Cryptocurrencies like Bitcoin have several unique properties. They can be used by pretty much anyone to send value to any corner of the globe, without any third party involved, nor can they be easily hacked or shut down. However, to achieve this, some trade-offs were made. One of the trade-offs is limited throughput. This means that the transactions per second (TPS) processed by the blockchain can be relatively low, a significant hindrance. However, there are several scalability solutions to overcome these limitations. One such solution is the Lightning Network.
Bitcoin has a problem, the scalability problem. As it gains more popularity and its network of nodes grows, the longer it takes for them to reach a consensus on transactions. So as the network grows more extensive, the average transaction speed gets slower. Let’s look at the numbers; currently, Bitcoin is capable of processing between 3-7 transactions per second. In comparison, Paypal is capable of processing over 150 transactions per second, while Visa is capable of processing 2000 transactions per second but can go as high as 56,000.
When there aren’t too many users sending funds, the TPS is not an issue. A user can simply set a low transaction fee and have the transaction included in the next block. However, when there are a significant number of users on the network, the transaction fee rises significantly, creating a backlog of transactions.
Layer-2 is a term that refers to a secondary protocol or framework that is built on an existing blockchain, with the goal of solving issues related to transaction speeds and scalability issues, such as in the case of Bitcoin. Transactions and processes on Layer-2 take place off the main chain, easing congestion on the main chain and increasing throughput. Another advantage of Layer-2 solutions is that they do not require the main chain to undergo any structural changes, with the second layer added as an extra layer on the main chain. This allows Layer-2 solutions to achieve high throughput without compromising on network security.
Initially envisaged in a whitepaper by Joseph Poon and Tadge Dryja in 2015, the Lightning Network (LN) is a Layer-2 solution built on the Bitcoin blockchain. It allows users to quickly send or receive Bitcoin through a new network of payment channels anchored in the Bitcoin blockchain. The testnet was released in May 2016, with the first implementation released in January 2017. The first real-world transaction on the Lightning Network took place in December 2017, when it was used to pay a phone bill.
The Bitcoin Lightning Network offers a solution to the current limitations faced by Bitcoin, providing instant transactions and achieving a throughput of up to 1 million transactions per second. The network is predominantly used for microtransactions and other small transactions that are not feasible on the main chain, thanks to the significant fees attached. However, users can use the Lightning Network for larger transactions as well.
The Lightning Network functions by creating a channel between two parties. Once a channel is established, the parties can send instant and inexpensive transactions to one another. The transactions also do not need to be broadcasted to the base layer of Bitcoin’s blockchain, while parties involved can settle on the Bitcoin blockchain and close the channel at any time.
Once the channel is closed and settled on the base layer, the funds are sent to the participating parties according to the transfer history recorded on the channel, which is added to the blockchain as a single transaction. The only transactions related to the Lightning Network broadcast to the Bitcoin Network are the opening and closing of the channels. As a result, block space is freed, and network fees are lowered on the main chain. Direct payment channels between two parties can also become part of the larger Lightning Network. If transacting parties do not have a direct channel, they can also transfer funds through interconnected pathways.
Let’s understand this statement with the help of an example, if you visit a coffee shop with a friend who has a channel open with the shop in question. You could use the Lightning Network to route your payment through your friend instead of opening a new channel with the coffee shop. This entire transaction can take place in a matter of seconds on the Lightning Network.
The Lightning Network has ushered in several benefits as a Layer-2 solution.
Speed and Scalability - The Lightning Network completes transactions significantly faster than the main chain. Transacting parties do not have to wait for block confirmations with the allocation of funds overseen by smart contracts, with each transaction completed almost instantly.
Micropayments - The Lightning Network enables users to make micropayments, making even smaller transactions cost-effective.
Privacy - While transactions on the Bitcoin blockchain can be traced, only the opening and closing of channels are recorded when a transaction is done through the Lightning Network. This means that payments done through the Lightning Network will be nearly untraceable.
As of March 2022, the Lightning Network has over 35,000 online nodes, 85,000 active channels, and over 3570 BTC in capacity. There are also several node implementations, such as Blockstream’s c-lightning and Lightning Lab’s Lightning Network Daemon, to name a few. Since the mainnet launch, the Lightning Network’s popularity has grown considerably. However, there are still a few niggles when it comes to usability. The Lightning Network also requires a certain degree of technical know-how when it comes to operating a node. However, despite these issues, the Lightning Network is set to become an integral solution to Bitcoin’s scalability issues.
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