What Is the Lightning Network?

What Is the Lightning Network in a Nutshell?

The current implementation of Bitcoin is great for the cryptocurrency’s current needs. However, the blockchain can only handle up to seven transactions per second, meaning that the network isn’t ready for mass adoption yet. The Lightning Network, also known as “LN,” attempts to fix this issue, as it’s a protocol meant to speed up and scale blockchains to accommodate a considerably higher number of transactions.

Although the Lightning Network was designed for Bitcoin, it can be implemented on top of any blockchain-based project that needs scaling. In this article, we intend to detail the LN’s features in order to increase public awareness and general understanding of the technology.

History

Back in 2008, Satoshi Nakamoto released the white paper “Bitcoin: A Peer-to-Peer Electronic Cash System.” In it, he described how the cryptocurrency would work and how blockchain technology would ensure decentralization, security, and speed for the network. So if you want the Lightning Network explained, this is where we must begin.

To become a worldwide payment system, Bitcoin needs to compete with traditional electronic payment methods in terms of the number of transactions it can handle. To put things better into perspective, Visa handles an average of 24,000 transactions per second, yet it can go as high as 50,000 without creating network congestion.

Bitcoin, on the other hand, has often dealt with scalability issues, something that was missing in Satoshi’s white paper. Around a year ago, the Bitcoin blockchain network became extremely congested, which led to a massive increase in transaction fees. Those who didn’t favor paying a couple dollars per Bitcoin transfer quickly found that their transactions would get stuck on the blockchain’s pending confirmations and never go through. To fix this issue, Bitcoin increased the block size limit from 1 megabyte, allowing each block to store more transactions, freeing up the network.

Currently, transactions are usually confirmed in 10–30 minutes, depending on their size and the fee paid. Bitcoin processes an average of seven transactions per second, so when compared to competitors like Visa, it’s pretty slow.

The idea behind the Lightning Network was first drafted by Satoshi Nakamoto, since the first version of the Bitcoin software included the draft of a code that would allow users to update transactions prior to their confirmation on the network. Satoshi also talked about the benefits of payment channels and their potential in facilitating private communication.

However, an important aspect worth keeping in mind was that Satoshi’s design of the Bitcoin Lightning Network came along with some security concerns. A user who opened up a payment channel could mix things up with the miners and force an older transaction to be confirmed—in other words, it allowed users to get coins out of thin air.

The first solution to this problem was proposed in 2011 on the BitcoinTalk forum by a user who described a two-tier payment channel, yet its downside was that it didn’t support vice-versa payments via the same channel. In 2013, when Bitcoin was facing its first network congestions, the idea reappeared, and a proof-of-concept was drafted. The design was then edited to fix irregularities, and Matt Corallo created a functional code.

For the next couple of months, Lightning Labs employees, as well as developers throughout the world, worked on the idea and made their own proposals. The first fully functional design of the Lightning Network surfaced in 2015, when “The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments”—the Lightning Network white paper—was published.

From that point onwards, companies, developers, and other interested parties started working on newer and better Lightning Network implementations that could be applied to numerous digital currencies, mobile wallets, Bitcoin gambling sites, micropayment systems, and more.

Today, the LN is almost fully functional. While Bitcoin hasn’t adopted the technology yet, as it requires several protocol changes, it is expected that the LN will be used on a larger scale within the next couple of months. Currently, developers are working on resolving several issues, including transaction routing, privacy, and other possible security risks.

How It Works

Knowing how the Lightning Network works requires a basic understanding of the technicalities behind Bitcoin transactions. First, we’ll need to answer the question, What network does Bitcoin use? In a normal transaction, a user publishes his intention of sending Bitcoin. Once this is done, the network nodes spring into action and verify whether the coins are indeed owned by the user. If they are, the transaction is included into a block, which is then verified by miners and stored on the blockchain network. This complicated process is repeated for all transactions, so it’s no surprise that the network tends to get congested from time to time.

The Lightning Network is different, and it’s based on a new technology called payment channels. With this in mind, when two different parties wish to send each other funds, they can open up a payment channel, which is basically a multi-signature transaction published on the blockchain. To create the transaction, at least one person has to add funds, which can then be used instantly for the transaction between the two parties.

The first transaction, responsible for opening the payment channel, will take around 10 minutes to confirm, as it’ll go through the traditional route. However, all signature-based transactions made within the payment channel will go through instantly and cost nothing. Based on this, Lightning Network transactions are simple redistributions of coins that are stored in the shared wallet. Once the two parties need individual access to the funds in question, or they no longer need to conduct business together, they can close the channel. After this happens, the blockchain network will distribute the funds to the two parties according to the updated balance sheets.

All data referring to the channel’s transactions and initial and final balances are published on the blockchain network once the channel is closed. As such, the Lightning Network allows users to conduct an unlimited number of transactions outside of the Bitcoin blockchain, which are finally recorded as a single transaction on the ledger after the channel is shut down.

To take things one step further, the Lightning Network will create a network of such channels, built via smart contracts. This will make sure that the network remains decentralized, as well as remove counter-party risks, increase transaction speeds, and decrease transaction fees. So what is a lightning node? They share similar features with Bitcoin nodes, with the only difference being their support for the new network.

Understanding Its Potential

One of the biggest issues with Bitcoin is that it’s not really relevant for small purchases, such as a cup of coffee. The confirmation time and fees associated with small transactions make it less likely to be used as a payment method. So what does the Lightning Network mean for Bitcoin? Well, a network of channels will make Bitcoin more similar to cash, and therefore more likely to be used for all sorts of small transactions.

However, it is important to note that the LN cannot provide users with the same security as the blockchain. Because of this, many believe that the technology holds the biggest potential in small and micro transactions, whereas larger coin transfers requiring more security should be done on the blockchain.

What is the potential of the Lightning Network? The Lightning Network can also help with cross-chain atomic swaps. These are token transfers made between different blockchains. In other words, you can exchange one coin with another without having to rely on centralized exchanges, as long as both blockchains support the LN.

Testing is already underway, and an attempt to exchange Bitcoin with Litecoin, via the Litecoin Lightning Network has been successful. As such, cross-chain atomic swaps can make crypto-to-crypto exchanges obsolete, hence increasing the overall security of the cryptocurrency market while also eliminating exchange commissions. Reports indicate that developers are working on integrating the Lightning Network with several other coins, including Ether, Stellar, Zcash, Ripple, and Litecoin.

It is believed that the LN can be leveraged for numerous other purposes. For instance, developers are working on games that use the network to help with in-game item purchases, as well as other forms of micro transactions between players. Some other uses of the technology include pay-per-call apps, leased Wi-Fi connections, pay walls, and payments for streaming video.

Disadvantages

As we’ve already outlined most benefits associated with the Lightning Network earlier in the article, it’s time to talk about its potential downsides.

1. Not Operational

When will the Lightning Network activate on Bitcoin? Currently, casual cryptocurrency users do not have access to the LN. There are a few test channels, but they’re meant for those who already have a deep understanding of the technology—even so, it is recommended that users testing out the system only make small payments, as the network is still buggy and cannot guarantee seamless transactions.

Building this network requires developers to tackle a wide variety of issues and make sure they have a bug-free code that can ensure security for its users. Because of this, there is no clear Lightning Network release date, yet updates should be issued within the next few months. It will likely take a bit more before the network is fully developed and can be implemented on a larger scale. However, it is expected that in the near future several companies working on the project will launch Lightning Network ICOs. This will increase awareness of the technology and make it more likely for the LN to reach its potential.

2. Channel Limits

The current versions of the LN have imposed channel caps. This means that users can only deposit funds into a shared wallet once, when the channel is opened. Because of this, the amount of Bitcoin that’s first deposited is the maximum cap for the channel in question. In turn, this creates several issues, as users are forced to decide whether they’d like to keep their liquidity within the channel or in their personal wallets.

3. The Appearance of Hubs

Creating the network of channels is very hard to achieve without hubs. These are similar to Lightning Network nodes, contain a large amount of capital, and process the majority of LN transactions. Some believe that these hubs will increase network centralization, whereas others believe that hubs won’t be able to generate enough profit, so there’s no incentive for centralization to happen. Regardless, it is important that cryptocurrencies remain decentralized, as control exercised by a central entity would defeat the main purpose of digital currencies and lead to numerous issues further down the road.

Not Newbie-Friendly

There’s no denying the fact that cryptocurrencies and blockchain technology are complex. The Lightning Network takes things one step further. With the help of wallets, Bitcoin has become easier to understand for the average person, yet the LN doesn’t currently offer a user-friendly interface. Getting started with the LN is difficult, even for those who are well versed in how crypto transactions work. It’s believed that this will change in the future, once the system is complete and adoption begins. However, an efficient educational effort for the public will be necessary.

Conclusion

Based on everything that has been outlined so far, the Lightning Network represents an interesting experiment, with big potential in changing the way cryptocurrency transactions are processed. Once the system is finalized, it will likely improve crypto adoption rates, provide a sustainable scalability solution for Bitcoin, reduce transaction costs, and increase speed to the point where the system becomes competitive.

The relevance of the Lightning Network for now depends on whether you see cryptocurrencies as a digital asset meant for long-term investments, or as an alternative to fiat currencies. There is no reason to use the network if you’re only involved with digital currencies for long-term gains, since you can easily hold funds in your crypto wallets, and bigger transactions should be done directly on the blockchain.