Every bitcoin enthusiast’s dream is for the world to realize the potential benefits the digital currency can bring to today’s financial ecosystem (that and also buying a Lambo). However, at the same time, we know that before that happens, bitcoin has to improve in certain aspects—mainly scalability.
At this moment, Bitcoin blocks can only hold so many transactions and a single block is created around every 10 minutes. Although that may seem fine when not many people are making transactions, it becomes a different story when numerous people try simultaneously—transactions take longer and become more expensive.
Because of block space being such a scarce resource, many people have looked for solutions, and in this article, we’ll take you through one of them: The Bitcoin Lightning Network.
What it is and how it works
The Bitcoin Lightning Network is a layer two or off-chain solution to the scalability problem. This means that it sits on top of the existing blockchain with the goal of making transactions function at “lightning” speed.
The Lightning Network has its own nodes and software, separating it from the Bitcoin network. However, it remains in constant communication with the chain through mini-ledgers called channels. Think of it as a DM (direct message) on Instagram that can facilitate fast transactions—they’re only visible to you and your counterparty.
You can also think of it as a smart contract that holds its own private ledger, allowing you to create many transactions. Let’s say two people enter the Lightning Network to make transactions—Charlie and Dom. They both put 5 BTC into the smart contract, which is going to be the balance of the entire ledger. Charlie could then create a transaction sending 1 BTC to Dom. Dom would then have 6 BTC while Charlie has 4. They can continue making transactions for as long as they’d like. Once they’ve decided to stop making transactions, they can publish the channel onto the blockchain. From there, each of their balances are updated on the main chain.
The purpose of creating these channels is to avoid the hassles of block confirmations. Payments are fast and there are no transaction fees (only the fees for entering and exiting the channel).
Essentially, entering the Bitcoin Lightning Network is like adding someone’s contact details to your “Favorites” on your phone—they’re one click away. The mentality behind the Lightning Network says that it’s not necessary to record every single transaction on the blockchain. Instead, we can create payment channels between two parties on a different layer for cheaper and faster transactions.
But what stops people from scamming each other within these private channels? Unique features like Hash Timelock Contracts (HLTCs) on the Lightning Network prevent that from happening. Hashlocks are conditions placed on transactions that allow specific participants to spend funds. Timelocks are conditions that prevent spending funds before specified times. HTLCs are a marriage between the two concepts, allowing users to protect themselves from threats.
As mentioned earlier, the Bitcoin Lightning Network provides a more scalable means of making transactions. You can make thousands of transactions once you and a counterparty create a channel—all for free. Once finished, simply publish the channel onto the blockchain.
If many users decided to hop onto the Lightning Network, block space on the original chain will be used more efficiently. Smaller transactions could be done, saving block space on the original chain for larger amounts.
On the Lightning Network, you can make transactions worth the smallest possible unit of bitcoin—1 satoshi. This makes its transactions ideal for micropayments as compared to the original chain, which has a minimum trade amount of approximately 0.00000546 BTC.
Aside from free and speedy transactions, it allows for more private transactions. Channels don’t need to announce themselves on the network. It’ll say that a channel has been created but people won’t be able to tell who’s involved and what’s going on inside it. If a channel is made private, only its participants will know what transactions are happening.
The Bitcoin Lightning Network may seem like a sweet deal but like everything else in this world, it has its disadvantages.
First, there’s the issue of channel caps. At the moment, the total balance between both participants is the maximum the channel can hold. So if there was a total of 10 BTC shared by both participants, that’s the channel cap. This isn’t ideal, as people with limited funds will, in turn, have lower channel caps.
Second, it’s complex. The idea behind the Lightning Network was to create a “web” of channels that could ideally allow seamless transactions. This web of channels, although they have the potential for more direct transactions, can also create overcomplicated routes—going through many intermediate channels and racking up fees in the process.
Lastly, the network isn’t fully operational yet—meaning there’s currently no way of telling how good it’s going to be. Yes, the concept is great on paper, but the network needs to be fully realized before we can properly gauge how beneficial it’s going to be.
Waiting for the follow-through
There’s no doubt that the Bitcoin Lightning Network is incredibly promising, as it aims to make bitcoin more scalable without compromising the original blockchain. However, it has a lot of growing up to do before it becomes applicable in today’s bitcoin trading ecosystem. The Lightning Network’s code is very complicated and still needs to be put to the test. It needs to prove itself as a safe layer-two solution before the community fully adopts it. Right now, all we can do is wait and see if they’ll actually deliver. If they do, we’ll have access to a cheaper, instant, and more anonymous way of making microtransactions.