The Lightning Network is a second layer scaling solution built on top of the Bitcoin network.
It enables off-chain Bitcoin transactions that are not recorded on the blockchain which allows for instant, low-cost transactions without sacrificing the trust and security of the Bitcoin network.
Why do we need it?
The Bitcoin network produces blocks every 10 minutes with all transactions being relayed and recorded on the blockchain. These blocks can only hold a limited number of transactions and it’s estimated that Bitcoin can do 5-7 transactions per second. As you can imagine, this would not be able to handle the thousands or tens of thousands of transactions that occur per second.
There is a trade-off between decentralisation, security and scalability. The bitcoin base layer prioritises the first two and the Lightning Network aims to solve the latter.
How does it work?
The Lightning Network is made up of payment channels between participants on the network.
A payment channel is a special type of on chain transaction that commits funds into a ‘contract’ between two participants. Once a payment channel has been opened, the two participants can send instant payments to each other in real-time.
Each participant will sign the ‘contract’ after each payment to record the updated balance between the two. These transactions now appear off chain and are not recorded on the blockchain. The users can make an infinite amount of transactions without paying an on chain fee (apart from opening or closing the channel) by updating the 'contract' of who owns what. This enables extremely fast and cheap payments.
As an example, rather than Alice and Bob sending 100 payments between each other over the course of a year on the Bitcoin base layer. They could open a channel at the beginning and pay a fee to miners to include this transaction into a block and record it on the blockchain. Alice and Bob can now send the remaining transactions back and forth over the course of the year. In the end, they can choose to close the channel and make the second on chain transaction which will be recorded on the blockchain.
However, the real beauty is a ‘network of p2p channels’. This allows two participants who do not have direct channels with each other to make secure payments. We won’t go into details of how this works but participants can route payments through channels over the network to participants with whom they do not have a direct channel in a trustless manner.
What does this mean for the future?
The Lightning Network will break down barriers in ways we can’t even imagine yet. Examples of this have already started to emerge and we believe this will have huge impacts on future business models.
One example is micropayments which makes streaming payments a reality and can change the game for content creators such as podcasters.
Another is international payments. It can drastically improve the current friction and costs of worldwide remittances with instantly settled, cheap, cross border payments.
There are many more examples today that are extremely exciting and many that will emerge in the coming years and decades.
How do I make a deposit using the Lightning Network?
How do I withdraw using the Lightning Network?