What is the Lightning Network?4 min readReading Time: 3 minutes
Bitcoin, the world’s first decentralized digital currency, can be accessed anywhere there’s an online connection, but its rapid growth led to issues with slower transaction speeds and higher costs, limiting its potential as the most-efficient vehicle for making and receiving payments. The solution to these issues is the Lightning Network (LN), built specifically for scaling the Bitcoin blockchain and improving its functionality as a Medium of Exchange.
Who Created the Lightning Network?
Joseph Poon and Thaddeus Dryja introduced the concept in the breakthrough white paper “The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments.” This 2016 work provided the foundation and an important start, but the design of the LN protocol evolved and improved over time with different implementations all compatible with the BOLT (Basis of Lightning Technology) protocol specifications.
Several teams built their own LN implementations, including the following:
- Blockstream – Creator of C-lightning
- Lightning Labs – Creator of LND
- ACINQ – Creator of Eclair
- Nayuta – Creator of Ptarmigan
How Does the LN Protocol Work?
The Lightning Network runs on a peer-to-peer (P2P) level where all transactions occur on an off-chain network built on top of the Bitcoin blockchain. For this reason, the protocol is considered a Layer 2 solution, with the blockchain itself being Layer 1.
Rather than record each individual payment onto the blockchain, the two parties (typically a buyer and seller) open bi-directional payment channels via the Lightning Network. To create a bi-directional channel, the participants must decide to open a payment channel where they can transact funds back and forth from each other’s wallets. To set it up, both parties need to fund the creation of the channel with an on-chain Bitcoin transaction. The total amount of the payment channel is the maximum amount of funds that can be transacted, thus protecting both parties from losing more funds than necessary. These transactions do not require a confirmation from the Bitcoin network since they occur off-chain on the second layer. As a result, they occur almost instantaneously through a smart contract, providing much lower fees and much higher throughput.
The most common example of how LN works is with the Alice & Bob Model. To get started, Alice and Bob need to fund a payment channel using a multi-signature wallet. With the funds in the payment channel, it can act as a smart contract, and the multi-signature wallet can act like a safe holding all of the funds being transacted. While the payment channel remains open, Alice and Bob can continue to make as many transactions with each other as they choose.
These transactions are kept on a “balance sheet” localized in the channel between Alice and Bob. After every transaction, they sign and update their copies of the balance sheet to record the amount of Bitcoin each one of them has. When they are finished, they can both agree to close the payment channel and broadcast their final balances to the Bitcoin blockchain. Both parties will receive their Bitcoin according to the latest version of the balance sheet submitted due to the rules of the Lightning Network smart contract.
Hashed time-locked contracts powered by the Lightning Network are designed to protect both parties and always require the approval from both parties for any funds to be moved. Anytime one party acts maliciously and attempts to remove funds from the payment channel without the other’s consent, they are penalized and must forfeit their funds to the other party in the channel.
Routing payments on the Lightning Network
As part of its solution to improving Bitcoin payments, the Lightning Network routes payments that occur on the network with interconnected payment channels. What does that mean? Even if two parties are not connected through a direct payment channel, they can still send and receive Bitcoin payments as long as a connection to the rest of the network can be established. This allows Alice to send payments to her friend Sally without having a direct payment channel as long as another channel on the Lightning Network is connected to Sally with enough funds to fit Alice’s payment.
For example, Alice has an open channel with Bob, who has an open channel with Sally, who does not have an open channel with Alice. In such a scenario, Alice can send the payment to Sally through Bob. The routing of payments over the Lightning Network may involve several hops, but the smart contract automatically searches for the shortest and most cost-efficient path available.
Benefits of the Lightning Network
- Instant Payments: On-chain Bitcoin payments require six confirmations, which aren’t feasible for real-world payments. LN allows for Bitcoin payments to be made instantly with zero confirmations.
- Micropayments: LN allows users to send and receive Bitcoin payments all the way down to 0.00000001 BTC (<0.01 Cents).
- Scalability: All Bitcoin transactions on LN occur off the Bitcoin blockchain (off-chain) without the delegation of trust or ownership, allowing users to conduct unlimited instant payments.
Conceived in 2016, the Lightning Network is now fully operational and successfully transacting micropayments around the world. As a pioneer of the Lightning Network, the team at OpenNode understands the value of providing a pleasant user experience with this new technology, and we constantly improve our platform with every new development.
OpenNode currently offers Bitcoin payment processing for both on-chain and Lightning Network payments. Learn more here.