After the introduction of Bitcoin as a more cost-effective alternative to fiat money in 2009, it became obvious very soon that it failed in the field of instant payment. Namely, the Bitcoin platform was characterized by high fees and slow transaction throughput. 

In order to overcome its speed and cost limitations, a new payment protocol labeled Lightning Network was added to the Bitcoin blockchain as a way of speeding up the remittance. The second layer to the database of encrypted blocks allowed for the creation of new payment channels on the platform, between any two parties. The transactions conducted via these new channels are faster, with minimal or no fees for the service. 

Gold bitcoin propped up against chopsticks

Understanding the Lightning Network

Since blocks in the blockchain represent transactions, there’s only a limited number of them that can enter the chain which has been pre-programmed to encrypt the transaction data into smaller-sized bits. 

Hence, if a transaction confirmed by the Bitcoin network is unable to be included in a block, it lines up in a queue. In other words, the transaction will need between several minutes to several days to be processed, i.e. it will take longer for your payment method to be verified.

Moreover, there’s the cost problem. To verify the transactions using a cryptographic consensus protocol labeled as Proof of Work (PoW), Bitcoin miners spend a significant amount of their resources for which they charge a hefty fee. 

The technical solution presented in the form of the Lightning Network offers more readily confirmed high-volume transactions by transforming them into off-chain transactions. This is especially important for a decentralized network such as these blockchain-based platforms. Bitcoin is notorious for its volatility, which can cause large-scale losses in case of a lengthier transaction process. 

Who Is the Creator of the Lightning Network?

The concept of the Lightning Network was first described in a white paper dating from 2015. Signed by Joseph Poon and Thaddeus Dryja as authors, the elaboration of their technical proposal contained information on how the Lightning Network was built and how it functioned. Added as a second layer to Bitcoin’s blockchain network, the Lightning Network was programmed to address the scaling problem of the existing blockchain.

The Lightning Network White Paper

On January 14th, 2016, Poon and Dryja released the Lightning Network whitepaper that thoroughly explained their new concept of making transactions on the Bitcoin platform. What’s interesting is that this concept has been developed side by side with Nakomoto’s Bitcoin concept. Namely, the Bitcoin whitepaper included a draft version of a raw code which was seen as the future tool for backing up the large number of transactions on the Bitcoin blockchain network.

In 2013, the senior software engineer and tech lead at Google Mike Hearn came up with a more elaborated concept that was considered as a sort of expansion of the Bitcoin development whitepaper. According to Hearn’s theory, the Lightning Network was predicted to enable the creation of multiple-party payment channels. Curiously enough, this quality of the lightning protocol has not yet been suited to serve the aforementioned purpose.

A year after Hearn published his insight on the new possibilities of the second-layer solution to the problems with speed and cost of Bitcoin transactions, GitHub issued the Bitcoin Lightning Network whitepaper. 

The Bitcoin Lightning Network

The Lightning Network is built independently from the Bitcoin blockchain network but actively interacts with it. This network enables its users to open personal payment channels through which they can conduct unlimited transactions in both ways, without impeding the functionality of the BTC blockchain. Also, the Lightning Network supports simplified atomic swaps that enable exchanging cryptocurrencies without the involvement of a third party. 

For an easier understanding of how the Lightning Network functions, we suggest we take two entities as an example. These two entities (two people, or a person and a store) often make transactions between each other that need to be swift and cost-effective. By using micropayment channels, the Lightning Network technology unburdens Bitcoin’s distributed ledger and relays the transaction data in the form of more readily confirmed off-chain transactions. 

If it weren’t for this parallel transaction protocol, the merchants would have suffered enormous losses. A good example of this would be a trader who sells a product but receives the payment days (or months) later, thus losing some percent of the product’s value. 

Lightning Network’s Off-Chain Protocol

Several digital solutions elaborated in the Lightning Network whitepaper were combined to provide an ultimate solution for the scalability issues on the Bitcoin blockchain. By routing the transactions away from the main platform chain, the teams that work on the development of this network aim to ensure transactions that are both independent and safe. 

There are three different developer teams of the Lightning Network who apply their own coding language while using the same set of rules. Labeled as the BOLTs (Basis of the Lightning Network), these sets of rules have been predetermined in order to retain the interoperability of the software. In this way, the Lightning Network displays the ability to operate as a second platform in conjunction with the Bitcoin blockchain platform while remaining independent at the same time. 

Off-Chain Transactions

When a transaction is conducted outside the blockchain, it’s referred to as an off-chain transaction. Despite the fact that the transactions offer independence from the blockchain, all parties must agree on the method by which the transaction will be conducted. The selected method must provide security, validation, and irreversibility of the transaction, as well as the possibility of exchange for another value in the future. 

Via the Lightning Network platform, the parties can both send and receive funds without having the cryptocurrency miners as intermediaries. In a fast and convenient way, they can conduct small and frequent transactions to the same business or individual party. 

After a predetermined period, the off-chain transaction channel automatically closes itself. Upon this process, the last set of encrypted data regarding the conducted transactions is added to the main blockchain. 

Lightning Network Nodes

The bits of software that serve as a connection to the Lightning Network are called Lighting Network nodes. Currently, there are approximately 5,349 Lighting Network nodes that possess the capacity for facilitation of nearly $6.3 million worth of transactions. 

These nodes are optimized for easier and faster lightning payments. The total network liquidity increases with the increase of the Lightning Network nodes because they facilitate a larger number of transactions in a shorter time. 

Off-Chain vs On-Chain Transactions

On-chain transactions (or blockchain transactions) are simply transactions conducted by modification of the blockchain. By adding value to a block, on-chain transactions must wait for validation by the blockchain. On the other hand, the off-chain transactions are independently conducted and are supported by other methods used for validation and record of the transaction data.

Since the on-chain transactions require more time to gather information on the unalterable nature of the transactions, consequently, they take longer to be performed, which often brings high financial and safety risks along. In this regard, off-chain transactions give enhanced safety for all the parties included in the transaction by offering an immediate guarantee that the encrypted data is safe from any modification.

Furthermore, while on-chain transactions are typically public, off-chain recording of both the data and transactions doesn’t need to be public. Even more so, some of the cryptography methods (such as the chaum tokens) prevent even the system operators from accessing the information on the participants in a given transaction.

What Are the Biggest Advantages of the Lightning Network?

A number of benefits come with the implementation of the Lightning Network. Not only do these networks provide fast transactions, but they also enable safe storage of the assets, as well as multiple smaller payments. 

Scalability

The term scalability refers to the ability of the system/blockchain to adapt to the increased volume of data encrypted in a digital ledger. In order to confirm a transaction, cryptocurrency miners charge a fee. When the transactions are low in volume, there’s a small fee for it. However, when the volume of transactions increases, the fees can be rather hefty due to the great demand. 

Currently, the block-size limit of Bitcoin amounts to up to 7 transactions per second, which directly relates to the scalability of the blockchain system protocol. Just for comparison, VISA manages to process between 24,000 and 50,000 transactions per second. 

Micropayments

The multiple payment channels used for micropayments are one of the Lightning Network methods implemented for overcoming the speed and cost limitations of Bitcoin’s blockchain network. They are suitable for numerous use cases.

There are several types of payment channels. The non-exhaustive list includes the following protocols:

  • Nakamoto High-Frequency Transactions;
  • Hashed Timelock Contracts (HTLC);
  • CLTV-Style Payment Channels;
  • Decker-Wattenhofer duplex payment channels;
  • Spillman-Style Payment Channel;
  • Poon-Dryja payment channels.

With the implementation of bilateral channels and the Hashed Timelock Contracts (HTLCs) protocol, the Lightning Network provides securely rooted payments across a broader network of peer-to-peer payment channels. The HTCL payment protocol is one of the most efficient software solutions for the management of different cryptocurrencies that utilizes different platforms, i.e. blockchains. 

After the Bitcoin network is informed that the user has opened a new transaction channel (i.e. mini-ledger), the transactions created between the two parties and the individually updated account balances will be recorded in the same ledger whenever the values are being moved. In this way, there’s no need for recording each action every time it’s repeated. 

In order for the parties involved in a transaction to commence using a lightning channel, first, they need to direct their assets to a multi-signature wallet address. These payment channels allow for the instant sending and receiving of crypto, provided the channel is open. 

Multi-Signature Wallets

The multi-signature wallets are one of the main advantages of the Lightning Network, as they function as a safe deposit box. They come as a set with private keys that enable access to the funds for each of the parties that participate in a digital currency transaction. 

After the parties set up a multi-signature wallet, they create a secret key (i.e. a value) for unlocking the conducted transaction. These values are used for the creation of a hash which is later exchanged between the participating parties. Also, a certain amount of Bitcoin has to be locked up in the payments channel. From this point on, the parties can create an open transaction to relay the transaction data onto the blockchain. After this process has been completed, the assets are managed by commitment transactions. 

The assets will be safely stored in the multi-signature wallets until (1) the parties sign finalization of a transaction using their respective private keys; (2) the transaction is submitted automatically after a predetermined time limit is reached (in this case, the funds are being transferred back to either party’s individual wallet); or (3) the decision to terminate the transaction is brought by one of the involved parties. 

The most commonly used multi-signature wallets include C-lightning and Lnd (nodes), followed by Zap, Eclair, and the Lightning App (wallets). 

Commitment Transactions

A commitment transaction is signed between the parties involved in a transaction. This type of transaction divides the assets in compliance with the mutual agreement concluded between the parties. Commitment transactions have the role of an informal written agreement that acknowledges the existence of a debt. 

A Word on Lighting Network’s Security 

The Lightning Network’s security systems are based on several segments:

  • Smart contracts;
  • Asymmetric revocation commitment; and
  • Timestamp.

Smart Contracts

Opening a payment channel is a prerequisite for the effective utilization of the lighting network. The payment channel serves as a transaction area through which the second layer of the Bitcoin blockchain network can transfer any value. For this purpose, a transaction is opened directly on the blockchain. The payment channel operates upon the basis of a smart contract

Smart contracts represent open-source programs that automatically execute the obligations stemming from the contract’s provisions. Typically, these blockchain-based agreements include clauses that protect the encrypted data of transfers from changing, erasing, canceling, or any other manipulation. The terms of the agreement are directly coded using a suitable programming language. 

Asymmetric Revocation Commitment (Private Key)

The asymmetric revocation commitment refers to the method of Lightning Network platform used as protection against fraudulent activities. If such an activity is committed by the counterparty and registered by the system, the other party has the right to claim compensation. 

Timelocks

Timelocks are another important feature of the Lightning Network. This includes an agreement between the parties included in the transaction on the lifespan of the payment channels they open. This feature typically sets the upper timeframe during which transactions may be conducted by either party. 

Does Ethereum Have Its Lightning Network?

Being the second most demanded cryptocurrency, Ethereum quickly followed suit with the solution designed for the Bitcoin blockchain platform. Ethereum’s second supporting layer is labeled as Raiden Network

Similar to Bitcoin’s Lightning network, the Raiden Network is based upon an algorithm consensus referred to as Balance Proofs. This software is aimed at creating fast and easy transactions on the Ethereum blockchain. 

In this regard, Litecoin also has its own smaller version of Bitcoin’s lightning network, which is conveniently labeled as the Litecoin Lightning Network. 

What Are the Biggest Challenges of the Lightning Network?

As a relatively new software solution primarily aimed at the scalability problem of the Bitcoin blockchain network, the Lightning Network protocol has several challenges that are yet to be addressed. Some of those issues include centralization and security. 

Due to the fact that the user’s assets and private keys are constantly stored online, they are extremely vulnerable to fraudulent activities and counterfeit. Lightning Labs co-founder, Elizabeth Stark, was one of the most vocal supporters of Lightning Network as a digital payments system. 

In addition, there’s a rising concern that the Lightning Network could lead to disruption of the primary blockchain network’s operations. While this platform was primarily programmed as a solution for the congested Bitcoin blockchain and the sky-rocketing transaction fees, in practice, it showed deviation from some of its basic concepts. 

In particular, this concern throws a shadow over the concept of the Lightning Network as a decentralized platform, since a problem like this often occurs in centralized systems.  

A Few Words Before You Go…

The Lightning Network protocol provides a fast, custodian-free, high-volume micropayments network that serves as a solution to the Bitcoin blockchain’s problems with speed and cost of transactions. By relieving the frequency of the Bitcoin blockchain transactions, the Lightning Network technology translates into a technological solution that provides a more cost-effective formula for more swift payment between two entities. In this way, paying for your preferred beverage in the nearest cafѐ shouldn’t last a ‘light year’ long anymore. Instead, it becomes ‘lightning (network) fast’. 

Lightning Labs’ Lightning Network Daemon, Blockstream’s C-lightning, and ACINQ’s Eclair are counted toward the most popular companies that offer easy installation of the Lightning Network on your device upon download. It’s also worth knowing that the lowest limit for conducting a transaction via the Lightning Network amounts to 0.00000001 BTC, which equals one satoshi. This fact adds to the idea that this decentralized ecosystem can become the best solution for building a stable peer-to-peer electronic cash system and a great alternative to the currently existing payment systems.