Lightning Network Explained: Accelerating Bitcoin Transactions for Lower Cost and Scalability

Introduction

Layer-2 scaling solutions have become an essential component of the blockchain ecosystem. Blockchains like Bitcoin and Ethereum have opened the door to blockchain-based transactions, decentralized applications, digital assets, and whatnot, but they still need some help with their scalability, which limits their full potential. Layer-2 scaling solution introduces some additional features to layer-1, making it a robust and scalable blockchain for mass adoption. This article will explore the Lightning network- a layer-2 for OG Bitcoin, its working, features, and more. 

What is Lightning Network?

Lightning Network is a decentralized peer-to-peer system specifically designed to enhance the speed and throughput of the Bitcoin blockchain by facilitating off-chain transactions. It processes transactions on the layer-2 Lightning network and settles them on the Bitcoin (layer-1 blockchain), removing the hassle of block confirmation on the primary blockchain every time you try to make a transaction. This way, it can reduce high transaction costs and improve the scalability of Bitcoin, making it a suitable option for day-to-day use. 

But what’s the need for a Bitcoin scaling solution? Bitcoin creator Satoshi Nakamoto envisioned Bitcoin just as a decentralized peer-to-peer electronic cash that lets people access financial services without going through any authority or middlemen. It has undoubtedly achieved this vision, but the Bitcoin blockchain suffers from two major limitations: high fees and low transaction speed. 

Bitcoin’s blockchain was designed with a limited block size of 1MB and can process only 5-7 transactions per second, significantly less than Visa payment’s thousand transaction speed. Furthermore, Bitcoin transaction confirmation time can take just a few minutes to several days, depending on pending transactions. As network usage increases, some individuals pay high transaction fees to get ahead in the queue, which ultimately results in increased transaction fees- sometimes even becoming more than the actual transaction amount itself.

Joseph Poon and Tadge Dryja came up with the Lightning Network in 2015 to overcome these challenges, improving the efficiency and performance of the Bitcoin blockchain. The project received support from many contributors, and its mainnet was finally launched in 2018 by Lightning Labs.

Read more: Bitcoin Whitepaper Explained

How does Bitcoin Lightning Network work?

Lightning operates through the concept of payment channels to take transactions off-chain from the Bitcoin blockchain. A payment channel is basically a smart contract that enables an unlimited number of peer-to-peer transactions between two users of any amount at instant speed and very low costs.  

Once a channel is established between users, the sender needs to add some amount of Bitcoin onto the Lightning network, to make transactions, and the receiver generates the receipt as per their wish. The important thing to note here is that the Lightning network does not actually settle transactions every time; once users decide to close the payment channel, all transactions are combined in one transaction and then sent to the Bitcoin blockchain for the record. This way, it eliminates network congestion caused by small transactions and also reduces high fees.

Additionally, the Lightning network enables multi-hop payments that let a user transfer funds to another user (who are not directly connected through a channel) by routing it between a series of channels. This gives flexibility and further improves the scalability of the network.

For example, If person A needs to make regular payments to person B, they can create a channel and do Bitcoin transactions at instant speed and cheap rates. When A and B close the channel, the opening and closing of the channel transactions will get recorded on the Bitcoin network. If A has to make a transfer to third-person person C, who has a channel with person B but not with A. Person A can still make transfers to Person C through the routing mechanism of the Lightning network.

Read more: What is Bitcoin Hash Rate? 

Advantages & Disadvantages

Here are a few advantages of the Lightning network:

• It offers high throughput, up to 1 million transactions per second, at very low costs (average 0.0029%).
• It allows swift micropayments, and users can send as minimum as 1 satoshi.
• Multi-hop payments further enhance the flexibility and scalability of the network.
• It also reduces energy consumed in Bitcoin’s Proof of Work mechanisms by decreasing the number of transactions. 
• It ensures the security and confidentiality of transactions and user data.

Here are the disadvantages of Lightning Network:

• Transacting through Lightning Network can be a complex process for some as one needs to set up, then open a channel, and top it up with funds after that can be made.
• As users’ funds are locked inside the channel, there are still technical and security risks of losing them.
• It still needs the functional scalability of the network.

Read more: Proof of Work vs Proof of Stake

Prevent fraud within the Lightning Network

The Lightning Network has introduced some measures to prevent risks to ensure the security and integrity of the network, as follows:

• Hash Time-Locked Contracts (HTLCs): The Lightning network utilizes cryptographic hashes and time locks to create smart contracts between participants. This way, it allows users to confirm transactions before time out, further enhancing security.
• Penalty Transactions: Users can create penalty transactions to claim stolen funds if another party tries to close the channel improperly or initiates a fraudulent transaction.
• Watchtowers: It implements specialized nodes called Watchtowers that monitor the blockchain and broadcast penalty transactions to help protect users from scams. If a fraudulent party tries to close a network to take funds, these watchtowers detect it, freeze funds, and create penalties for fraud.

Future of Lightning Network

Lightning network sure has the potential to transform Bitcoin scalability issues and increase its adoption. It allows off-chain transactions, enabling fast, cheap, and accessible Bitcoin transactions for daily uses. It also adds smart contract functionalities on top of the Bitcoin layer, opening the way for Decentralised Finance, gaming, Non-fungible tokens (NFTs), and other decentralized applications. Furthermore, the Lightning network team is continually working to improve further the scalability, security and performance of its ecosystem.

Read more: Bitcoin vs Ethereum

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