What is the Lightning Network?

The Lightning network was introduced in 2015 and has been live since 2018. Lightning has many great features for Bitcoin – including a high level of anonymity and the possibility of micropayments in the cent range.

What is the problem?

Bitcoin cannot be torpedoed or manipulated by any central entity such as states and central banks. To ensure this, Bitcoin must be slow. This is necessary to keep the data to run its own hub, called a node, at a level where everyone can run their own node. This ensures that Bitcoin is as it is today. Unable to be manipulated by anyone, limited to 21 million Bitcoin, and accessible to anyone. So that we don’t have to limit or change these parameters, we need other solutions for this, such as the Lightning Network.

In general, however, we have a so-called Trilema in all decentralized systems, which consists of decentralization, security and scalability. Only two of these parameters ever go together, but never three. You can build a secure and decentralized system, but you lose scalability.

As interest in Bitcoin increases, so does the number of transactions that are processed via the network. Since each transaction requires space in a block of the blockchain, not every transaction can always be included directly in the next block. In addition, the programming of the Bitcoin protocol is such that typically a new block can only be found every ten minutes. Therefore, a queue is created in the mempool that is processed by the miners. This is done based on the principle that “the more fees paid, the more likely the transaction will be included in the next block.” This results in the cost of writing a transaction to the blockchain increasing exponentially in a reasonable amount of time if the number of transactions requested exceeds the capacity of the blocks. Unless one is willing to pay high transaction fees, it can also take hours or even days for the network to confirm the transaction.

To handle more transactions, one could of course shorten the time between two blocks or increase the maximum size of the blocks. However, for various reasons, this method would not be a good solution and would cause many problems elsewhere. For example, the cost of running a fullnode, a computer that stores the entire blockchain and validates transactions, would increase significantly. The bandwidth, processing, and storage requirements for each fullnode increase as the block size increases. Increasing transaction capacity in this way would have the undesirable effect of centralizing the system, as only a few entities would be able to operate it.

The Lightning network focuses on scalability and decentralization. Because it is built directly on top of the Bitcoin blockchain as a base layer, it can still have a high level of security. Although the Lightning network does not solve the trilemma, it can be elegantly circumvented in combination with the Bitcoin network.

What are the advantages of the Lightning Network?

Since no payments are required for miners on the network, transactions can be made for just a few cents or even completely free of charge. The average fee for a payment on the Lightning network is less than one cent.

Because transactions on the Lightning Network occur outside of the blockchain, they are almost always instantaneous. This enables real-time transactions and near-instantaneous micropayments, which is very useful for applications such as retail, microservices, and content monetization.

Although a satoshi is the smallest unit that can be transferred on the Bitcoin network, the LN allows even milisatoshi (mSat) payments, which provides a tremendous advantage and improved flexibility for certain microtransaction applications.

By executing transactions outside of the Bitcoin chain, the Lightning Network provides an additional level of privacy. This increases user privacy and confidentiality by limiting the amount of transaction information exposed to the public blockchain.

How does the Lightning network work?

When a transaction is made on the Bitcoin network, Identity A writes a transaction to a block, defining that Identity B is now the owner of the Bitcoin sent. In the Lightning network, on the other hand, there is a direct connection between two parties, called Lightning Channels.

But what happens when two parties are not directly connected?

If two parties are not directly connected via a Lightning channel, they can route payments via the Lightning network. In this process, the payment is routed between different parties via a series of Lightning channels until it reaches the recipient. Each channel checks to see if it has sufficient funds to route the payment. Once the payment reaches the last channel in the path, the recipient receives the payment and confirms this back along the path.

Applications and innovation

The Lightning network offers opportunities for a range of creative applications. It enables new business models, including pay-per-use services, streaming payments and micro-donations. Decentralized exchanges, micropayments for the Internet of Things (IoT), and machine-to-machine transactions can be enabled with it.

While the Lightning Network shows promise in overcoming Bitcoin’s scalability issues and enabling faster and cheaper transactions, it is still an emerging technology that needs further development. A scalable and effective payment infrastructure that supports a variety of applications, improves financial inclusion, and enables new economic models powered by Bitcoin has the potential to transform the future.

It is important to keep in mind that while the Lightning Network holds promise, there are obstacles to overcome and potential trade-offs to be made. Some examples include the required liquidity of the network, efficient routing, and security issues. These difficulties are being actively addressed by the developers and the Bitcoin community as the technology develops and matures.