In this article we are going talk about what is lightning network and how does it work?
Since Bitcoin announced in 2008 by Satoshi Nakamoto, many expected that it would have scalability issue. After ten years, still scalability is the Bitcoin’s major problem. But what does scalability mean?
In fact, Bitcoin can process only 7 transactions per second. This amount was enough at the beginning, but after a while the users of the network increased exponentially. Consequently, the transactions take a long time to process and users have to pay higher amount of transaction fee.
If Bitcoin wants to use as a medium of exchange for daily purchases, it has to be able to compete with other payment options. For a comparison, Visa can process around 24,000 to 50,000 transactions per second.
As solution to this problem, Bitcoin community came up with different ideas. The ideas such as BitcoinCash, etc. One of the proposed solutions was what we call “Lightning Network”.
What is the Lightning Network?
Put simply, the idea behind Lightning Network is that, there is no need to keep the record of every single transaction on the blockchain.
In other words, Lightning Network adds an extra layer to Bitcoin’s blockchain. The users can use this layer in order to create payment channels between any two parties. The created channels can exist as long as it’s required. The channel is only between two parties. As a result, it provides quick transactions with low or even zero transaction fee.
How does Lightning Network work?
In order to make it easy to understand, we explain it with an example. Imagine Dave and John are friends. They need to send money to each other constantly. For this purpose, they need quick transactions with minimal fee. So, they will create a channel on the Lightning Network.
At first, they have to create a multi-signature wallet. Now, they both can have access to the wallet using their private keys. After that, they both deposit some amount of Bitcoin into that wallet. For example, each of them deposit 3 BTC.
Then, they can have unlimited transaction between each other. For instance, if Dave wants to send 2 BTC to John, he needs to give the ownership right of 1 BTC to him. Then, they both will use their private keys in order to sign the updated balance sheet.
The funds will transfer once the channel gets closed. In this case if they decide to close the channel, finally Dave will get 2 BTC and John will receive 4 BTC.
Once the channel closed, the initial and financial balance will broadcast to the Bitcoin blockchain. As you can see, by using Lightning Network, users are able to perform unlimited transactions outside the main blockchain and then record them as a single one.
Advantages and disadvantages of Lightning Network
By using Lightning network, you do not need multiple confirmations for each transaction. It doesn’t matter how busy the network is, all the transactions happen instantly. As a result, it can compete with other traditional payment systems such as PayPal, MasterCard and Visa.
As we mentioned above, the transactions happen outside of the main blockchain. As a result, the transaction fee is really low and is almost zero. This is one the main advantages of Lightning Network. If it works and develops properly, it can make Bitcoin as a suitable choice for daily purchases.
The Lightning Network is much faster than the main blockchain. It can process over 1 million transactions per second.
Security and anonymity
Most of the cryptocurrencies out there are not totally anonymous. But, for Lightning Network it would be different. For the reason that all the micro-transactions happen outside of the network, it’s impossible to trace a transaction.
Still cannot use fully operational
This is the main disadvantage of Lightning network. It’s not still fully operational because it requires more development. In fact, it’s a bit soon to decide certainly on it that it works properly or not.
Complexity of channels
The Lightning Network consists of multiple channels. In fact, it’s sort of web of channels. So, at first, you need to create a channel in order to have seamless transactions. As a result, when the transactions require going through dozens of intermediate channels, the transaction fees will increase.
In order to use it, the user require depositing some amount of crypto. As a result, they have to choose to whether have liquidity within the Lightning Network channels or liquidity on the main blockchain.