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Lightning Network – what is it and how does it work?

Lightning Network – what is it?

Commonly abbreviated to LN, the Lightning Network is an idea that first appeared in 2015. There are two men who are responsible for coming up with this concept. Joseph Poon and Thaddeus Dryja wanted to create a type of payment protocol that won’t be on the main part of the blockchain. Instead, it would be an off-chain solution thanks to which scalability wouldn’t be such an enormous problem for Bitcoin. Of course the same thing applies not only for the most popular cryptocurrency there is, but for all other cryptocurrencies that are dealing with scalability issues.

The reason why people started to think of alternatives such as Lightning Network was the result of limitations that many cryptocurrencies, including Bitcoin, were facing. As you know, the efficiency of Bitcoin is just 2-7 transactions per second. It means that if hundreds of thousands users wish to make transaction at the same time, it may take much longer than expected. The problem with Transactions Per Second (TPS in short) wouldn’t be as big if not the fact that the market of cryptocurrencies is getting bigger every day. The number of users, and hence the number of transactions, is keep growing. This is why the effectiveness of Bitcoin and other altcoins is dropping. LN is just one of many possible solutions that may help while fighting with congestion of the blockchain of Bitcoin or other digital currencies.

How does Lightning Network work?

The concept behind this network is quite simple. It basically is an off-chain network that deals with transfers. The users build it on top of the blockchain of Bitcoin. It makes use of P2P system, namely users do not have to worry about long-lasting transactions and any delays. As long as there are bidirectional payment channels (direct connection between wallets), everyone can make use of it without worrying about the speed.

Let us clarify the entire process. Let’s assume that two people decided to open a payment channel. Once they do that, they are able to transfer any number of currency without any delays between connected wallets. The reason why Lightning Network can eliminate unnecessary congestion on Bitcoin blockchain is very simple. Once we open a channel by making an on-chain transaction, all other transactions will take place off-chain, without the need of putting them through the entire process of verifying. Of course to make these transactions, we need to have a smart contract that can execute them quickly. Thanks to that, we won’t be in need of paying fees for each transaction and the general TPS rate will be higher.

Of course there are special safety precautions when it comes to using Lightning Network. For example, even if we make off-chain transactions, they are still recorded on respectable balance sheet. It means that basically we are opening a channel with the use of on-chain channel, then make several transactions off-chain, and once we are done, we close the channel, send the information with the latest changes in their wallets, and then wait for Bitcoin blockchain to verify everything. It means that instead of making several transactions on the Bitcoin blockchain, we will have to interact with it only twice. The first time when we open a channel, and the second time when we close it, after making numbers of small transactions.

Network Routing

Network Routing is a very interesting thing that allows two parties to make transactions even if they do not have a direct payment channel. It can happen when there is a system of interconnected payment channels. It means that if person A has got an opened payment channel with person B, and person B has got his or her own channel with person C, then Network Routing allows person C to make transaction with person A via person B.

What makes LN so good?

There are several advantages of introducing Lightning Network. First of all, it will basically help Bitcoin in reducing the traffic it currently has. This is one of the solutions that may be successful while taking care of scalability issue. Secondly, thanks to bidirectional payment channels, or simply direct connection between wallets, it offers us almost instant transactions, what is a huge step for the financial transaction system of cryptocurrencies.

Noteworthy is also the fact that this might be the best option every time we wish to make the so-called micropayment, which is a transaction with very low value. What is more, it is possible to automatize micropayments by implementing machine-to-machine technology system. Thanks to that people will not be necessary to make transaction between electronic devices.

The problems Lightning Network has to face

The only way LN transactions can come through is if two people are online. It means that we cannot apply this technique if one of the receivers is offline. What is more, our funds are not always safe when we are connected to payment channels. Although it is possible to handle this risk by using monitoring services from the third parties, it is still an issue worth noting.

The biggest limitation Lightning Network has regards the value of payments. Although we can make a lot of transactions, it is not possible to make larger ones. It is all due to the characteristics of multi-signature wallets. These are simply shared wallets and rarely there will be sufficient balance in order to provide one party with the payment might not be. What is more, in order to stabilize our wallet account, we need to close the channel. This; however, requires operating on the main blockchain. Unfortunately, it takes both time and money (as a result of transaction fees).

When will this be up?

Although the announcement by Lightning Labs took place nearly two years ago, there is still no official date when Lightning Network will be a permanent and stable part of Bitcoin. However, we should bear in mind that there are still a lot of LN alternatives, like for example c-lightning or eclair. Let us not forget that the first beta tests that take place on Bitcoin Test Network started a long time ago. It means that with each month we come closer to the release of LN.

The moment beta tests started, one could notice a huge increase in popularity of LN. More and more people decided to use Lightning Network to speed up small transactions. At the beginning of 2019 it is said that there has been approximately 25,000 payment channels already running.

Summary and conclusion

One of the most important things Lightning Network can help with is of course the problem of scalability. Although beta tests proved that LN needs some improvements, it still has a huge potential and can definitely have a positive impact on Bitcoin and the entire ecosystem in which cryptocurrencies operate.