Understanding The Lightning Network

Jack Choros

Content Marketing

The Bitcoin Lightning Network exists to increase the scalability and transaction speed of the Bitcoin blockchain. To gain a greater understanding of what it is, how it works, and why decentralized currencies need it, it’s important to look at cryptocurrency adoption from a 5,000-foot view.

The idea that currencies can be decentralized and trustless, free of government control, and make exchanging value on a large scale easier for all of humanity, in the long run, is great in theory.

However, getting to the point where cryptocurrencies as day-to-day payment solutions are both faster, easier, and more secure than using the Canadian dollar is still a work in progress, to say the least.

Bitcoin’s Lightning Network implementation (along with other scalability solutions that live on other blockchains) aims to get Bitcoin closer and closer to that reality.

Understanding The Lightning Network

The Bitcoin Lightning Network and Layer 2 Solutions

If the coding structure that makes up the Bitcoin blockchain represents the foundation of its existence, The Lightning Network is a second layer on top of that. It is not a separate cryptocurrency. It still lives within the Bitcoin ecosystem.

In a broader sense, Layer 2 solutions aim to improve transaction speed and scalability. Any solution that lives on top of any blockchain’s coding structure (IE. the Casper, Plasma, or Sharding upgrades that exist on the Ethereum blockchain) are all collectively considered Layer 2 solutions.

The Practical Reason for Layer 2 Solutions

The reason Layer 2 solutions are a necessity in the blockchain world is because of a principle called the Impossible Triangle. The Impossible Triangle suggests that while all decentralized apps and cryptocurrencies aim to maintain decentralization, security, and scalability, it’s impossible to account for each of these traits perfectly.

The Ripple blockchain and its XRP token can scale to 1,500 transactions per second. However, permissions related to the Ripple blockchain are controlled by a private company. It is not a truly decentralized project.

On the other hand, Bitcoin is a completely decentralized project, but it can only handle 5 to 7 transactions per second.

Neither one of these projects can compete with the transaction speed offered by traditional payment systems like Visa, which can handle up to 65,000 transaction messages per second. Visa also offers security because traditional payment networks work closely with governments. The downside of that is that you have to give up your privacy. Visa is also a centralized entity.

The Practical Reason for Layer 2 Solutions

The Finer Details and Functions of The Lightning Network

The Lightning Network exists to make Bitcoin transactions move faster. It does this by temporarily allowing transactions to occur off of the blockchain. This way, only the bare-bones details of a transaction are registered on-chain. Every transaction is still going to be validated by nodes reaching consensus, but using all of the blockchain’s resources to get the job done is no longer necessary.

This is all done using payment channels. The Lightning Network enables participants to open a payment channel to facilitate transactions. The opening of a payment channel is validated on-chain. So is the closing of that payment channel. However, all of the transactions that occur in between happen off-chain.

Therefore, payment channels take the majority of transactions that might occur between two or more parties off-chain so that the computing power used to take care of everything happening on-chain can be dedicated to that.

The Lightning Network is a more efficient way to facilitate a greater number of transactions.

A Practical Example of The Lightning Network in Action

Pretend that you love peach flavoured tea at Starbucks. You go to the same Starbucks location every day and have the same peach flavoured tea every morning. You want to pay in Bitcoin and find out that you can indeed do just that.

You know from experience that you’re not the only one who loves Starbucks. Since it’s popular, you know you’re going to wait in an extra-long lineup every day. You don’t have time for the blockchain to spend precious moments confirming all of your transactions because it’s also validating the transactions of every commuter looking to get their cup of Starbucks right alongside you.

The manager of Starbucks sees your point and enables the ability to open up a payment channel between you and the store using multi-signature addresses on the blockchain. The multi-signature address exists so that you and the Starbucks manager still have a record of the daily transactions happening off of the blockchain. But remember, only the opening of that payment channel will register on the blockchain.

You both agree that once a month you’ll spend an extra two minutes waiting for your tea so that you can close the payment channel, have a final record of your monthly peach flavoured tea expense living on the blockchain, and then open up a new payment channel for the next month. You can repeat the process over and over again to save the most time, money, and blockchain resources possible.

A Practical Example of The Lightning Network in Action

Making The Lightning Network Truly Useful

There is a caveat to the above example. It assumes that you and the Starbucks manager are handling the technical aspects of opening a multi-signature payment channel, trading Bitcoin in exchange for your peach flavoured tea, and then also closing the payment channel to make everything official and put it on the blockchain.

In reality, this requires technical knowledge. That said, the idea is that in the future, the above processes will happen in the background while you conduct your day-to-day activities.

As with any other scaling solution or advancement in blockchain though, there are several pros and cons to The Lightning Network implementation.

The Advantages of Bitcoin’s Lightning Network

If you’ve been using cryptocurrency for a while, you probably understand that things like transaction speed and transaction fees are major challenges developers and project creators are looking to improve on. Bitcoin’s Lightning Network offers several benefits in pursuit of a more efficient and scalable decentralized payment process.

Payment Channels Reduce Stress on the Blockchain

In a general sense, it reduces the load on the blockchain which is an idea that we’ve already discussed. The main point here though is that only two transactions register on the blockchain. One transaction opens the payment channel, and another transaction closes the payment channel and registers the result of all of the transactions on the blockchain.

The fact that a multi-signature address is used to open and close payment channels ensures that even though not every single transaction is being registered on-chain, all of the participants can sign off after they have finished exchanging value.

Nobody Can Steal from Each Other

With multiple signatures being required to open and close payment channels, each participant can see a running balance of whatever’s happening. The data is still transparently available to all parties. Keep in mind that all parties in the Starbucks example still have to have the necessary funds available to complete all transactions. There is no way of buying now and skipping out on paying later.

The Lightning Network Finds the Fastest Route Possible

This Layer 2 implementation finds the fastest way possible to read a transaction. This means even when you’re finished with your payment channel and you’ve closed it off, the blockchain is using only minimal resources to validate all of the payments that occur within that channel.

Nodes Open and Close Payment Channels for You and Pick the Best Possible Route

Remember that everything described in the Starbucks example happens on the blockchain. It’s not an interaction between two people physically providing signatures to open a payment channel. It’s all digital.

The Lightning Network allows nodes to open and close payment channels and pick the best possible route for your transactions to take place without you having to be a blockchain developer.

With all of that being said, there are also a few downsides to The Lightning Network solution.

Nodes Open and Close Payment Channels for You and Pick the Best Possible Route

The Disadvantages of The Lightning Network

As with any advancement in the world of blockchain technology, the Lightning Network implementation also comes with its share of disadvantages.

It’s Impossible to Confirm Transactions Off-Line

It is estimated that more than 2 billion people on this planet don’t have a bank account. That means there are still a lot of people in this world who can’t participate in the traditional financial system. If you’re a cryptocurrency veteran, you might already be aware of that.

What you may not be aware of is the fact that more than 50% of the world’s population still doesn’t have access to the Internet, according to the United Nations.

Doesn’t that blow your mind?

The fact that Internet access is still scarce in many parts of the world means that many of the people counting on blockchain technology to free them from being unbanked also don’t have the Internet access necessary to participate in transactions on The Lightning Network.

The Lightning Network May Centralize Power

The Lightning Network upgrade allows nodes to become payment hubs. Nodes host the opening and the closing of payment channels and account for all of the transactions happening in between. This means that nodes with high volumes of Bitcoin transactions swapping inside of their payment channels become large hubs.

Centralizing value means centralizing power, and part of Bitcoin’s Mission is to avoid the centralization of power and make access to wealth a democratic endeavour for everyone.

The Lightning Network Is Only for Relatively Small Payments

The Lightning Network implementation works great if you’re just buying a coffee at the corner store. It’s not quite ready for big-time purchases yet. There have also been recent issues related to spamming attacks that can raise fees dramatically, meaning that facilitating a big transaction would cost you too much.

Buy Bitcoin with Netcoins

Many Layer 2 solutions will continue to come out of the woodwork as developers race to solve the challenges of the Impossible Triangle. The good news is, you don’t have to be an expert on The Lightning Network or blockchain development to save on fees.

The first step to saving money related to Bitcoin transactions is to start by using Netcoins. Netcoins is the fastest-growing cryptocurrency exchange in Canada. It operates out of Vancouver and offers some of the most competitive transaction fees within the Canadian crypto exchange market.

Register for a free account today and take advantage of all the growing developments occurring in the world of Bitcoin, Ethereum, Litecoin, and many of today’s hottest cryptocurrencies.

Written by: Jack Choros

Writer, content marketing at Netcoins.