What Does The Lightning Network Do?

The Lightning Network is a layer-2 payment protocol built on top of the Bitcoin blockchain. It enables faster and cheaper Bitcoin transactions through a network of bilateral payment channels. These payment channels can be used to send and receive payments without the need for each transaction to be recorded on the Bitcoin blockchain. Here is an overview of how the Lightning Network works, its benefits and drawbacks, and its potential impact on the future of Bitcoin and cryptocurrencies.

The Background

The Bitcoin blockchain is a distributed, cryptographically secured ledger that records all bitcoin transactions. Each transaction is verified by a network of miners and added to the blockchain, which is a public database of all bitcoin transactions that have ever occurred. However, recording transactions on the blockchain can be slow and expensive. This is because, by design, new transactions are written to the blockchain–that is, new blocks are added–only about every 10 minutes on average and there are limits to the number of transactions that are included in each block.

The Lightning Network aims to solve this problem by allowing bitcoin transactions to be conducted off-chain, that is, not written to the Bitcoin blockchain, while retaining important security properties of Bitcoin. It does this by allowing participants to create and use a network of payment channels  to send and receive bitcoin transactions and means that transactions can be made instantly without needing each transaction to be recorded on the Bitcoin blockchain.

How it works

The Lightning Network uses a system of payment channels that are opened between two parties. These payment channels allow the parties to send and receive bitcoin without needing each transaction to be recorded on the blockchain. Once a channel is funded, which is done by adding bitcoin to a layer-1, two-of-two multisig Bitcoin address, the parties can make as many transactions as they want within the payment channel, and the channel balance is updated by the participants each time a transaction is made, thus allocating funds to one participant of the channel or the other. All the transactions made within the payment channel are off-chain transactions.

When the payment channel is closed, the final balances allocated to each channel party are recorded on the Bitcoin blockchain. This means that the only transactions that are recorded on the blockchain are the opening and closing transactions of the payment channel. 

The Lightning Network uses a routing system to allow transactions to be made between parties who do not have a direct payment channel between them. The routing system works by finding a path of payment channels between the sender and the receiver. Each payment channel along the path is used to forward the transaction until it reaches the receiver.

The Benefits and Drawbacks

The Lightning Network offers several benefits over traditional on-chain bitcoin transactions. One of the main benefits is speed. Transactions on the Lightning Network are instant and can be completed in seconds. This is much faster than layer-1 bitcoin transactions, which can take several minutes and up to an hour to be confirmed.

Another benefit of the Lightning Network is cost. Because transactions on the Lightning Network are off-chain transactions, they do not require the same level of verification as on-chain transactions. This means that the fees for Lightning Network transactions are much lower than on-chain transactions. This makes the Lightning Network an attractive option for smaller transactions.

However, there are also some drawbacks to the Lightning Network. One of the main drawbacks is complexity. The Lightning Network is a relatively new technology and can be difficult for non-technical users to understand and use. In addition, the routing system can be complex and may require multiple payment channels to complete a transaction. 

The Lightning Network has the potential to improve the usability and scalability of Bitcoin. Enabling faster and cheaper transactions could make bitcoin a viable payment option for everyday use. It could also open up new use cases for bitcoin, such as small payments and machine-to-machine transactions. Companies and businesses are investing in creating infrastructure for the Lightning Network to reduce complexity and allow transactions to move without friction.