Lightning Network Explained – What is it? Why do we need it?
The Lightning Network is a protocol designed to improve scalability and speed up transactions on blockchains. The network was first described in a whitepaper by Joseph Poon and Thaddeus Dryja in January 2016. It is a system of smart contracts that operate on top of the Bitcoin blockchain. It will allow for instantaneous microtransactions while maintaining privacy and enhancing cost-effectiveness. In fact, while specially designed for the Bitcoin blockchain, it will be able to be implemented on top of other blockchains too.
“Lightning Network can work on the Bitcoin blockchain, on other blockchains, or it can be used to instantly transfer different assets between blockchains using “cross-chain atomic swaps.” The consensus rules for each blockchain can be different, allowing for secure crossing of asset classes without custodial clearing agencies”. Elizabeth Stark, Co-Founder of Lightning.
Scalability, Speed, Fees
The primary reason for the development of the Lightning Network was to address the Bitcoin blockchain’s scalability issues. Currently, Bitcoin’s network is limited to an average of around seven transactions per second. In contrast, VISA’s payment network processes several thousand of transactions per second. Next, the current block confirmation time on the Bitcoin blockchain is approximately 10 minutes. Once in place, the system will enable users to send and receive transactions instantaneously. Lastly, current transaction fees of up to NZD$0.14 make microtransactions expensive to perform. The Lightning Network will help reduce these fees by keeping microtransactions off the primary network.
Cross-chain Atomic Swaps is another feature the Lightning Network will realise. An Atomic Swap utilises smart contracts to permit p2p transactions without using a centralised exchange. In other words, users can exchange crypto directly from one blockchain to another. For this purpose, both blockchains need to have the network implemented and use the same hash function such as SHA-256. Because of Atomic Swaps, a more decentralised economy will be achieved.
Lightning Network Explained – How does it work? When is it coming?
Big day for bitcoin, Lightning goes live on mainnet! ⚡
Announcing the first Lightning beta release for the live bitcoin network, lnd 0.4. Read about it here: https://t.co/aaYec7Orsj 👩🏻🚀👨🏿🚀🚀
— Lightning Labs⚡ (@lightning) March 15, 2018
The ultimate end goal is to encompass the world’s financial transactions using a blockchain. Ideally, in a way that won’t sacrifice the security blockchain decentralisation provides. So, how does this new Lightning Network work?
- A 2-out-of-2 multisig wallet, or “payment channel”, is set up and saved to the public blockchain, with at least one party committing initial funds to this 2-of-2 ledger entry.
- The two involved parties conduct transactions on this payment channel. Each party has one private key, and spending on the ledger only occurs when both keys sign.
- The ledger acts as a balance sheet to reflect the ownership of the BTC in the payment channel.
- Transactions are written to the main blockchain in the event of a dispute or payment channel closure.
- The initial transaction opening the payment channel takes approximately 10 minutes for confirmation. Afterwards, the two parties transact with each other instantly by using the funds allocated to the channel.
- Smart contracts ensure the network functions in a decentralised manner while mitigating counterparty risk.
- Only a few nodes connect everyone throughout the network.
- Users transact with anyone connected to their network of payment channels via multiple hops. This means you don't require new payment channels every time you transact with a new party.
In using bidirectional payment channels, the network requires the consent of both parties. This enables either party to update the balance inside the payment channel and transactions can move in both directions. A further benefit to bidirectional channels is that either party can close the channel if the other party becomes malicious. When closed, you broadcast the channel to the blockchain. A “fidelity-bond”, aka Revocable Delivery Transaction, sends the entire balance to party A if B breaks the contract terms. This significant penalty is in place to prevent one party from stealing the other’s BTC. For more detail on the security methods in place, please refer to the whitepaper.
“The architecture of the Lightning network is still trustless (because it is based on smart contracts) and will always make sure that the funds will reach their destination through intermediaries or issue a refund if there is no indirect path to the destination possible.” Lukas Schor, The Argon Group.
Lightning Network Explained – Are there any issues? What’s next for Bitcoin?
Peer failures/offline payments:
Both parties need to sign to close a transaction and publish it to the blockchain. If one party is unresponsive, the other will have to wait. Additionally, this means you can’t pay someone who is offline.
Not ideal for large transactions:
The Hashed Timelock Contacts (HTLC) used as part of the payment process are more suited to smaller amounts. A high-value payment could get “stuck” if the other party was offline or not responding. One would then have to wait for the contract to expire before receiving a refund.
Centralisation: some believe the network may encourage payment hub centralisation similar to that of mining pools.
Core nodes and their keys must remain online always for lower latency, which may make them more susceptible to hacks. However, End-users and lesser nodes can keep their private keys securely offline.
Atomic multi-path payments:
The future of Lightning may involve multiple-person Atomic Swaps. This potential development would allow several people to transact on the same payment channel. Ultimately, they would be able to do so in multiple Lightning Network supported cryptocurrencies.
The Watchtower protocol works on the network to monitor transactions to ensure the other party completes them as required. It functions as an added security layer.
Lightning Network Explained - The Future
Poon and Dryja believe that through using Lightning Network, it’s possible Bitcoin will scale to billions of transactions per day. As well as addressing scalability issues currently facing Bitcoin, the Lightning Network provides many other benefits. Instant transactions, micropayments, exchange arbitrage, and cross-chain payments to name a few. The future of blockchain technology will be an innovative one following the implementation of this legendary development.
If you want to learn more about other developments happening across blockchain networks check out our post on Blockchain 3.0 and future technology. Or read more about other challenges facing blockchain tech and the teams working to solve them.
Want to learn more about blockchain technology?
Read this post to find out more about the future of blockchain: The Cryptocurrency Future: Hurdles and Heroes
Disclaimer: The above references an opinion and is for informational purposes only. It is not intended as personalised financial or investment advice. The opinions expressed by the author do not represent the opinion of BitPrime.
Last updated: 25/05/2018