- Lightning Network at a Glance
- Bitcoin Transaction Settlement Today
- What is the Lightning Network?
- How Does the Lightning Network Work?
- Lightning Network Use Cases
- How does the Lightning Network prevent cheating?
- Where is the Lightning Network today?
- Liquid by Blockstream
- Some Companies Engaged in R&D for the Lightning Network
- Other Projects on the Lightning Network
- Current Issues with the Lightning Network
Lightning Network at a Glance
The Lightning Network allows users to send small amounts of Bitcoin to each other almost instantaneously with near-zero fees.
The Lightning Network is a second-layer solution designed to allow the Bitcoin network to handle more transactions and process small transactions faster. By taking some transactions off of the main chain, the Lightning Network intends to decongest the network, speed up transaction times, and lower transaction fees.
Scalability has become one of Bitcoin’s biggest concerns. As Bitcoin became more popular, transaction volumes have increased and the network has had a hard time keeping up. This has resulted in longer transaction times at peak periods of network congestion, which causes transaction fees to skyrocket. The figure below shows the extent of this problem during Dec 2017 to Jan 2018, when Bitcoin prices hit all-time highs.
This was clearly an issue since Bitcoin’s primary benefits include faster transaction times and lower fees than conventional money transfers.
Bitcoin Transaction Settlement Today
To achieve mass adoption, Bitcoin must scale efficiently and securely. To better understand why attaning scalability is a challenge, we must look at how transaction settlement works today.
Currently, transactions are stored in blocks and these blocks are linked (hence the name ‘blockchain’). Block size is capped at 1 megabyte, meaning that each block accommodates roughly 4,000 transactions. Average block time, or the time before each block is confirmed and recorded to the blockchain, is approximately 10 minutes. The limitation in block size leads to greater transaction volumes and longer confirmation periods. This impacts the settlement time for transactions and makes it less feasible to initiate small transactions.
Each initiated transaction goes to an unconfirmed transaction pool so that they can be ‘mined’ into blocks. Miners use computing power to validate transactions for a fee. They gather and confirm transactions before they are included in the blockchain. Miners choose which blocks to confirm first; in practice, they choose whatever has the highest transaction fee to maximize their profits.
Therefore, an easy way to ensure faster transaction settlement is to pay higher transaction fees. This encourages miners to prioritize the confirmation of your transaction. However, this is not a cheap option and discourages people from making smaller transactions, which is a barrier for mass adoption. After all, if you cannot buy lunch or coffee with Bitcoin, the average person has less reason to use Bitcoin.
The BTC community has brainstormed multiple solutions to address BTC’s scalability problem. They came up with some ideas (which we will discuss below):
- Increase block size;
- Separate transaction signatures from other transaction information. This method is called Segregated Witness (SegWit);
- Setting up separate transaction channel called the Lightning Network (LN) away from the main Bitcoin blockchain.
Bitcoin’s proposal to replace fiat currency as a medium of exchange introduces the problem of how fast it can process transactions. How does Bitcoin compare with Bitcoin Cash (BCH) and Visa, for instance? Here are some estimates according to Cointelegraph:
- BTC can process 7 transactions per second.
- BCH can process 61 transactions per second.
- Visa can process an average of 24,000 transactions per second.
The initial divide within the community to increase the block size for BTC led to the Bitcoin Cash (BCH) hard fork. BCH ended up implementing a larger block size of 8 megabytes, allowing BCH to include more transactions in a block.
The BTC community didn’t believe increasing block size would be a feasible long-term solution since increased block size can further strain the network.
Segregated Witness (SegWit)
A second alternative was to ‘cheat’ the BTC block size cap. A method introduced by developer Pieter Wuille called “Segregated Witness”, or SegWit, separates transaction signature information (known as “witness” information) from each block to free up space. Previously, almost 65% of transaction data consisted of signature data. With Segwit, signatures and scripts can be moved outside the base transaction blocks without altering the transaction ID. In effect, transaction data takes up much less space, meaning that more transactions can be included in a block.
Some of the biggest developments to the BTC blockchain brought by SegWit are second layer protocols. One of those second layer protocols is the Lightning Network (LN).
What is the Lightning Network?
A concept that quickly gained traction was that not every transaction needed to be recorded immediately. It is inconvenient to wait for multiple transaction confirmations before they are settled, especially for smaller transactions. This affects BTC’s reputation as a quick and secure payment system, and in turn, scalability.
LN is a second layer solution to the Bitcoin network introduced by Thaddeus Dryja and Joseph Poon back in 2015. It creates a network on top of the Bitcoin blockchain where users can create independent and private payment channels and can send payments back and forth. These channels set up between different parties enable transactions to become nearly instantaneous with extremely low fees. There are three teams currently working on this: Blockstream, Lightning Labs, and ACINQ.
How Does the Lightning Network Work?
The Lightning Network speeds up transactions and drastically reduces transaction costs by operating separately from the Bitcoin blockchain.
Since transactions settle away from the Bitcoin blockchain, users avoid long wait times and high fees. This allows for smaller payments (micropayments) as little as one satoshi (0.00000001 BTC). This is great for everyday transactions such as coffee or soda.
To start using the Lightning Network, two people first set up their channel on the Lightning Network. They then create a shared multisignature wallet which both of them can access. Both of them deposit a certain amount of BTC in that wallet.
The two parties can then initiate an unlimited number of transactions with each other from their wallet. These transactions are basically redistributions of the funds stored in the wallet that the parties share. For example, if person A wants to send BTC to person B, ownership of the amount of BTC for transfer is just reassigned to the transferee. Owners of the multisignature wallet use their private keys to sign for an updated balance sheet. This is called a “commitment transaction.”
The actual distribution of funds happen when the channel is closed, using the updated balance sheet to finalize the transactions that occurred in the channel.
This removes the need to record each transaction on the blockchain. Numerous transactions can be made within the channel, but will only be recorded on the Bitcoin blockchain as a single transaction. Users don’t have to wait for several transaction confirmations. This feature enables faster micro-transactions between parties involved.
A feature currently being tested on the Lightning Network is the cross-chain atomic swap, where token transfers between different blockchains can be made. This will enable swaps between cryptocurrencies without using crypto exchanges.
A lightning node runs through the channel. These nodes can hold funds, function as a financial intermediary, and monitor the channels for malicious behavior.
Lightning Network Use Cases
The Lightning Network has opened new possibilities in micropayments, a feature once deemed unfeasible in the BTC network due to difficulties in transaction settlement. Micropayments will benefit individuals who want to pay each other, and even small and medium-sized enterprises. Here are a few Lightning Network use cases.
Send small payments to friends and family overseas
The Lightning Network lets you send and receive small payments with minimal fees, as opposed to traditional remittance systems that have much higher fees and can take days, even for small payments. Instead of having to combine individual transactions into one large transaction, you can make as many transfers as you wish.
Tip people on Twitter (and get tipped)
Twitter users can integrate Tippin.me into their Tweets to allow others to tip you in small amounts of Bitcoin. Of course, you’ll need a Lightning wallet (see below).
Machines can automatically make payments
Since LN channels can be programmed for automated payments, machine-to-machine payments can be made easier and autonomous. A good example are autonomous vehicles paying for their own fuel at the gas station using cryptocurrencies.
Automate your company’s payroll
Employers and employees can open their own payroll Lightning channels and automate salary payments. Money can reach employees faster.
How does the Lightning Network prevent cheating?
Transactions made within Lightning Network channels depend on the latest broadcasted state to determine the finality of transactions. The last broadcasted state before a channel is closed is the transaction detail that gets recorded on the blockchain. This presents a possibility of malicious actors cheating transactions by broadcasting old states, at the expense of the other parties in the transaction.
The network prevents this by keeping channels open until the latest transaction is broadcasted. A smart contract secures the parties from malicious actors by establishing a disincentive system for those who try to broadcast an old transaction state as the “valid” transaction. The smart contract says that “if an old state is broadcast to the blockchain by your counterparty, you can take all of your counterparty’s money.”
When a channel is closed, there is a five-day lockout period before funds are finally distributed according to the “valid” transaction determined in the channel. If the other party goes online during the lockout period, disputes the details of the transaction, the party that tried to cheat loses all the funds they locked in escrow.
Where is the Lightning Network today?
There are already apps that support lightning as a payment method but engineers have yet to release software which allows real Lightning transactions. Additionally, lightning apps are still too complex for the average user. For example, Zap requires users to configure their nodes and plug in IP addresses. We’re seeing some improvements, such as with LND where channel creation has been automated for senders and receivers.
Furthermore, the innovation that powers the LN today is being developed for adoption in other cryptocurrencies such as Stellar (XLM), Litecoin (LTC), Zcash (ZEC), Ethereum (ETH) and Ripple (XRP).
Liquid by Blockstream
Blockstream is a research and development firm working on the BTC ecosystem and protocol. Blockstream was founded in 2014 by Dr. Adam Back, a BTC developer and cryptography consultant. It raised around $90 million in a series of seed rounds.
Liquid is its flagship project developed for the BTC network. It functions as a BTC ‘federated sidechain’. A federated sidechain means that instead of building an actual sidechain that enables trustless BTC swaps, it relies on a group of companies to manage the sidechain. It also connects to exchanges to provide quicker transaction settlement and better liquidity. The idea is for the sidechain to facilitate greater volumes of transactions more quickly for many companies. Early adopters include BTC companies such as BitFinex (planning to launch Tether on the LN) and Binance, exchanges, brokers, and the managers of the sidechain.
Liquid operates by converting BTC into the liquid BTC token (LBTC), which carries the same value as Bitcoin. Once LBTC gets to exchanges, it can be traded more securely and quickly than BTC since it does not have to stick to the BTC blockchain anymore. Once sent there, exchanges can move money around securely and much more quickly than on the main bitcoin chain.
According to Paolo Ardoino, Bitfinex’s CTO, “Liquid’s instant settlements will allow our traders to achieve faster bitcoin deposits and withdrawals, more efficient arbitrage, and even better pricing through tighter spreads.”
The firm also launched its Issued Assets (IA) program on the sidechain, enabling users to create their own tokenized assets. This feature lets users create tokens that represent financial instruments like tokenized fiat, cryptoassets, attested assets, or any other asset.
Blockstream recently released a tool on Liquid that enables atomic swaps through the Liquid Swap Tool. This allows users to trade between tokens launched on the sidechain. This is an experimental tool that makes it easier for users to swap tokens launched on the Liquid sidechain without using intermediaries. According to Blockstream, finalizing transactions within the platform can take less than 2 minutes.
Some Companies Engaged in R&D for the Lightning Network
ACINQ is a French startup founded in 2014 working on developing solutions for the LN and BTC ecosystem. Its products include Strike, Eclair Mobile, and the ACINQ Node. Strike is an API and dashboard that eases acceptance of Lightning payments on the BTC mainnet. It aggregates lightning payments on behalf of the user and periodically sends them to the BTC blockchain.
Lightning Labs is an LN development company based in San Francisco. Lightning Labs introduced the Lightning Network Daemon (LND). LND is an implementation of the LN protocol which is still at an early stage. Through LND, users may open payment channels, maintain a channel graph for monitoring, and forward incoming payments automatically, among other things. It also fully conforms to BOLTs, or the Basis of Lightning Technology. BOLT is a technical standard and framework for LN to help address concerns on interoperability and network creation.
Other Projects on the Lightning Network
Bitcoin Lightning Wallet
Bitcoin Lightning Wallet is an Android app that lets users send and receive payments on the Lightning Network. It also features watchtower services, especially for users that can’t be online regularly to monitor LN transactions.
Zap is an open source LN wallet. Its UI is created from Electron, React, and Redux, on top of the LND (Lightning Network Daemon) implementation of the network deployed on BTC and LTC. It functions on desktop and mobile. LND is a software that lets users open peer-to-peer payment channels, monitor channel transactions, and automated payments, among others.
Lightning Joule is a browser-based LN wallet, compatible with Chrome, Firefox and Opera. To run their wallets, users must have a node running on their own machines.
BlueWallet is an open-source LN wallet available for both Android and iOS. Its features include giving users the ability to plug in their own BTC full nodes, bump and cancel sent transactions, a Lapp browser, among others. It also supports wallet standards such as BIP44 (HD), BIP49 (HD SegWit), BIP84 (HD bech32, native SegWit), BIP39 Breadwallet-compatible, Legacy single-address, and SegWit single-address (P2SH). It currently accommodates twenty currencies including USD, EUR, GDP, JPY, and RUB.
Breez is a non-custodial wallet and payment platform available on iOS and Android. It is the first project built on Neutrino, and promises to resolve the issue on how users can dispute purchases and get refunds. The Breez app automatically connects to the Breez hub and other lightning nodes.
BitcoinVisuals shows an overview of the LN statistics such as the number of nodes on the network, number of channels, network capacity, capacity per channel, and other important LN statistics.
LND Explorer is a web interface that developers can use to interact with the LN.
LightningJ is an API that makes it easier for developers to integrate existing LN implementations using Java.
BTCPayServer is an open-source payment processing application for BTC and other cryptos. It allows for direct, peer-to-peer BTC and Altcoin payments without any transaction, processing, or other fees, except when transactions are made in other networks. It works as a self-hosted invoicing system.
Lightning-charge is a drop-in solution built on top of C-lightning which users can use to accept LN payments. C-lightning is an LN protocol implementation standard which users can customize. It can be used to open channels and send and receive payments over LN.
NanoPoS is a point-of-sale system which intends to allow merchants to make use of the LN.
Tippin.me is a browser extension that allows Twitter users to tip other users with crypto through the LN. It also includes a wallet and a messaging system.
Current Issues with the Lightning Network
Does not completely solve BTC’s transaction fee problem
It is still possible for the Bitcoin blockchain to be congested even with the Lightning Network. This means that Bitcoin transaction fees can still periodically spike, which in turn affects the cost of LN transactions. LN transactions costs have two parts: the transaction charges in opening and closing LN channels, and the possible routing fee for payments made between other channels.
Remaining online at all times makes nodes vulnerable
In order to close channels and prevent cheating, each node is required to remain online. This is to prevent the risk of fraudulent channel closing, which happens when some parties go offline. In such cases, when channels are closed in bad faith, and the other party in the channel runs off with the funds, the closing of the channel can be contested. However, neither party can’t go offline for very long because the contestable period over fraudulent channel closure also expires. There is also a risk that comes with lock-up of user funds in LN nodes – a server outage could lead to some users being unable to take their funds out of the nodes and into their wallets.
A solution that adds ‘watchtowers’ are already in the works. Watchtowers are tasked to oversee fraudulent and malicious actors on LN channels that try to double spend by broadcasting old transactions. This entails additional costs, however, including fees charged by ‘watchtowers’ for monitoring the blockchain 24/7, remaining online on user’s behalf, and storing channel states for the network. These can either later be charged under subscription fees or other methods.
It may not solve Bitcoin’s network effects problem
LN’s main purpose is to help BTC become a globally viable payment system. However, the current increase in Bitcoin transaction volume is largely attributed to trading and not other uses such as payments. There are valid questions over how LN can help reduce blockchain congestion when one of its primary causes is trading and not increased use as a medium of payment.
Even if LN proves that it can effectively increase Bitcoin transaction speeds, there is still no assurance that it will be widely adopted for everyday uses. A factor that may hinder widespread usage is the Bitcoin price volatility, which makes people reluctant to spend their Bitcoin.
The Lightning Network has the potential to lower Bitcoin transaction costs while improving transaction speeds. Crucially, it makes it feasible for people to transfer very small amounts of Bitcoin almost instantaneously at near-zero fees. This ability can open the door for Bitcoin to be used for everyday purchases such as food and coffee. This may spur the widespread adoption that crypto believers have dreamed about.
Progress still needs to be made, however. The ecosystem around the Lightning Network still needs to be developed. Software for real-world use cases are still being developed. User friendliness is still an issue – using Lightning Network wallets need to be as easy as tapping a credit card or using Apple Pay, for example. Merchants need point-of-sale systems that can handle Bitcoin.
Most importantly, the wider public needs to start viewing Bitcoin as something that they can spend instead of just trade or hold. This shift in mindset may take time, especially as long as Bitcoin prices remain volatile.
The good news is that the technology is actively being developed. Given the sharp rise in awareness of digital currencies in the past three years, it is possible that we see the Lightning Network widely used even sooner than we predict.