Lesson 13 of 20
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13. What is the Lightning Network, and how does it work?

Lightning Network (LN) is closely related to Bitcoin and the layer two solutions we discussed in our previous lessons. The flagship cryptocurrency has revolutionized the banking system, giving us the ability to invest without the oversight of central banks or governments. However, from the beginning, its Achilles’ heel was limited in transaction processing and scalability. To improve this issue, it was decided to use a  solution, the Lightning Network (LN). Below you will find an explanation of what it is  and how it works. 

Lightning Network – definition 

LN is a layer two solution. You know it improves scalability and throughput while maintaining full integrity with the blockchain. The Lightning Network is often referred to as an ‘overlay’ or ‘second layer’ of the underlying BTC blockchain. In fact, it acts as a sidechain. It allows users to create payment channels away from the main blockchain. These are known as off-chain transactions

The first transaction using LN was performed on 6 December 2017. Two famous cryptographers specializing in BTC technology, Joseph Poon and Thaddeus Dryja,  are behind the idea of this solution. Nowadays, many companies are working on the development of LN. We can include Blocksteam or Aciq, for example. 

The whole ecosystem resembles one big electrical grid with thousands of channels that connect users all over the world. Thanks to this, the network will always find a  quick way to transact between users. As more and more people use this way, the network becomes even faster and more expansive. 

The war between small and big blockchainers 

The scaling of Bitcoin to handle the transactions of millions of people around the world is also nothing new. If it was discussed very early on, and even mentioned briefly by Satoshi in his white paper, the question only came up again in late 2014.  Increasingly insistent, part of the community is indeed proposing to abolish the preset limit of 1 MB per block, known as the blocksize limit. Years later and by August 2017,  there would be a real war within the Bitcoin community. 

Initially, very good-natured discussions about how to scale Bitcoin eventually heated up as the issue became more and more concrete, introducing some to a sense of urgency and that a growing part of the ecosystem was involved. 

The two opposing camps are: on the one hand, the big blockchainers, who want an increase in block size so that the network can accommodate the growing adoption of  Bitcoin as a means of payment. This group is not homogeneous, with some wanting only a moderate increase in block size (for example, to 8 MB) as long as the existing infrastructure (bandwidth, hardware, etc.) does not allow it to go beyond that. Others favour a clear initial growth followed by a limited but regular increase in block size

until a certain threshold is reached. One thing everyone agrees on is that growth is needed for Bitcoin’s increasing adoption. 

On the other hand, small blockchain players oppose such growth for various motives. 

Here are the three main reasons: 

Increasing the block size by changing the block size requires a hard fork.  However, the latter are seen as dangerous because they are a source of instability. 

Increasing the block size too much harms the decentralization of the network,  as it no longer allows a full Bitcoin node to run on ‘low-end’ hardware such as,  for example, a Raspberry Pi or an old personal computer. 

Making block sizes infinitely larger to prevent them from filling up hurts the long-term security of Bitcoin. Because it relies increasingly on transaction costs, as block grants shrink from half to half. 

How it works 

The entire network is based on smart contracts. They create off-chain payment channels between users. The channels are responsible for recording transfers. They open directly between the seller and the buyer. That is, when one user sends a  payment and the other accepts it, then a channel is created. This makes the whole process much faster and easier, especially in terms of technology. Importantly, the channel thus created has its own block where transactions are recorded. The channels remain open until one of the users decides not to withdraw Bitcoin. At that point, the transaction is completed, and the entire payment is recorded as a single transaction on the main BTC blockchain. Such a process allows for faster approval of larger transactions. If the whole process used the standard BTC blockchain network,  everything would be longer and definitely more expensive. So what is the benefit of this? By using LN, we avoid network fees. We only pay for the opening and closing of the resulting channel. 

The fact that Lightning Network payments are made in real-time is also crucial. We do not have to wait for network confirmation. However, the whole system has a few drawbacks. The first is the maximum amount of BTC we can transfer-it is 0.167 BTC.  Another is the difficulty of layer two transfers. There are only a few wallets that allow them. 

LN’s impact on Bitcoin

The resolution of tier two has definitely accelerated the adoption of Bitcoin. It solved  many of the significant problems that the cryptocurrency initially had: 

∙ LN has reduced the price of transactions to a minimum. 

∙ It accelerated network bandwidth to as much as 10,000 TPS. 

∙ It reduced transaction times to just a few seconds.

∙ LN has expanded the functionality of the network’s smart contracts. 

Despite the complexity of Layer 2 transfers, LN users are increasing every year. In  2019, there were just over 2,000 nodes. In 2022, we are already talking about tens of thousands. What’s more, the number of companies using Lightning Network solutions is also growing. 

Summary 

Layer 2 solutions, not just Lightning Network solutions, scale the network. From today’s lesson, you already know what LN is and how it works. If something is unclear to you, or you need an addendum, take a peek at our previous lesson, where we discuss in detail how Layer 2 works

Curiosities 

∙ As of March 2022, 80 million people have used the LN. These are figures from a report by Arcane Research

∙ Many BTC users do not even realize they are using it. All because of the apps they use to perform transactions. 

∙ We are talking about millions. According to the report, the number is steadily growing. 

∙ The greatest interest in LN is recorded in El Salvador, where BTC is a full-fledged means of payment. 

∙ The most popular wallets that support LN transfers include Wallet of Satoshi,  Blue Wallet, Electrum, Muun, Phoenix, Breez, Eclair.

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