Bitcoin is touted as the future of our financial system. The technology, however, is limited in its potential to scale due in part to the speed and costs of transactions. Thankfully, a new protocol known as the Lightning Network makes it possible to increase the Bitcoin network's scalability.
You may be wondering what the Bitcoin Lightning Network is and how it helps to scale Bitcoin. If so, this article is for you.
What Is the Bitcoin Lightning Network?
The Lightning Network is a peer-to-peer network that uses Bitcoin to secure its transactions. It is a second-layer payment protocol that operates on top of the Bitcoin blockchain. Its network allows for fast and cheap transactions with Bitcoin, and it can also be used on other blockchains.
With Bitcoin, all transactions have to be broadcast to every node on the network. Transactions that are broadcasted must be included in a block that is mined and settled on the blockchain.
This is different from the Lightning Network, which is composed of decentralized nodes that allow for greater volumes of transactions to be made over a given period of time.
How Does the Lightning Network Work?
Transactions between parties are written on a payment channel, also known as the mini-ledger. Both parties may write their available balances to the ledger. One party may then write their transaction to the ledger for a payment they wish to receive by creating an invoice, presented as a string of digits in the form of a QR code.
A transferor to a transaction on the Lightning Network may scan the invoice with their Lightning Wallet and confirm their intent to make payment with a digital signature. After this is done, the ledger is updated to change the balances.
The updates may continue until the channel's state is published to the Bitcoin blockchain and balances on-chain are changed. Parties to the transaction may close the transaction and exit the network after the payment is completed.
How Does the Lightning Network Help to Scale Bitcoin?
The Lightning Network takes transactions away from the main chain. This means that not every transaction is settled on the blockchain. By not settling every transaction on the blockchain, Bitcoin's transaction speed and throughput can be increased.
Bidirectional payment channels are key to the functionality of the Lightning Network. They allow two parties to create ledger entries for transactions without immediately broadcasting them to the blockchain.
The payments are managed through payment channels, with either party holding a certain amount of the funds locked up in a channel. Parties may send payments by routing them through to each other via nodes on an onion router.
Timelock contracts (HTLCs) are needed to direct transactions through the peer-to-peer bidirectional payment channels. Smart contracts with programmable instructions enable parties to carry out transactions using a secret that functions as a password.
The smart contract allows the beneficiary to collect payment using a secret from which a hash is created from. This is known as a hashlock. Conversely, a timelock is based on smart contracts that instruct the network to credit payment back to the sender of a transaction if it has not been redeemed over a certain period.
You may be worried about the fact that Lightning Network transactions are not fully on the blockchain.
This concern has been addressed with several measures, such as asymmetric revocation commitments. The technique gives users the power to claim their wallets' full balance if cheated by another user in a transaction. Not only can users claim the amount, but also, the cheaters are punished for their behavior.
What are the Benefits of the Bitcoin Lightning Network?
Lower Transaction Fees
The average Bitcoin transaction fee is currently $17.15, while the fee paid for the average Lightning Network transaction is a fraction of a cent.
The Lightning Network lowers transaction fees by moving transactions away from the main blockchain. With fewer transactions being carried out on-chain, there is less competition for transactions to succeed and less work that needs to be carried out by miner nodes on the Bitcoin blockchain. This helps to keep the fees low.
Faster Transactions
Transactions on the Lightning Network can take place over a matter of seconds, in contrast to the Bitcoin blockchain, where transaction confirmation can take anywhere between 10 minutes up to several hours.
As transactions take place on the Lightning Network instead of the Bitcoin blockchain, there is no need to wait for block confirmation to send the cryptocurrency. This makes transactions instantaneous.
New Cryptocurrency Services and Marketplaces
The second layer built on top of the Bitcoin blockchain allows for new services to be created to meet users' needs. For example, Lightning Labs created Pool, a peer-to-peer marketplace for Lightning node operators to buy and sell access to liquidity. Network operators can use Pool to manage payment flows on the network.
The network allows for different blockchains to be linked through its payment channels. This means that users can execute what are known as "atomic swaps" to exchange cryptocurrencies with each other.
Continuous Upgrades
New upgrades continue to be made to the Lightning Network to improve on deficiencies in the technology infrastructure.
For example, the first iteration of the network had weaknesses that attackers or bad faith actors could exploit to manipulate transactions. An old transaction state could be chosen over the correct state, and the malicious party could confirm the transaction even if one party were offline while it was taking place.
Now, a penalty transaction on the network is possible. If an individual tries to broadcast the prior state of a transaction, they can be punished with a penalty transaction. An individual can outsource this to another entity to apply while they are offline.
Over the years, it has become easier to use the Lightning Network. A wider range of wallets can be used to convert Bitcoin to Lightning Bitcoin easily.
The wallets reduce the time needed to learn the network's technical details, plus offer easily understandable options that help users to engage with the network. Instead of having to use complex public keys, payments can be made using QR codes.
What are the Disadvantages of the Bitcoin Lightning Network?
Support for Offline Payments
Like a lot of peer-to-peer connections, the Lightning Network does not support offline payments. This means that parties to transactions on the network may have to wait for extended periods of time to complete transactions.
Network Vulnerabilities
There are different vulnerabilities in the Lightning Network, which can be difficult to resolve without presenting design challenges. For example, some updates, such as Neutrino, have improved the user-friendliness of mobile wallets but also given rise to new attack vectors.
Bitcoin Lightning Network Makes Bitcoin Faster
The Lightning Network could be the key to scaling up Bitcoin like never before.
Therefore, it should not be surprising that more cryptocurrency service providers are implementing it to improve transaction time and reduce fees.
However, many challenges require time to solve. While the technology solves several problems of the Bitcoin blockchain, such as transaction speed and transaction cost, it also presents new problems in the form of network vulnerabilities and user-friendliness.