What Is the Lightning Network?
The Beginner’s Guide to Bitcoin Lightning Network
The Lightning Network (also referred to as Lightning, or LN) is a scalability solution built on top of Bitcoin that allows users to quickly send and receive BTC with virtually no fees.
Lightning is considered to be an off-chain, Layer 2, solution, meaning that transfers are done via a new network of payment channels anchored in Bitcoin’s blockchain.
As the world’s first and leading cryptocurrency, Bitcoin has become an important means of transacting value because, for the first time, any holder has the freedom to:
- Hold bitcoin without unexpected supply inflation
- Send and receive bitcoin without the need for an intermediary
- Verify transactions using their own nodes
However, many agree that Bitcoin still needs better functionality in order to become a global medium of exchange and a peer-to-peer cash system as originally laid out in the seminal whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System. Currently, Bitcoin faces the following limitations:
- Fees – As block space is limited, mining fees can fluctuate wildly based on demand for transaction inclusion.
- Transactions per second – Bitcoin is only capable of approximately 7 transactions per second (TPS)
- Network congestion – Slow block times and heightened use of the network can result in delays in transaction confirmations
The Bitcoin Lightning Network aims to solve these limitations by providing instant and inexpensive transactions while achieving a throughput of approximately 1 million transactions per second.
While Lightning can be used for any type of transfer, most find it useful for micropayments or smaller transfers that are typically uneconomical due to base layer fees.
As of August 2021, Lightning Network stats show that more than 2,000 BTC have been transferred using the network.
It is important to note that the Lightning Network does not implement a new token and allows for the same freedoms as Bitcoin – it’s decentralized, permissionless, and open source. Its security derives from on-chain Bitcoin transactions, which use smart contracts to enable instant, off-chain settlements.
Benefits of the Lightning Network
Bitcoin's Lightning Network was developed mainly to further the adoption of day to day bitcoin payments by increasing transaction speeds and decreasing transaction fees. However, opening payment channels on a second layer has brought several other benefits.
Bitcoin is a global broadcast system where everyone verifies every transaction before adding them to the blockchain. While this system allows Bitcoin to be truly decentralized, its main drawback is that it can only allow for roughly seven transactions per second (TPS).
Lightning’s channel system allows for reusable routes that are added to the Bitcoin blockchain once channels are closed. Theoretically, this means that LN can help scale Bitcoin’s TPS to up to one million TPS.
Transactions on the Bitcoin blockchain can be traced from wallet to wallet. Using the Lightning Network, only the opening and closing of channels is recorded to the chain, meaning that most micropayments will be nearly untraceable.
A Brief History of the Lightning Network
The Lightning Network was originally envisioned in a whitepaper written by Joseph Poon and Tadge Dryja in 2015.
Its testnet was released in May 2016 and, by January 2017, Lightning’s first implementation – lnd – was released in its alpha stage. The first real-world transaction over a Lightning Network channel occurred in December 2017, when Alex Bosworth used Lightning to pay for his phone bill.
In a poetic ending to the alpha development stage, Lazlo Hanyezc – the first person to use bitcoin in the real world by paying 10,000 BTC for two pizzas in 2013 – used Lightning to, once again, purchase two pizzas.
There have been several teams that have since released Lightning nodes on mainnet, including Blockstream’s c-lightning, Lightning Labs’ lnd and Acinq’s Eclair solutions.
In January 2019, pseudonymous Twitter personality Hodlonaut sent 0.001 BTC (or 100,000 satoshis) to a trusted wallet using the Lightning Network. The goal of this exercise was for this recipient to add 10,000 satoshis to the total and send it to another LN wallet, thus setting off a chain of transactions worldwide.
The metaphorical torch was transferred 292 times, including to the likes of Jack Dorsey, Elizabeth Stark and Pierre Rochard, before reaching 4,390,000 satoshis that were then sent to Bitcoin Venezuela, a non-profit organization aimed at promoting Bitcoin in Venezuela.
How Does Lightning Network Work?
The Lightning Network is built off-chain for users to conduct bitcoin transfers in an effort to reduce on-chain network congestion.
To start, a channel is opened between two parties where they can submit funds. They can then use this channel to send BTC between themselves instantly, with near-zero fees, without needing to broadcast every transaction to the base layer of the Bitcoin blockchain.
Either party can settle on the Bitcoin blockchain and close the channel at any point in time.
When the channel is closed and settled on the base layer blockchain, the funds are sent to each party according to the channel’s transfer history, which is summarized in its entirety as a single transaction on the Bitcoin blockchain. The only Lightning-related transactions that are broadcast to the Bitcoin network are the opening and closing of channels. This helps free up block space, resulting in lower network fees and an increase in economic activity per block.
The direct payment channel between the two parties can also become part of the larger Lightning Network. If two parties don’t have a direct channel, they may transfer funds through interconnected pathways. Lightning nodes on the network search for the best route to perform the transaction.
For example, if your friend (who you have a channel with) takes you to their favorite coffee shop, who they have a channel with, Lightning Network would allow you to route your payment through your friend when you pay for coffee, without you needing to open a new channel with the coffee shop. This all happens in a few seconds and is not subject to long waits or high fees like on the main blockchain.
Of note, Bitcoin on-chain analysts can quickly identify these transactions as coming from the Lightning Network because they appear as complex smart contracts that include the various public keys and signatures used in the channel. This issue is tackled by the Bitcoin Improvement Proposals included in the Taproot upgrade, which aim to improve the privacy of each transaction.
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