Bitcoin was not designed to handle a lot of transactions at once—its popularity made it slow and expensive. To solve this, developers created cryptocurrency layers where the first layer is the primary blockchain. each layer beneath that is secondary, tertiary, etc. The Lightning Network is a second layer for Bitcoin that enables faster, cheaper payments between participating nodes.
By doing this, it increases the efficiency of transactions that can be conducted on the blockchain. The Lightning Network is a layer that uses multiple payment channels to connect parties or Bitcoin users. A channel between two parties allows them to make payments to each other.
Transactions on the Lightning Network are conducted much faster than those on the Bitcoin blockchain, and they often incur lower fees as well. The Lightning Network can also be used to conduct other types of off-chain transactions involving exchanges between cryptocurrencies.
Joseph Poon and Thaddeus Dryja first proposed the Lightning Network in 2016 as a solution to Bitcoin’s slow transaction time and the low number of transactions that can be processed.
How Does the Lightning Network work?
The Lightning Network employs smart contracts in order to set up off-blockchain payment channels between two users. With these established channels, funds can be quickly transferred with little to no delay.
The network doesn’t need to create pairs between all users, which is clever. For example, if User A has a channel with User B and User C also has a channel with User B but not with User A – funds can still be transferred freely between the networked parties.
Lightning addresses look like regular Bitcoin addresses and the payment process is very similar for users. Users are able to close their payment channels at any time in order to settle their final balances on the core blockchain.
The Lightning Network can facilitate Bitcoin transactions more quickly because only the opening and closing of payment channels are recorded on the blockchain. Moreover, these sorts of transactions can be private due to them, not all appearing on a public ledger.
What Does It Try to Address?
The issues below are some of the reasons why Bitcoin wasn’t created to handle the number of transactions that now occur daily. The Lightning Network attempts to correct these:
- Quick confirmation of transactions – With more and more users each day, it has become quite expensive and time-consuming. The problem is two-fold: not only does the mining difficulty increase over time, but also the number of transaction confirmations required per user interaction.
- Conserve energy – The computing power required to generate this information is massive, making it very expensive to maintain the Bitcoin blockchain.
- Introduce multi-signature scripts and smart contracts – The Lightning Network relies on smart contracts and multi-sig to ensure that funds sent through channels reach their intended recipients.
The Lightning Network allows participants to open channels between themselves so that multiple transactions can be conducted without waiting for the slower main net to confirm single exchanges. Once a channel is opened, parties can shift funds between themselves as needed until they close the channel. When the channel is closed, all of the transactions are sent to the main net for confirmation.
Why is something like Lightning Network important?
In 2008, Satoshi Nakamoto first described Bitcoin in a whitepaper using the phrase “peer-to-peer electronic cash.” Obviously, at that time they were suggesting that cryptocurrency might one day become popular for people paying for goods and services online.
However, as Bitcoin’s value has increased exponentially over the years, so has the general consensus of what it’s useful for. Now, most people think of Bitcoin as being more like digital gold––a safe place to store your wealth long-term where it won’t be affected by inflation.
The reason for this is, in part, due to the layout of the Bitcoin network. By design, Bitcoin allows two people anywhere in the world to securely send or receive value without needing a credit card company or payment processor present.
The solution that Nakamoto found to this problem was mining, though it can be a very lengthy process. In order to help Bitcoin function more like the digital cash that Nakamoto envisioned, the Lightning Network processes transactions “off-chain” much quicker and cheaper than Bitcoin’s core blockchain—with fees typically being fractions of a cent.
While the main Bitcoin blockchain can only handle a few transactions per second, Lightning Network has the potential to process millions of transactions each second. Not to mention, Lightning-powered transactions also use less energy.
Potential Flaws of the Lightning Network
One of the most concerning problems with the decentralized Lightning Network is that it could lead to a recreation of the hub-and-spoke model present in today’s financial systems. Currently, banks and financial institutions are dominant influences in transaction management.
Businesses can become central hubs in the Lightning Network by investing and having more open connections with others. However, there are some negatives to this including fraud, fees, hacks, and price volatility.
Closed Channel Fraud
One of the risks when using the Lightning Network is that you may have to close your channel and go offline. For example, suppose Mark and Carol are transacting, and one has malicious intent. The dishonest party may be able to steal coins from the other participant by closing the channel fraudulently.
If Mark and Carol each put up an initial deposit of .5 BTC to open a channel, and a transaction of 1 BTC takes place in which Mark purchases goods from Carol, logging off (closing the channel) after transferring the goods would mean that Mark could broadcast the initial state. This would be to retrieve both and get their original deposits back as if no transactions were done-in other words, Mark receives 1 BTC worth of goods for free.
In order to maintain secure transactions within the Lightning Network and prevent fraud, third parties run nodes called watchtowers. The purpose of a watchtower is to monitor transactions and help ensure that channels are not closed fraudulently.
The Lightning Network is also believed to be vulnerable to hacks and thefts because payment channels, wallets, and application programming interfaces (APIs) can be hacked. Payment channels between various parties that combine to form a network of Lightning nodes routing transactions among themselves make up the Lightning Network. Different payment channels are interconnected, which results in the formation of the Lightning Network.
There are transaction fees associated with using the Lightning Network, which includes routing charges for sending payment information between nodes, opening and closing channels, and Bitcoin’s usual transaction fees.
Some businesses may start charging their own additional fees once they adopt the Lightning Network as a payment and settlement layer. Additionally, because watchtowers are third-party services, many of them charge Their own separate fees.
Arcane Research reports that Lightning Network’s payment volume increased 410% in the first quarter of 2022 compared to the previous year. This suggests that more users are now using the network for payments.
Once two parties have settled a bill, they need to record a closing transaction on the blockchain, which includes a fee charged for forwarding the transactions. This can be either a base fee (a set amount) or a fee rate (a percentage of the transaction).
Congestion from a malicious attack is another risk to the network. If payment channels become congested and there’s a hack or attack, participants may not be able to get their money back quickly due to the congestion.
Attackers can also use a denial-of-service attack to congest a channel, essentially freezing it. In these types of attacks, the attacker could use the congestion to steal funds from parties who are unable because of the freeze to withdraw their own funds.
How to get started?
You can only use the Lightning Network to make transactions if you have a Bitcoin (BTC) account. Fortunately, there are dozens of wallets that support this system. When deciding what type of cryptocurrency wallet to use, you have two options: custodial and non-custodial. Here’s how they differ:
- Non-custodial wallets – The options for wallets are Muun, Breez, Phoenix, and Zap. With these user-controlled wallets, only you have access to your private keys which is popular among more experienced traders. If any damage or loss occurs to your wallet or if you forget your password, you could wave goodbye to permanently losing access to those funds unless you know how backing up or restoring works for whichever wallet you choose.
- Custodial wallets – Some good choices for beginners who want to manage their private keys include Strike, Blue Wallet, and Wallet of Satoshi. These wallets make it easier to send and receive cryptocurrency. For example, if you forget your password, you can reset it.