What is the Lightning Network?

Beginner Sep 7, 2021

lightning network
Key Takeaways:
— Bitcoin, the most popular cryptocurrency, is the store of value of the digital age, however, it struggles to become an effective medium of exchange due to its slow and cost-intensive transactions.
— The most effective and popular solution to this is the Lightning Network, a layer-2 solution for Bitcoin that takes transactions off-chain using smart contracts called channels.
— In this article, we explore why Bitcoin needs the Lightning Network in the first place, how the latter works, and its advantages and disadvantages.

Wondering what the Lightning Network is all about? We’ll walk your through the whys and hows. Fasten your seatbelt.

“Suffering from Success,” although a music album, is a phrase that resonates closely with the challenges faced by the Bitcoin network today.

Bitcoin: Digital Gold Suffering from Success

In its early days, Bitcoin was simply seen as the safest and most secure system to circumvent the centralization and corruption of the legacy financial system. It empowered people to become sole owners of their money and transact however and with whomever they wanted to; no questions asked.

To warrant this security, however, Bitcoin bowed to what is now called the blockchain trilemma. According to the blockchain trilemma, it is technologically impossible for a blockchain to maximize all three of its fundamental characteristics: decentralization, security, and scalability. 

As is obvious, Bitcoin compromises its scalability and speed to attain maximum decentralization and security.

All of this was cool until Bitcoin became handsomely popular. As more people flocked to Bitcoin, the transaction completion time grew further due to network congestion. Besides, people wanted to use Bitcoin as a medium of exchange for their day-to-day transactions. But its unreasonably slow transaction speed and high cost limited its use. 

According to Blockchain.com, Bitcoin’s average transaction time ranges between five to 10 minutes. In addition, the transaction fee on the smallest of transactions didn’t add up well to that equation. 

Now, it’s all a matter of circumstances. You could comfortably pay a dollar or 20 and wait 10 minutes or an hour to send a few hundred, thousand, or million dollars in Bitcoin. But imagine paying the same fee for buying a soft drink can and waiting at the store for five minutes for the transaction confirmation. Not so cool or efficient, is it?

The more transactions we have on the network, the more time the network may take to process your transactions. Then, the longer you’ll have to wait at the store and the more anxious you’ll grow about people frowning at you for taking so long to make your payment.

And then Struck the Lightning Network

The Lightning Network is what is popularly known as a layer-2 solution. As the name suggests, a layer 2 solution is an additional layer over the main blockchain that tends to enhance the efficiency of the underlying blockchain network.

In Bitcoin’s case, the Lightning Network — introduced in 2015 and launched in 2018 — aims to bring maximized speed and minimized transaction fees for Bitcoin transactions. To achieve this, Lightning Network kicks out the need for you to interact with the Bitcoin network’s slow protocol for every Bitcoin transaction. 

Instead, you can set up “channels”, a.k.a. smart contracts, with people you want to transact with. Inside these channels, you can add Bitcoins and conduct all transactions almost instantly and at a negligible cost. 

To do this, however, the Lightning network interacts with the Bitcoin network for the creation and closing of the channels. It sends to the network the details of the first transaction to create a channel and the last transaction to close that channel and the final value of Bitcoin held by each participant. That way, the Bitcoin network doesn’t need all the transaction details but just the balance of each user at the opening and closing of a channel.

So, as long as a channel stays open, you and other participants of the channel can transact with each other in Bitcoins without interacting with the Bitcoin blockchain.

How This Works Out in Real Life

Suppose you go to a grocery store daily morning to buy milk and bread and make your payment in Bitcoin. To make your payments fast and cheap, you can create a channel with the grocery store owner, fund it with a certain amount of Bitcoin (which remains yours unless you initiate a transaction), and instantly pay for the milk and bread daily. 

Every day, when you make a payment in Bitcoin, the channel updates its ledger to reflect your and the store owner’s current Bitcoin balance. 

When you decide you no longer want to buy from that grocery store, you can close the channel and both you and the store owner will respectively receive in your wallets the final balance as recorded in the ledger.

But… you already sense a problem, right?… Does this mean you have to create an individual channel with everyone you want to transact with? Well, yes and no.

Yes, because that’s how Lightning Network works. No, because Lightning Network can also process transactions through mutual channels. So, suppose you have a channel with a friend of yours who has a channel with a medicine store. 

Now, if you want to make a Bitcoin payment to the medicine store, you can do it without opening a new channel with the medicine store. When you make a payment, it will go from your channel with your friend to your friend’s channel with the medicine store, thus reaching its intended destination. And the ledgers on both channels will be updated accordingly.

Quite clearly, this ability amplifies as the Lightning Network grows more popular and an increasing number of people open new channels with each other. 

This is similar to how having just one Facebook friend with 200 friends, each of whom had 100 more friends, makes your third-level network have as many as 20,000 people. If you replace Facebook with Lightning Network in the same example, having just one channel with such a friend can help you make Bitcoin payments to 20,000 people. 

You can now do the math. Or not.

And of course, this process is automated for the most part and made user-friendly by the ever-growing number of lightning network apps aka LApps

But There are Also Drawbacks

There had to be. 

The first and most critical drawback of using the Lightning Network is that it prevents users from using their Bitcoin outside of the channel(s) until the channel is closed. This implies that although you’re paying the grocery store owner for milk and bread daily, the owner cannot use those funds unless the channel is closed.

Besides, Lightning Network is connected to the internet 24×7, and there’s no way, at least not yet, to use a cold wallet with the channels on the network. So, there comes kicking in a security issue that prompts you to not store a large amount of Bitcoin on the network. Because anything connected to the internet always has risks associated with it.

Lightening Network: It’s Still Worth It

For Bitcoin to become a commonly used medium of exchange, there’s no way around faster and cheaper transactions. And the Lightning Network, despite some drawbacks, stands to this cause in the best possible way. So, unless there’s a better way to steer clear of the challenges of Bitcoin, Lightning Network will enable you to make your day-to-day payments with ease.

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