Introduction to the Lightning Network – Bitcoin’s Scalability Savior

Beginner’s Guide / 11.01.2020

Bitcoin’s Rampant Growth and Scalability Problem

Throughout its existence, Bitcoin has only been capable of processing around 7 transactions per second. Growing at a rate that most people would call unsustainable, Bitcoin’s scalability problem has slowly become a hindering issue. While low transaction count was enough at the very beginning, the system has been congested for a few years now. 

As a result, transactions today take a long time to processand transaction fees are extortionate due to the demand. Ten years later, scalability is still the biggest problem for Bitcoin, as well as for other veteran cryptocurrency systems.

Numerous solutions to this problem have been discussed. Some solutions involved forking the entire protocol to increase block size, while some talked about reducing the block content so that more translations can be verified. 

The SegWit Solution

One of the more famous solutions was SegWit or Segregated Witness. SegWit discussed implementing a soft fork to the Bitcoin Network and increasing transaction count, by removing parts of the signature data and leaving more space. As digital signatures account for almost 65% of a transaction’s size, SegWit proposed to scrap off the unwanted parts of the signature and push them to the end of a block. This radically reduced the transaction size and increases the block size. 

But since then, the increase of traffic has made even the SegWit implementation more congested. A new solution was yet again required, in order to loosen the strain on the main chain of the Bitcoin Protocol. 

What is the Lightning Network?

Lightning Network (often denoted as LN Network) is a kind of a Layer-2 mechanism that is primarily built for micropayments and increase of Bitcoin’s scalability. The LN Network runs on top of the bitcoin network, utilizing its multi-sig scheme to form side/parallel payment channels. 

The Lightning Network adds another layer to Bitcoin’s blockchain and enables users to create payment channels between any two parties on that extra layer. These channels can exist for as long as required, and because they’re set up between two people, transactions will be almost instant, and the fees will be extremely low or even non-existent.

How Does it Work?

The workings of the Lightning Network are essentially quite simple. By creating an off-chain record, the network can put less strain on the main blockchain and use the side-chain for a faster relay. The Lightning network uses voluntary nodes to run the side channel. 

To carry out a transaction, two parties need to create a multi-signature wallet, which is a wallet that they can both access with their respective private keys. Then, they both deposit a certain amount of Bitcoin – say, 2 BTC each – into that wallet.

From then on, they can perform unlimited transactions between the two of them. Essentially, these transactions are redistributions of the funds stored in the shared wallet. For instance, if Alice wants to send 1 BTC to Bob, she will need to transfer the ownership right of that amount to him off-chain. Then, the two of them use their private keys to sign for an updated balance sheet.

The actual distribution of funds can happen when the channel gets closed. The algorithm uses the most recently signed balance sheet to determine the balances of each. If Alice and Bob would decide to close the channel after that one transaction, Alice will get 1 BTC and Bob will receive 3 BTC to their respective wallets.

Only after the channel is closed, the information about its initial and final balance is broadcasted to the Bitcoin blockchain. Thus, Lightning Network works by enabling users to conduct numerous transactions outside of the main blockchain, and then record them as a single transaction on a later date.

Features of the Lightning Network

Transaction Speed

With the Lightning Network, one can ensure Lightning-fast payments without worrying about block confirmation times. As it is on the Layer-2, security is enforced by blockchain smart-contracts, without creating an on-chain transaction for individual payments. The payment speed off-chain can be measured in milliseconds to seconds.

Low Fees

By transacting and settling off-blockchain, the Lightning Network allows for exceptionally low fees, which allows for emerging use cases such as instant micropayments.

Scalable 

The LN project is working towards an off-chain solution for the scalability problem. If successful, it may reduce the traffic on the Bitcoin blockchain. Theoretically, it is said to be able to take the transactions per second figure of Bitcoin and other cryptocurrencies to unprecedented heights of at least 1 million transactions per second.

Cross-Chain Transfer

Layer-2 solutions like Lightning Network aren’t just limited to bitcoin, they can be applied to any blockchain protocol provided that they have the recipe built-in (multi-sign scheme). A lot of experiments are happening for the LN networks on other blockchain platforms like Ethereum, Cardano, or EOS.

Criticisms and Failures 

Liquidity Problem

Since the Lightning Network mandates funds to be locked onto a Smart Contract until the account is settled, the funds are put out of supply and cannot be used for any immediate need. The locking of funds reduces the liquidity of the owner as well as the entire network. 

Too Complex for Immediate Implementation

Since its proposition and beta releases, LN has shown a lot of problems in its implementation. Several factions have come up, who each use and develop a different iteration of the original idea. Due to this, the complexity of general use increases as it gets tougher for a majority to use a single mechanism.

What the Future will Bring

The success of the Lightning Network very much depends on how we intend to use it. If the network is confident that it will provide a viable solution for micro-transactions and for those parties that frequently transact, then there will be no stopping the growth. But personally, I am less confident that the network will evolve to serve as a global payment network without accepting large tradeoffs.

While the LN may end up being relatively centralized, I do think there is place for that. Having a more traditional system in place on Bitcoin may not be all bad. The beta version has been going through a lot of experimentation and its efficiency is yet to be proved. Nevertheless, the Lightning Network does have a huge potential to improve the Bitcoin and the cryptocurrency ecosystem.

All the major wallets also support LN network, and once they are applied everywhere, we would surely be able to see a decentralized finance revolution where scalability won’t be an issue. The collective work of nodes and payment channels is what makes the Lightning Network an interesting solution for the scalability problem.

As mentioned by Mathieu Louis in a post on Bitcoin Predictions, the cumulation of network functions and developments will highly correlate with any future price increase. Just like Lightning Network needs Bitcoin, Bitcoin too needs Lightning Network. 

To Learn More

Lightning.Network | Lightning Paper 

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.