Scalability remains a stumbling block for Bitcoin (BTC). Despite the rise in BTC's prominence since 2009, the Bitcoin blockchain is slow compared to more traditional payment options like Visa and MasterCard. Instead of handling thousands of transactions per second (TPS), Bitcoin can only handle about 7 TPS. Plus, many competing cryptocurrencies already offer fast and virtually feeless transactions. With only 7 TPS, it is impossible for Bitcoin to be the standard of mode for to day transactions.
The Bitcoin Lightning Network (commonly called LN) aims to address Bitcoin's scalability issues by moving BTC microtransactions off the main blockchain. Although the LN is still in development, it may provide crypto holders with a secure, swift, and nearly feeless way to pay in Bitcoin.
What is the Lightning Network?
The Bitcoin Lightning Network is a BTC payment portal that's built on top of the Bitcoin blockchain. Many refer to the Lightning Network as a "layer-2 scaling solution" since it's attached to Bitcoin's layer-1 main chain, which can approve transactions without the need of an additional network.
Although the LN relies on Bitcoin's blockchain, it can record innumerable BTC transactions "off-chain." In other words, all transactions within the LN aren't recorded on Bitcoin's main chain. It's only when LN users open or close payment channels that these transactions post on the Bitcoin blockchain.
Developers Joseph Poon and Thaddeus Dryja proposed the idea for the LN in their 2016 paper, "The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments." Both Poon and Dryja believed settling crypto transactions off-chain could make BTC micropayments feasible. Soon after, Poon and Dryja created the company Lightning Labs to make the LN see the light of day.
Although the Bitcoin Lightning Network is still under development, many crypto wallets and exchanges have begun implementing this layer-2 solution. In 2020, there were 1,000 BTC deposited into the Bitcoin Lightning Network, and that number continued to rise to 4,000 BTC in mid-2022.
Why was the Bitcoin Lightning Network created?
The Bitcoin Lightning Network’s purpose is to make BTC microtransactions (those day-to-day purchases we mentioned earlier) possible. Although Bitcoin's mysterious founder Satoshi Nakamoto envisioned their blockchain as a peer-to-peer payment system, the main chain takes too long to settle small transactions. Given Bitcoin's block size of 1 MB, it can only handle about 7 TPS. It may take hours for a small transaction to clear on Bitcoin's blockchain, making it an impractical choice in small- and mid-scale stores like grocery stores, restaurants, and cafés.
Not only does Bitcoin's block size limit the number of transactions, but BTC miners are also less likely to prioritize validating small transactions. Bitcoin's proof-of-work (PoW) consensus mechanism rewards miners with transaction fees and a bonus BTC reward. Understandably, the larger the BTC transaction is, the more a Bitcoin miner stands to gain from fees.
Speaking of fees, the transaction fees on Bitcoin's main chain are often higher than what you’d pay for products like a cup of coffee. When the Bitcoin network is extra congested, you can pay double or even triple the amount of BTC for a small payment.
The LN wants to make BTC microtransactions more realistic, thus increasing BTC's usefulness in day-to-day life. By settling small transactions off-chain, the LN can make it possible for you to quickly send and receive BTC for virtually no fee.
It also helps the Bitcoin blockchain scale without creating a separate blockchain (aka a “fork”). Around the time the LN was proposed, some Bitcoin developers created a "hard fork" of the Bitcoin blockchain known as "Bitcoin Cash." Although Bitcoin Cash is based on Bitcoin's PoW algorithm, it uses a larger block size to handle faster and cheaper transactions.
Bitcoin Cash is still available on many crypto exchanges, but it has yet to eclipse Bitcoin in terms of market cap or public awareness. The LN proposes to use Bitcoin's existing network effect and security to offer many of the value propositions of Bitcoin Cash (i.e., faster and cheaper microtransactions).
How does the BTC Lightning Network work?
To transact on the LN, you first need to open a "payment channel," which is possible when you deposit some BTC into an app that integrates with the Bitcoin Lightning Network. This initial deposit gets recorded on Bitcoin's main chain and costs a standard BTC transaction fee.
Once the payment channel is open, you can exchange the BTC in your account with another user off-chain. All the transactions on the LN will neither post on Bitcoin's main chain nor cost standard BTC fees. Instead, LN node operators help confirm every Lightning Network exchange between payment channels.
Either you or the other user on the LN can close the payment channels at any moment, and Bitcoin's main chain records the final transaction whenever either party closes the payment channel. Therefore, the only times the LN directly uses Bitcoin's main blockchain are when opening and closing payment channels, where there could be innumerable transactions in between. This facilitates more transactions to occur on the Bitcoin network.
Interestingly, LN users don't have to connect directly with everyone they want to send BTC payments to. As the LN expands, they can send BTC through multiple accounts to reach the intended target.
To better understand how the BTC Lightning Network works, let's take a look at an example.
Let's say you want to open a Bitcoin LN payment channel with your favorite pizzeria. You can deposit 0.025 BTC in a Bitcoin Lightning Network app like Strike that connects to your pizzeria's account. Every time you pay for a pizza with BTC, a portion of your 0.025 BTC will go into the pizzeria's Bitcoin wallet.
So, if you bought one pizza for 0.00075 BTC, your account would have 0.02425 BTC, while the pizza shop's Bitcoin Lightning Network wallet would have 0.00075 BTC. You could continue to make purchases until you run out of BTC funds or you/the pizzeria closes the payment channel.
However, you may not need to directly connect with your favorite restaurant. For instance, if your friend already has a connection with this pizzeria, you can connect to your friend's LN account and send your 0.00075 BTC to the restaurant's LN wallet.
Developers hope that as the BTC LN goes global, it’ll be possible to make payments to everyone on the network after making a few initial connections.
Are there any downsides to the Lightning Network?
The LN is an exciting project for Bitcoin fans, but it’s not without its flaws. Here are a few main critiques experts have raised about its viability and security:
- BTC fees: Although it costs pennies to send BTC while on the LN, you’ll still have to pay the regular Bitcoin fees when opening and closing payment channels. Therefore, whenever you’ll want to claim your BTC on the main chain, you won't get the full amount in your account. Also, it's unknown whether businesses will tack on extra fees for using BTC as a payment option.
- Competition from other cryptocurrencies: Bitcoin may be the largest cryptocurrency, but many competing altcoins (or non-Bitcoin cryptos) can already process microtransactions faster and cheaper than Bitcoin's main chain. Coins like Litecoin, Bitcoin Cash, and Dash have already made in-roads in the peer-to-peer payment space. It's also possible to transact in a synthetic version of BTC called "wrapped BTC" on the faster Ethereum (ETH) blockchain.
- Concerns of federal regulation: Since payments on the LN can theoretically pass through hundreds of users to reach their target, it can make transactions virtually impossible to track. Plus, remember that all transactions in the LN are off-chain. While these features may be a positive for users who value anonymity, they increase the likelihood that federal regulators will take issue with the LN.
- “Store of value” argument: While it's possible to use BTC for daily transactions, many people buy Bitcoin as a "store of value" investment similar to gold. Critics argue Bitcoin's reputation as a long-term investment might make users less prone to spend it as a daily currency. This is because the value per coin changes. An optimal means of payment shouldn’t fluctuate significantly in value.
- Potential for hacks: Hackers can manipulate the LN to their advantage. Indeed, many LN developers have raised concerns over an attack called "flood and loot." For instance, if you close multiple payment channels simultaneously, it can cause heavy congestion on the network. Theoretically, a hacker can take advantage of this confusion to siphon off funds before others realize what's happening.
- Private keys are always online: LN nodes need to be online 24/7. And, if you’re using the LN, you’ll always have your private keys online. Unless the LN team develops cold storage solutions, this can compromise any bitcoins stored in payment channels. Unfortunately, you can lose all your BTC if a hacker figures out your wallet’s private keys.
- Lack of adoption: Although the LN’s integration with apps like Cash App allows roughly 80 million people to access it, adoption is still slow. Other fintech apps like PayPal and Apple Pay already have around 400-500 million users each. Also, the 4,000 BTC currently on the LN represents just 0.019% of Bitcoin’s 21 million supply.
Wrapping up
While the Bitcoin Lightning Network has a long way to go, it has already captured the crypto community's attention. Companies like Twitter and countries such as El Salvador are already experimenting with LN payments. As more wallets, exchanges, and businesses open up to the LN, it may become one of the most-used layer-2 solutions in crypto.
Worldcoin is another project that aims to make “lightning” crypto transactions possible for all of you. We aim to put a share of our crypto in the hands of every individual on the planet for free. We’re also airdropping free DAI to anyone who downloads our app. Subscribe to our blog to learn more about the cryptocurrency market.
