Be[In]Crypto Video News Show: The Lightning Network

In this episode of Be[In]Crypto’s Video News Show host Juliette Lima explains Bitcoin’s popular Layer-2 payment solution, the Lightning Network.

Although the use of Bitcoin has increased significantly, this has been accompanied by a subsequent increase in transaction times and fees. At seven transactions per second, Bitcoin’s network is effectively inefficient at making payments.

This is because all Bitcoin transactions must be broadcast to every node in the network. Once broadcast, transactions have yet to reach final settlement on the Bitcoin blockchain.

With the blockchain creating new blocks approximately every 10 minutes and the block sizes being limited, this process is rather time consuming. Additionally, with the limited number of transactions that can be settled per block, fees are likely to increase significantly as participants jostle for priority.

Lightning Network

This is where the Lightning Network comes in. Designed by Joseph Poon and Thaddeus Dryja in 2015, the Lightning Network is a second layer protocol that sits on top of the Bitcoin network.

Its inventors used the concept of payment channels to help combat the scalability issues surrounding Bitcoin, by optimizing the speed of on-chain bitcoin transactions, as well as the cost per transaction.

Currency as Layer 2

If second layer protocols are unfamiliar, here is an analogy. Think of gold as a first layer form of money. Although it has several valuable qualities, such as rarity, durability, and fungibility, its weight prevents its portability. In the past, one solution was to use paper receipts, which effectively represented a certain amount of gold kept in a safe place.

People thought they could take this paper to the bank and exchange it for gold. Eventually, these paper receipts turned into currencies, like the US dollar. The convenience of paper invoices made transactions much easier and they could occur much more frequently.

You could think of paper money as a second layer on top of the first layer of the gold standard. Bitcoin and the Lightning Network work much the same as gold and paper money.

Compromise

In the case of Bitcoin, the choice was made to optimize security and decentralization, with transaction speed being sacrificed. This ultimately led to highly variable transaction fees, depending on the demands on the network. These two points make on-chain bitcoin payments difficult, especially in small daily increments.

The Lightning Network effectively relieves Bitcoin of these payment duties and instead is optimized for high speed and low cost, ultimately finalizing transactions using Bitcoin on the main chain.

Bitcoin Payment Channels

The Lightning Network works by setting up a payment channel between two separate parties, called a funding transaction. Both parties fund the chain with on-chain bitcoin, creating an on-chain arrangement between the two. These funds represent the channel’s maximum capacity, you cannot spend more than the total of these funds combined.

This funding transaction, the initial channel opened between two parties, uses what is called a multi-signature address, which means that multiple signatures are required to move the Bitcoin held at this address. For example, in a 2-2 multi-signature address, you would need both people to agree to sign for the funds at that address for them to be spent.

Pay the bill

In this payment channel on the Lightning Network, only the first and last transactions are put on the bitcoin blockchain. All other transactions between the open and close transactions will occur off-chain, i.e. outside the Bitcoin blockchain. These transactions between the first and the last are called commit transactions, and they are not limited by Bitcoin protocol fees or transactions per second.

An equivalent process would be to open a tab in a bar. Instead of paying for each drink individually throughout the night, which takes longer and costs the establishment more money in transaction fees, an initial tab or payment channel is opened and updated after every drink order. The tab is then settled at the end of the night with a single trade. Closing a bar tab is similar to closing a payment channel in the Lightning Network.

Other benefits of the Lightning Network

With the Lightning Network, payments can be routed through multiple channels to any of the network participants. For example, if a payment needs to be made to someone, but a direct channel is lacking, it can still be routed through another network participant.

The speed of the Lightning Network also enables micropayments, where payments can be made incrementally over periods of time. Service providers could now charge by the minute rather than through monthly subscriptions, or employers could pay almost instantly for work performed rather than through weekly paychecks.

As the benefits of using the Lightning Network increase, its users have also increased dramatically. At the time of writing, there are currently around 36,000 nodes on the Lightning Network with a network capacity of 3,600 BTC.

Portfolio Options

There are many wallets, with custodial and non-custodial options, that facilitate Lightning Network payments. Some of the best are Strike, Bluewallet, Cash App and Muun.

One important thing to note is that Lightning QR Codes are somewhat different from Bitcoin Chain QR Codes. Some newer wallets allow switching between on-chain Bitcoin and Lightning Network Bitcoin, but erroneous transactions are often caused by sending to the wrong type of address.

Warning

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