What is the Lighting Network?
Everything you should know, from what it is, why it's relevant and how it works.
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Last week I shared with you all some wise words from Michael Saylor about his journey into Bitcoin, and one of the key arguments is that Bitcoin is a higher quality property, which he defines as “hardest to steal, hardest to tax, easiest to move, most desirable, and easiest to upgrade”.
So today, let’s look at one of the key developments and upgrade on the Bitcoin network: the Lighting Network.
In a nutshell, the Lighting Network is a payment protocol that operates on top of the Bitcoin network. It facilitates micropayment, allowing for huge numbers of transactions at an extremely fast speed, at negligible fee.
It is essentially, a Layer 2 solution to Bitcoin’s scalability problem.
What is a Layer 2, you ask?
Layer 2 is a collective term for solutions designed to help scale applications by moving some of the transactions “off-chain”. This way you get to reduce the number of transactions to be processed, without compromising security and decentralization.
Let me leverage an example I used before:
When you go to the bar, you get yourself a nice drink and swipe your card. You then order a second one, and pay a second time, and so on. You’ve made many separate transactions and the staff would have had to swipe your card the same amount of times.
Alternatively, you could open a tab, buy a bunch of drinks and at the end of the night, you close your tab and pay the bill. In this case, you’re making one single transaction and this saves a ton of time and transaction fees!
This is the same in crypto: you only settle and record the main transaction on the blockchain.
What scalability problem is it solving?
Well, Bitcoin was created originally as peer to peer electronic cash system that is decentralized and secure.
However, the Bitcoin blockchain’s capacity has significant constraints to realize this vision of being the network that encompasses all global financial transactions.
Let’s put this into perspective: Bitcoin has a throughput of 7 transaction per second (tps) limitation. Just to give you a sense, VISA handles around 1,700 tps, and can handle up to 65,000 tps. Quite a gap between both, no?
This limitation is due to Bitcoin’s block size.
A blockchain is basically a distributed ledger that has transaction data stored in different blocks. Each block has limited space, and in the case of Bitcoin, it takes around 10 mins to be created.
Why can’t you expand the block size or increase the speed?
Well, this would certainly be a simpler solution, and it’s in fact what many Bitcoin Forks have done, as in the case of Bitcoin Cash.
However, by doing so you would compromise on security and decentralization because eventually, only a handful of computers would be able to store the full history of BTC transactions because it would be too large for most of them to handle.
If the block time is too fast, it limits the number of computers that can verify the transactions on time, and if there are too many, then we would quickly end up with conflicting transactions.
Now, where does the Lighting Network comes from?
Joseph Poon and Thaddeus Dryja first proposed the Lighting Network back in 2015.
Subsequently, the whitepaper was then published in January 2016, and they founded a company called Lighting Labs the same year.
Lighting Network was launched in February 2018, after more than 2 years of development.
Overall the Lighting Network has seen some serious adoption, with a particular boost post El Salvador’s adoption of BTC as legal tender.
It currently has over 86,000 open channels, adding up to a value of over 3,700 BTC, which at its current value is almost $150 M.
Now, to the meaty part… How does the Lighting Network work?
It works on the concept of Payment Channels created by two parties on the Bitcoin network.
First, you both create a payment channel on the Bitcoin network, by creating a multisignal wallet.
You both deposit and lock in a certain amount of BTC, which should be the same or more of what you expect to transact for security reasons. If you didn’t pay what you owe, the BTC you put in the wallet will be sent to the other party, or the other way around. This collateral incentivizes good behavior.
The wallet will only perform a transaction if the signatures agree.
These payment channels allow you to transact the BTC between each other instantly as many times as you want, for next to nothing. This is because you are not sending actual BTC, but digital IOU (I Owe You) of payments.
So instead of recording multiple transactions that are irrelevant to the blockchain, you will only perform the Closing Transaction to settle the final balance of the record.
The payment channel can be kept open indefinitely and can be close at any time.
Why is the Lighting Network not just a two-way street between two people, but a Global Network?
Have you ever used the Splitwise application? Splitwise is an app for splitting expenses with your friends. It lets you and your friends add various bills and keep track of who owes who, and then it helps you to settle up with each other.
You can have 10 people in a group, but the bills shared are not necessarily always including all 10 members, you can select how to split it based on who has been part of a specific spending.
The beauty of the app is that it will combine all the bills based on who owes who into one final balance, minimizing the total number of payments.
The Lighting Network also does something similar: it allows for multiple payment channels to be connected end to end, enabling routing transaction for any of the network participants. So as long as a participant has at least one channel open on the blockchain, it is possible to create transactions inside the whole network.
Imagine if the payment channel only works between two people, and you had to create channels with everyone else. This definitely wouldn’t solve the scalability problem.
So scalability is achieved by using this large network of micropayment channels.
Are there Risks & Concerns?
Well, yeah, just like everything, it has pros and cons. So to give you the full perspective, here are some of the risks and concerns for the Lighting Network:
Amount locked in: you need to have the same or higher amount of BTC locked in the blockchain in order to transact using Lighting Network. Not everyone has the asset to do so.
Harder to sell: having your Bitcoin locked in the blockchain means that in order to sell it, you have to close the channel, move it to an exchange, and then only be able to sell it, which is not very straight forward.
No incentive in keeping channels opened or in the Network: other than the fast and cheap transactions, there are no particular rewards that incentivize people to keep their channels open.
Code vulnerabilities: the network has had some amount of vulnerabilities, and not all of them have been resolved.
For those interested in reading more, here is the link to the Whitepaper. Enjoy!
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