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What is Bitcoin Lightning Network? A Complete Guide to Second Layer Solution

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What is Bitcoin Lightning Network? Satoshi Nakamoto introduced Bitcoin to the world a decade ago amid much fanfare of a new decentralized method of payment that could potentially challenge the existing financial system. It seemed to work very well for some because there were fewer transactions conducted at the time.

Bitcoin grew in popularity and many people began stockpiling the new digital asset. Some were doing it as a hobby, others were investing, and a few were just testing the Bitcoin network. What started out as an interesting journey for the network users became a nightmare because the system was slow and clogged.

Bitcoin’s biggest challenge was just exposed. The new digital currency was too slow and had scalability issues. This is the reason why bitcoin critics such as Nouriel Roubini have constantly reiterated that the digital currency will fail as a payment solution because it cannot scale to the capacity of its competitors such as VISA.

Let’s turn some things into perspective by giving the numbers. Bitcoin is capable of only 7 transactions per second (TPS) while Visa supports 24,000 TPS and can scale up to 50,000 TPS.

While the bitcoin network has been forked several times to address its challenges, a new way of thinking was required to solve bitcoin’s scalability problems. The Lightning Network was born.

What is Bitcoin lightning network?

The lightning network is a second layer payment protocol that works as a secondary chain of a blockchain-based cryptocurrency such as bitcoin, ethereum, etc. It allows faster transactions for participating nodes and is regarded by many to be the solution to bitcoin’s scalability problems.

There is a lot of technicalities involved but this article will simplify the bitcoin lightning network as simple as possible.

Imagine you want to send a letter to someone in another country. You have to write the letter (obviously), seal it in an envelope, and make sure that that it has a postage stamp. You take a letter to the mailbox where it will be flown to the destination country. It is then collected by the mailmen and sent to various cities where it is narrowed down to its final destination.

This is a very complicated process that involves a lot of people and checks and balances that pretty much have nothing to do with your letter.

Imagine how simple the internet and email have simplified the process of sending and delivering messages. It has removed the need for various people and the communication is only between two parties – sender and receiver. The first scenario is like the Bitcoin network and the second scenario is analogous to the Lightning Network.

The idea behind the Lightning Network is to do away with a lot of data recorded on the blockchain whenever a single transaction is being made. The Lightning Network adds a second layer that allows transacting parties to create payment channels away from the main layer. The channels are set between two parties. The transactions are faster and cheaper.

How Bitcoin Lightning Network works

Let’s assume two parties wish to transact with each other using the Lightning Network. They have to set up a multisig wallet – one that requires at least two signatures to facilitate a transaction – to hold an amount of bitcoin. This is the first step that ensures that a payment channel has been set up.

Under normal circumstances, people have to transact by entering their data on the blockchain. The Lightning Network changes things a bit by making it possible for the two parties to transact with each without touching the blockchain. Each transaction requires the two parties to sign a balance sheet that reflects the amount of bitcoin each party has.

When the transaction is complete, the two people opt out of the channel and their balances are recorded on the blockchain. The Lightning Network deals with disputes by allowing the two parties to have a look on their two most recently signed balance sheet and recover their bitcoin stake in the multisig wallet.

It is not necessary to set up a direct channel in order to transact on the Lightning Network. You can pay someone using any of the channels you have previously created and the network will use the shortest route possible.

History of Bitcoin Lightning Network

Like many blockchain projects, the Lightning Network was announced to the world in 2016 via a paper published by Joseph Poon and Thaddeus Dryja. The following year a number of tests were performed on the Bitcoin core implementations.

The crypto startup Blockstream launched a payment system aimed at web retailers in January 2018. It was considered to be in testing mode with 60 nodes operating on the main network.

Lightning Labs, another startup focusing on second layer solutions for blockchain, released a beta version (Ind 0.4) for developers. In March the same year, Jed McCaleb, the CTO of Stellar and founding member of Ripple announced that the Stellar Network was going to implement something similar to the Lightning Network.

The Bitcoin Lightning Network had a steady growth rate of nearly 15 percent between April and August last year. The network’s nodes doubled from 1,500 to 3,000 and the channels have increased from 4,000 to 11,000.

Nodes on the Lightning Network suffered a DDOS attack in March 2018. Nearly 200 nodes were sent offline.

There are currently three companies – Blockstream, Lightning Labs, and ACINQ – working on the implementation of the second layer network. The implementations are written in different programming languages and are also interoperable, which means that they can smoothly work with one another.

Benefits

The Lightning Network is still in its infancy stage and it is too early to say whether it will be successful or not. If the network reaches the potential that developers say it will, then some of its benefits include:

  • Speed – users won’t need to wait too long for their transactions to go through once the network goes live. The transactions will be settled almost instantaneously even if the blockchain network is extremely busy. This will draw the cryptocurrency market a step closer to competing with highly scalable payment solutions such as VISA, PayPal, and Mastercard.
  • Scalability – blockchain suffers from low transactions per second. The Lightning Network is tipped to increase the transaction speeds of cryptocurrencies to one million TPS.
  • Lower transaction costs – all transactions take outside the main blockchain and users are compelled to pay a very small amount in transaction fees.
  • Privacy and anonymity – cryptocurrency transactions are not completely anonymous. Lightning Network transactions happen off-chain which make the transactions very difficult if not impossible to trace.

The future of the Lightning Network

The Lightning Network is still in its infancy and it will be a couple of years before it reaches its true potential. It is not user-friendly at the moment as it can only be used by advanced users.

The prospects of the Lightning Network are exciting – instant transactions, low cost, and increased anonymity – at the moment, it seems like the perfect solution to bitcoin’s challenges.

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