Bitcoin Lightning: Everything to Know
By Beluga Research October 27, 2023
- Bitcoin Lightning Network (LN) is a layer 2 protocol built on top of Bitcoin, and enables faster, cheaper transactions by moving payments off the main blockchain
- Bitcoin Lightning Network uses smart contracts to define transaction rules and conditions
- As of October 2023, Bitcoin Lightning Network is still in the testing phase.
- Bitcoin Lightning Network's advantages include instant transactions, reduced fees, scalability, micropayments and enhanced privacy
Bitcoin Lightning Network (LN) is a layer 2 protocol built on top of Bitcoin, and enables faster, cheaper transactions by moving payments off the main blockchain. As of October 2023, Bitcoin Lightning Network is still being tested. It may experience issues with usability and security.
LN was created to lower the cost and increase the speed of bitcoin transactions. Bitcoin's fees for transactions can vary considerably. Making the fees lower and more predictable encourages the success of the platform. Such actions also help Bitcoin compete with traditional forms of spending, such as credit cards. LN is mostly targeted at microtransactions, very small payments for digital goods and services. One example is a purchase of an accessory for an avatar in a web-based game.
A Brief History
Joseph Poon, a researcher focused on blockchain scalability, and Thaddeus Dryja, a researcher focused on cryptocurrencies, first proposed LN in a 2015 whitepaper. They then worked on the idea and released another iteration of it in a 2016 whitepaper. Poon and Dryja envisioned LN as a method to create a network of off-chain payment channels. LN became more popular over time. It was initially implemented in 2018. Since that point, it has become more refined and had a greater influence on Bitcoin use.
Bitcoin Lightning Network: Everything to Know
LN operates on top of the Bitcoin blockchain. It leverages the Bitcoin blockchain's decentralization yet provides scalability. LN utilizes smart contracts to define transaction rules and conditions. Participants can open payment channels and conduct transactions when needed.
LN works by opening a payment channel between two parties rather than sharing the transaction with the entire Bitcoin network. The opening transaction and the final transaction of the interaction are shared with the Bitcoin blockchain. The parties can engage in multiple actions off the blockchain before settling the final balances of their payment channel.
LN creates a network of interconnected payment channels between participants. Individuals who have used LN are then able to transact with people they have not engaged with directly before.
Most transactions with LN are of small amounts. LN-enabled wallets are not user-friendly. Since they are in the public testing phases, LN advises users not to transact with large amounts.
- Acquire a Bitcoin wallet that supports LN. There are custodial and non-custodial wallets. A user can read web forums and do research to determine which LN-enabled wallet will work for them.
- Set up the wallet and fund it with bitcoin (BTC).
- Create a LN channel. A channel is a private payment channel between two participants that enables off-chain transactions. Opening a channel allows a user to transact directly with other Lightning users. Only the first and last transactions are shared with the Bitcoin blockchain. This method of engaging with another party reduces transaction fees and speeds up the process.
- Make micro-payments with LN. A user can send and receive payments through LN using the recipient's Lightning Network address. The address is called a Lightning invoice. Invoices contain the necessary information for LN to route the payment to the intended recipient.
- Offers instant transactions . Traditional bitcoin transactions require blockchain confirmation. LN transactions occur off-chain. As a result, payments can be settled instantly between participating parties.
- Increases scalability. LN significantly increases the Bitcoin blockchain's transaction capacity by conducting transactions off-chain. This alleviates congestion and high fees associated with on-chain transactions. It allows a large number of transactions to be processed simultaneously.
- Introduces routing. Users can send payments to recipients without a direct payment channel by leveraging the network of interconnected Lightning channels. When a payment is initiated, LN automatically finds the most efficient route through multiple channels until the funds reach the intended recipient. This routing capability enhances network liquidity and accessibility.
- Lower transaction fees compared to on-chain Bitcoin transactions. LN transactions occur off-chain. They do not require the same computational resources and validation as on-chain transactions. This means LN users have significantly lower transaction fees.
- Instant Transactions: LN enables near-instantaneous transactions by conducting them off-chain. Users can send and receive Bitcoin without waiting for confirmations on the main blockchain.
- Reduced Fees: Transaction fees with LN are significantly lower compared to on-chain transactions. Since most transactions happen off-chain, users can avoid higher fees during network congestion.
- Scalability: By moving most transactions off-chain, LN enhances the scalability of the Bitcoin network. This enables a higher throughput of transactions, making Bitcoin more suitable for everyday use.
- Micropayments: LN enables users to send and receive very small amounts of Bitcoin. This opens up possibilities for pay-per-use services, streaming content and micro-donations.
- Privacy: Transactions on LN offer enhanced privacy compared to on-chain transactions. Lightning transactions are not recorded on the main blockchain. This gives users more anonymity.
- Channel Management: LN requires users to open payment channels and manage their liquidity. This process can be complex and may require technical knowledge. Users need to monitor and maintain their channels to ensure they stay operational.
- Centralization Risk: As LN grows, there is a risk of centralization. Larger nodes may become more dominant. This could undermine the decentralized nature of the Bitcoin network.
- Security: LN is still in the testing phase. There is a risk of funds being lost or stolen if users do not take proper precautions or if vulnerabilities are discovered.
- Utility Concerns: LN is appropriate for micro-transactions, not large amounts. Also, most LN-enabled wallets are not user-friendly.
- Limited Network Reach : LN relies on a network of payment channels between users. The reach of LN is limited to the number of interconnected channels. It may be difficult to find routes for transactions in areas where there are less participants in LN.
- UX Complexity: Using LN is more difficult for average users than engaging in regular bitcoin transactions. LN requires LN-enabled wallets and a working understanding of how to interact with LN. Users can do research to learn some of this information. Still, novices to the crypto ecosystem and entities with low incomes may be short on time and resources like Internet access to do such research.