Bitcoin and blockchain technology have the potential to change the world’s financial system as we know it. However, the rising demand for the cryptocurrency has revealed one of Bitcoin’s major flaws – scalability.
VisaNet, the network that processes Visa credit card payments, can processes over 1,600 transactions per second, with the potential to scale up to 56,000 transactions per second if needed. Bitcoin’s network, on the other hand, can only process a maximum of 7 transactions per second.
As the volume of Bitcoin transactions increase, the number of transactions on the blockchain waiting to be processed by miners also increases. As a result, transaction fees can rise considerably in an effort to incentivize miners and prevent failed payments. In the past, fees have risen as high as $30US per transaction!
These scalability issues make Bitcoin a less than ideal solution for worldwide mass payments. The lightning network seeks to make Bitcoin the fast and inexpensive payment system it was intended to be.
What is the Bitcoin Lightning Network?
The Lightning Network was launched as a public beta on March 15, 2018, by the Bitcoin developer community, with contributions from Lightning Labs. It is a “second layer” payment protocol that operates beside the network’s main blockchain.
Simply put, instead of scaling the main blockchain, the network permits instant payments by keeping transactions separate from the main chain. The Lightning Network intends to help Bitcoin become a more feasible day to day currency by ensuring that small, everyday transactions do not overcrowd the main network. Because of the way it works, transactions on the Lightning Network are called ‘off-chain.’
How Does the Lightning Network Work?
The first, and most important, element of the Lightning Network is the payment channel. A Payment channel is an off-chain network that operates beside the main blockchain. This allows persons to conduct multiple transactions seamlessly without broadcasting them to the network.
The lightning network works by first creating a payment channel between two parties who wish to transact with each other. This is done by creating a multi-signature address; that is, an address that requires signatures from both parties. To start the channel, a certain amount of Bitcoin is deposited to the channel by each person. The deposit value equals the amount that will eventually be exchanged at the end of the transaction.
Once the payment channel is made, its creation is broadcast to the blockchain. Both parties are now free to send funds back and forth as many times as they wish without ever interacting with the main blockchain.
With each transaction, both parties digitally sign a balance sheet which records the amount of Bitcoin in the multi-signature wallet, as well as the amount that belongs to each person. Both parties in the multi-signature address keep and maintain this balance sheet.
Once both parties are done transacting, the payment channel is closed and broadcast to the network to be validated. This is the ONLY transaction done on the main blockchain. Upon validation, the funds are released to both parties in accordance with the information on the latest balance sheet.
The “network” in Lightning Network is so named because users can conduct transactions through the payment channels of other connected users. This means payments can be made through “indirect” channels rather than setting up a payment channel for each new transaction.
This way, the network will automatically find the shortest route using ‘intermediate payment channels’ that connect the sender to the receiver. The entire network is based on smart contracts, ensuring that funds are returned to the sender in the event of rerouting failure.
Benefits of the Lightning Network
Since the Lightning Network is independent of the main blockchain, transaction fees are significantly lower. Fees can be fractions of a cent as compared to fractions of a dollar when using the main blockchain.
The other main advantage of the Lightning Network is the ability to settle payments instantaneously. Because the main blockchain is not involved, the time it takes for funds to travel back and forth between destinations is reduced to fractions of a second as opposed to fractions of an hour.
Potential Shortfalls of the Lightning Network
Although technology can address many of the shortcomings of Bitcoin, some members the Bitcoin community have raised concerns. Firstly, since the network works via P2P channels, unresponsive peers can slow down transactions.
Additionally, there is a concern that this solution may not be ideal for large payments. The Lightning Network depends on intermediaries having enough funds in their multi-signature wallets. So, although a payment route may exist, some connecting multi-signature wallets may not have enough funds to carry out the transaction.
Finally, the greatest concern expressed by the community is the fact that the Lightning Network may encourage centralization. Large corporations, such as banks, may be encouraged to set up their own payment channels. These channels can act as payment hubs to carry out large-scale payments, making other “smaller” intermediaries obsolete.
Final Thoughts
The Lightning Network aims to restore Bitcoin’s original intention being a fast, efficient, and inexpensive payment solution. This solution can prove to be the game-changer in the world of finance if implemented correctly.
There are some concerns with this technology though, particularly with the issue of centralization. However, the network is still in beta, and its impacts can only be fully realized once it undergoes mass adoption.
