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Bitcoin: On-Chain & Lightning Explained5 min read

June 16, 2021 4 min read

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Bitcoin: On-Chain & Lightning Explained5 min read

Reading Time: 4 minutes

The concept of layered money is not new in monetary history. Large card networks like Visa and Mastercard do not function by themselves. These organizations work with the layers directly above and below them. Each layer represents a specific kind of financial institution that must interact with the other layers for every transaction to make it from the consumer to the merchant. Similarly in Bitcoin, there are layers for scaling and speeding up transactions. In bitcoin, these layers are designed to solve the technical limitations of the blockchain.

On-Chain (Bitcoin Blockchain or Base-layer)

All Bitcoin transactions recorded on the blockchain are considered on-chain base layer transactions. On-chain transactions refer to transactions that are recorded and validated on the Bitcoin blockchain. On-chain transactions offer the most security and transparency as they can’t be modified once confirmed and recorded on the blockchain. On-chain transactions must be validated by all of the network’s participants, also known as full nodes.

Every transaction that occurs in the bitcoin economy is registered in a publicly distributed ledger, which is called the blockchain. New transactions are checked against the blockchain to ensure that the same bitcoins haven’t already been spent, thus eliminating the double-spending problem. 

The Bitcoin blockchain is decentralized and distributed where no single group or authority controls it. Data can only be inserted and viewed; no data is ever edited or deleted.

Benefits of On-Chain payments

On-chain transactions are extremely secure and reliable. Once a transaction is recorded on the blockchain with 6 or greater blocks settled after it the transaction is secured and cannot be altered or reverted by anyone. Bitcoin’s base layer optimizes for decentralization and durability. Bitcoin’s proof of work allows the decentralized nature of Bitcoin and also eliminates the potential for a single point of failure, making it more resilient than traditional currencies. The Bitcoin blockchain ledger provides a permanent record of all transactions, and the open-source accessibility of the ledger allows anyone to view and verify previous or ongoing transactions and addresses. The ability of anyone to view and self-audit bitcoin transactions is essential to fostering the decentralized nature of Bitcoin. 

Limitations of the Bitcoin Blockchain

Although the base layer provides excellent security, transparency, and decentralization, it can be slow and costly for widespread everyday transactions. In Bitcoin, new blocks are generated on average every 10 minutes and support less than 7 transactions per second with a 1-megabyte block limit. In contrast, a payment processor like Visa or Mastercard can support thousands of transactions per second. As the Bitcoin network grows, mining fees in the network are expected to rise due to higher network traffic and demand, making it impractical for everyday use. Transactions confirmed on the bitcoin blockchain may even take several hours before it is confirmed with finality. 

Lightning transactions (Layer 2 Solution)

To achieve much higher transaction throughput without compromising on decentralization and security, the Lightning Network was proposed to make transactions extremely fast and cheap.

image of the Bitcoin Lightning Network explained with layers

The Lightning Network is a decentralized network that uses smart contract functionality to enable near-instant payments over a network of peer-peer participants. The Lightning Network is a second layer protocol built on top of the Bitcoin network; A layer 2 solution means that although the Lightning Network is built separately, it can still interact with the Bitcoin blockchain. It allows transactions in the network to scale while still keeping the security and decentralization of the Bitcoin network.

The Lightning Network works by opening a bi-directional payment channel between two users. A bi-directional payment channel allows payments to flow in both directions. Using payment channels, users can send or receive bitcoin transactions locally and privately outside of the Bitcoin blockchain. Transaction between users occurs through the payment channels, and the ledger is updated locally between the participants. Unlike on-chain transactions, there is no need for miners to mine blocks and broadcast them to the entire Bitcoin network.

In the event that a bi-directional payment channel is not open between the transacting parties, the payment can also be routed through the network. This is done using an onion routing technique similar to Tor, and it requires that the sender and receiver of the payment have enough mutual peers to find a path for the payment.

Image of the Bitcoin nodes on the Lightning Network
The Bitcoin Lightning Network visualized according to the geolocation of nodes in the network — Source: https://explorer.acinq.co

Benefits of the Lightning Network

  • Speed: Settlement time on the Lightning Network is near-instant
  • Throughput: There is no theoretical limit to the number of payments per second that can occur in the Lightning Network as long as there are enough funds and a payment path.
  • Privacy: The details of individual Lightning Network payments are not publicly recorded on the blockchain
  • Low Fees: While Bitcoin transactions can be costly depending on the demand, transactions using the Lightning Network cost very little around one Satoshi, equivalent to a fraction of one cent making it ideal for everyday use.

Conclusion

If we compare Bitcoin with fiat, Bitcoin’s base layer is like fed wire or ACH, while the Lightning Network is like visa or MasterCard but much more scalable and efficient. Critics of bitcoin completely miss the fact that speed and efficiency should take place on higher layers, NOT on the base layer. Lightning will show the world bitcoin’s true capabilities as a medium of exchange.


At OpenNode we believe that merchants should have the ability to leverage both on-chain payments and Lightning Network payments and thats why we offer both options in our checkout. Are you interested in earning Bitcoin payments with your business using both on-chain & Lighting Network payments? Visit our website to learn more about us and get started for free today!