecosystem allows for about 65,000 transactions per second, and currently, it processes millions of transactions daily. Bitcoin, on the other hand, can process up to seven transactions per second due to a 1MB block limit. Assuming a mean of 300 bytes per Bitcoin transaction and an unlimited block size, the corresponding ability of the Visa transaction volume of 65,000/sec would be around 8GB for every Bitcoin block within average intervals of 10 minutes. This exceeds 400 TB of data annually. Bitcoin can’t achieve similar networking functions like Visa today.
Alternatively, Bitcoin could become as centralized as possible, so the goals of Bitcoin and the purpose of mining to generate new coins would be defeated. If this happens, this centralization will destroy the decentralized aspect of the network that makes Bitcoin secure. This is because the ability of the miners to make the chain valid is what helps Bitcoin to ensure the correctness and security of the ledger.
The availability of fewer miners or network validators because of bigger blocks doesn’t just mean fewer people will get the general ledger correctly, but it also means fewer players can verify the blockchain as miners. As in the case above, a very large block with an average of 8 GB within ten minutes means that just a smaller number of validators can validate the block.
For Bitcoin to hold the proposition of being a functional unit of transaction in the nearest future, it must solve the problem that consigns the block size.
What Is LN?
Lightning Network is a Layer 2 technology used for Bitcoin, which extends the blockchain’s ability to conduct transactions to be more efficient, making use of micropayment channels. Transactions conducted on the Lightning Network are instant and will significantly enhance Bitcoin’s utility as a medium for daily use.
The Lightning Network is designed to reduce associated transaction fees by extracting transactions from the main blockchain and disconnecting from the network. Lightning Network can also be used to conduct other types of off-chain transactions, including exchanges between cryptocurrencies. It is useful to facilitate atomic exchanges where one cryptocurrency can be exchanged for another without intermediary interference, for example, a cryptocurrency exchange.
How Does LN Work?
The Bitcoin Lightning Network operates separately from the Blockchain network, but also works in tandem with it, communicating with the main blockchain. The Lightning Network requires its very own nodes and software to work with the Bitcoin blockchain.
- Two parties open an initial ledger on a blockchain.
- Off-blockchain, these parties set up a channel.
- These parties can make transactions on this channel.
- When finished, the ledger on the blockchain is closed.
- This way, only one transaction is logged on the blockchain.
- The blockchain is less cluttered and can be scaled up.
For rapid Bitcoin transactions to be made across the Lightning Network — without the need to wait for block confirmations — two peers need to be looking to buy and sell Bitcoin to and from each other. In addition, a multi-signature BTC lightning wallet must first be created. This is to provide a secure passage for any peer-to-peer Bitcoin transactions.
First and foremost, the wallet must be saved onto the Bitcoin blockchain. A mini-ledger known as a channel is then created using smart contract functionality. These channels are only visible to the buyer and seller. Unlimited transactions can be made between these two parties in lightning-quick fashion, without the need to update any information on the Bitcoin blockchain.
With each peer-to-peer Bitcoin transaction, both parties must sign and agree to a revised balance sheet, confirming the amount of Bitcoin within the wallet that is owned by each party. Once both parties have concluded their transactions, the secure mini-ledger can be closed. This way, only one transaction is logged on the blockchain.
Lightning Network Pros
Micropayments: Lightning Network allows for even smaller payments than a satoshi, the smallest unit at the basic Bitcoin level. Route fees paid to smart nodes on the Lightning Network are often expressed in millisatoshi or msat.
Privacy: Details of individual payments are not published on the blockchain’s Lightning network. Payments on the Lightning Network can be routed through multiple sequential channels, and the operator of each node can see the payments on its channel, but, if not nearby, they cannot see the source or destination of these funds.
Transaction throughput: There is no default limit on the number of payments per second that can be made within the protocol. The number of transactions is limited by the capacity and speed of each node.
Transaction speed: Once the network is up and running, there is no need to wait for more confirmations for every transaction. No matter how busy the network is, transactions happen almost instantly. When this happens, the cryptocurrency market will make great strides in competing with existing payment systems such as Visa, MasterCard, and PayPal.
Transaction fee: Transactions take place on the off-chain Lightning Network, so you only need to pay a minimum fee. This is one of the main advantages of the Lightning Network. This way, Bitcoin can be viably used as a payment method for small amounts in stores, cafes, bars, etc.
Scalability: The Lightning Network can bring the volume of transactions per second for Bitcoin and other cryptocurrencies to unparalleled highs (e.g. 1 million transactions per second).
Exchange of atoms through the network: The first tests of blockchain transactions worked, and they were all very interesting. As long as both blockchains use the same cryptographic hash function (as long as most have one), users can send money from one chain to another without relying on third-party intermediaries, like an exchange. This technology has potential for innovation.
Security and anonymity: Most cryptocurrencies are not completely anonymous. Transfers from one wallet to another can still be tracked. However, in the case of the Lightning network, it is almost impossible to track all micropayments made through the Lightning channel as most transactions take place outside the main blockchain.
Lightning Network Cons
Not yet working completely: The biggest downside to Lightning Network right now is that it isn’t fully functional yet, so you can’t see how good it is in its entirety. Also, the concept looks good on paper, but we don’t know if it will look good once implemented.
Channel complexity: Lightning networks are designed as a type of channel network that, when created conceptually, allows seamless transactions in theory. Of course, fees increase if the transaction has to go through dozens of intermediate channels.
Channel restrictions: Another downside to the network is that in the current version, channels are restricted. This means that when both users create a channel, the number of Bitcoins they store in their wallets is the maximum in that channel. This setup creates a situation where some users have to choose between having liquidity on the Lightning network channel; or liquidity outside on the main blockchain. This is not particularly convenient for those with very limited resources.
Hub: There have also been concerns about the formation of a „hub“, the type of high capital target that most centralized transactions pass through. Many Bitcoin enthusiasts see this as the centralization of the network. However, such hubs will probably not benefit from transaction fees.
Scalability Solution With Lightning Network
It seems that the cryptocurrency community is eagerly awaiting the launch of the Lightning Network. It was developed specifically for Bitcoin but is currently being developed for various cryptocurrencies such as Stellar, Litecoin, Zcash, Ether, and Ripple.
Bitcoin has already been transacted on the network and is almost always accepted by Blockstream, Lightning Labs, and ACINQ implementations, showing that all three are compatible. Also, the Lightning specification was published, describing the rules for working on the network.
These specifications are a major step as application developers can use and implement Lightning Network in other programming languages.
Developers advise users to be patient as the LN code is very complex and requires thorough testing. For the Bitcoin community to get fully adapted to the Lightning Network, the developers need to prove that the Lightning Network is safe and useful. Given this and many other factors, experts say that the Lightning Network can still take a year or two to fully function.
The answer to why Lightning Network is needed is simple – scalability. If the LN provides a solution to Bitcoin’s underlying problems, it is likely to be adopted by other cryptocurrencies. And this could be another step in creating a truly decentralized financial world.