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Austin Jacob • April 16th, 2020

What is the Lightning Network?

lightning networkThe word Lightning Network has been thrown around in the cryptocurrency community for several years now.

However…

Many still don’t know what the Lightning Network is, and how it works.

That’s where we come in.

After reading this guide, you’ll have a full understanding of what the Lightning Network is, and how it’ll be used to solve many of Bitcoins scaling issues.

Arguments For Lightning Network Adoption

Cost – The average Bitcoin transaction is about $0.50 although fees can easily go higher. During the bull run of 2017 people paid as much as $50 for a single transaction.

Time – Bitcoin transactions take about 1 hour to confirm and that’s assuming that your transaction ends up in the next block. If you pay the lowest fee it could take hours for a transaction to be sent.

A solution to Bitcoin’s slow speed is needed and that solution is the lightning network: a protocol to send instant Bitcoin transactions for a marginal fee.

In this article, we’ll cover the good, the bad and the ugly of the lightning network.

Main Points

  • Normal Bitcoin transactions are slow and somewhat costly. The lightning network provides a way to send Bitcoin instantly and for only a small fee.
  • The lightning network is complex and requires moderate technical expertise to use
  • Currently, the lightning network only works for smaller transactions, $50 or less as a rule of thumb. This could increase quickly in the future if more people open channels

Why Bitcoin Needs Lightning

Although it’s slow and expensive (at least compared to other cryptocurrencies) it would be a grievous error to say that the Bitcoin network is broken. This is far from the case.

Instead, the Bitcoin community has prioritized other, slightly more intangible features: decentralization and security. Thanks to its massive security network the Bitcoin protocol is the most decentralized in the entire crypto ecosystem. It’s also the most secure.

The news is rife with security breaches like the Ethereum Classic 51% attack, the IOTA hack, the Vertcoin hack, the Bitcoin Gold hack, etc. Yet Bitcoin, the largest honeypot of them all, remains unaffected. This excellent security record should not be taken for granted.

Unfortunately, the biggest tradeoff of great decentralization and security is speed. A lot of solutions to that speed problem were proposed but the lightning network was the answer that the community finally settled on.

Here’s how it works.

Lightning Network Explained

The lightning network is an off-chain solution. That is, it’s a piece of software that’s implemented without making major changes to the Bitcoin core protocol.

This is advantageous as it reduces the possibility of a critical bug. With several hundred billion dollars’ worths of stored wealth, the Bitcoin protocol is extremely valuable and the Bitcoin developers who maintain it must be very careful before they make any changes. Since the lightning network works off-chain it was able to be implemented without creating much risk to the network.

To use lightning a Bitcoin user must send some Bitcoin to a lightning address. This will allow them to open a channel (account) that is connected to another user.

For instance, Andy could open a channel with Billy’s Coffee Shop.

Once the channel is open Andy can send Bitcoin to Billy instantly and for a nominal fee. This channel can be kept open for as long as it needs to be and any transactions between Billy and Andy will be instant and nearly free.

When Billy decides that he’d like to sell the Bitcoin he’s collected from Andy he can close the channel. At that point, the lightning network will send all of Billy’s earned Bitcoin to the address that he opened the channel with.

Billy can then send that Bitcoin to an exchange to sell it or he can store it safely in a hardware wallet. Any Bitcoin that Andy has left after paying Billy will also be refunded to the Bitcoin address from which he opened the lightning channel.

That’s a simple example with just two parties transacting. However, the lightning network also allows people to send payments even if they haven’t opened a channel between each other. Here’s how.

  1. Andy opens a channel to Billy’s Coffeeshop
  2. Billy opens a channel with Corey
  3. If Andy wants to send some Bitcoin to Corey he can use Billy as an intermediary. I.e. Andy sends Bitcoin to Billy who passes it along to Corey
  4. By using intermediaries the lightning network allows users to send Bitcoin to people even if there is no direct channel open between them

Caption: Each dot represents a channel. It’s possible to see how some channels are only connected to one person while “super channels” like the red one are connected to multiple channels. In our scenario, Billy’s Coffee Shop could be the red dot.

It’s important to point out that intermediaries must have enough Bitcoin in their accounts to clear the payment. For example, if Andy wants to send Corey 1 Bitcoin, Billy’s Coffee Shop as the intermediary must have 1 Bitcoin in his channel in order to pass it along.

This is the reason why large transactions are currently not possible with the lightning network. As of publication, the lightning network has a capacity of $8,000,000. Given that there are 36,000 channels that means that the average channel has just a $220 capacity.

While this number is inaccurate (the average is skewed heavily by a handful of “super channels”) it illustrates the point that the lightning network cannot handle large transactions yet.

That being said, new developments and a better UI could go a long way toward improving the lightning network which could quickly increase adoption. There is no technical reason that the lightning network cannot support larger transactions, it simply requires more investors to open channels with larger balances.

Once that happens the lightning network can live up to its potential so that everyone can send cheap, fast Bitcoin transactions.

For up to date statistics on the lightning network please check here.

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