Introduction to the Bitcoin Lightning Network

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  • The Bitcoin Lightning Network could be the answer to Bitcoin’s scaling problems
  • Started in 2015, the project now has over 10,000 nodes and $70 million locked in it
  • What is the Lightning Network, and how does it work?

The Lightning Network has long been one of the hottest topics in the crypto sphere. Changing the face of Bitcoin in many ways, it’s something that could realistically make the leading cryptocurrency perfect for day-to-day use. We’ve heard the likes of Twitter’s Jack Dorsey discuss Bitcoin holding the potential to become the world’s single currency – the Lightning Network could help make that a reality.

There is no doubt that the arrival and rollout of the Lightning Network is a hugely exciting development, but many are still in the dark as to what it is and how it works. To this end we’ve put together the following FAQ that should help you get up to speed on all things Lightning Network related.

What is the Lightning Network?

The Lightning Network is a ‘layer 2’ system that functions on top of Bitcoin’s blockchain, with its purpose being to reduce both transaction fees and transaction times. The idea is that by running transactions through the Lightning Network and away from the main network, it will – at least over time – make Bitcoin more functional from a day-to-day perspective.

Why Do We Need the Lightning Network?

Bitcoin has a problem that is becoming almost unignorable – scalability issues have seen transaction fees skyrocket, to the point where it has heavily impacted the cryptocurrency’s usability as a currency. Back in December 2018 iit peaked at $34 per transaction, which is why the calls for a solution to this problem have become so prominent. We’ve seen various outlets attempt to bring transaction fee costs under control – see SegWit adoption – but the Lightning Network has emerged as the most viable solution.

How Does it Work?

You might think that the Lightning Network is tough to navigate given explanations you’ve heard elsewhere. Trust us, this development is by no means as complicated as it might seem. The Lightning Network is a smart contract system that functions directly on top of the base-level Bitcoin blockchain. It’s effectively a supplementary system that generates interactions between the two, allowing for cheap and fast transactions.

What’s required for the Lightning Network to function is a multi-signature wallet from a single party. Once set up, the wallet address can be saved to the Bitcoin blockchain, along with a balance sheet that details how much of the Bitcoin deposit belongs to whom. Following the creation of this payment channel, it’s then possible for two parties to carry out an unlimited number of transactions without the need to alter the information on the blockchain. For each transaction that takes place between the two parties, the balance sheet is updated to reflect what value of the stored Bitcoin belongs to each party involved.

Both users are given copies of the balance sheet, with the final balance not uploaded to the blockchain until it is mutually signed and the payment channel is closed. In premise, the Lightning Network sounds complicated, but, for the end user it’s something that can be navigated in just a few steps, with it being a background process for the most part.

The easiest way to think about the Lightning Network is as a Bitcoin plugin that allows you to transact with others privately away from the main Bitconi blockchain. Instead of broadcasting your business publicly (via the public blockchain), it puts transactions between you and another party under a cloak. This, in turn, reduces transaction costs and speeds in the process.

How do Payment Channels Work?

Here’s where the Lightning Network becomes pretty interesting. The Lightning Network – as its name suggests – is a network. This means that there are connections that spread between its users, effectively meaning that you can transact easily with others. In theory it means that you can be linked to everyone via just a few nodes. Think ‘Six Degrees of Separation’ and you have some idea of the potential scale of the Lightning Network.

The Lightning Network is built upon a trustless architecture – hence the use of smart contracts – so this has a two-fold benefit: it makes sure that the funds will reach the intended destination through intermediaries. If this can’t be done or there is no plausible indirect path to the destination, it will issue a refund if. Plus, it allows for the seamless creation of new ‘relationships’ within the network. Through just a few hops, the Lightning Network could very well make it possible to transact with anyone.

What Are the Benefits of Using the Lightning Network?

Low fees, low fees, low fees – we can’t make this any clearer. All fees are proportionate to the transaction size, which means you’ll be charged just a fraction of what you would usually pay otherwise. The Lightning Network has the power to curb Bitcoin’s expanding fee base, which brings it in line with functional day-to-day currencies.

Another major benefit of the Lightning Network is its speed, with payments being settled instantly. Plus, the privacy element is also increased, with the number of transactions held on the public blockchain being minimized. When you add up all of its advantages, it’s easy to see why the Lightning Network is generating such huge public attention.

What’s the Catch…?

The Lightning Network has come on leaps and bounds since it was first proposed by Joseph Poon and Thaddeus Dryja in 2015. However, it would be foolish of us to say that it’s perfect, as it still has issues that need to be ironed out. There are still vulnerabilities, including the potential for malicious actors to spam a payment channel and freezing the funds inside, although they can’t steal them.

There’s also the issue that users can’t pay someone that’s offline, as a payment in waiting feature isn’t currently viable for the Lightning Network. This brings up another major issue, in that the Lightning Network still isn’t quite stable enough for larger payments. This is due to the funds in peer’s multi-signature wallets not being sufficient enough to transfer big sums. Obviously, as the network grows this should become feasible, but at present time it still remains an issue.

What Stage is the Lightning Network Currently In?

The Lightning Network is currently in its 0.4 beta phase, which it has been since March 2018. Adoption has been impressive however, with upwards of 10,000 nodes currently connecting through it and over $70 million locked within the system. In February, exchange OKEx announced that it was going to implement the Lightning Network for its Bitcoin transactions, which represents the first large scale test of the technology.

Lightning Network Could be the Answer to Bitcoin’s Scaling Problem

There are still many unanswered questions surrounding the Lightning Network, and its future is all but secure, but we’ve strived to cover the basics above. The fact that over $70 million is locked in the Lightning Network and large crypto entities such as OKEx are starting to use it shows that, years after its creation, it may finally be coming of age. When all is said and done, what’s clear is that this development could be the missing link between Bitcoin and widespread use.