Understanding Lightning Network? Its Basics and Mechanisms?

Today, we will be discussing one of the most significant advancements in the cryptocurrency industry - Bitcoin's Lightning Network. Its purpose is to provide users with a simple method to make "off-chain" bitcoin payments with low fees, nearly instant settlement, high transaction throughput, and enhanced privacy.

In early 2018, the Lightning Network was launched (Beta) on the Bitcoin mainnet. During its first year, the Lightning Network has grown exponentially, both in terms of technology and popularity. However, it is still in its early stages and has a long way to go before it can be considered "mature." The potential user experience (UX) improvements for Bitcoin have not yet been fully realized. In other words, we are still in the "Infrastructure" development phase.

In this article we will cover:

Why the lightning network matters
What the lightning network is
How the lightning network was conceived
How the lightning network works
Current status (live on mainnet)
Risks, concerns, and speculations on the future of Lightning

Why the Lightning Network Matters

Before we can explain what the lightning network is or how it works, it’s important to understand the problem it solves. In short, the lightning network was created in response to BTC’s limited transaction scalability on the base layer.

The Bitcoin protocol is built on top of a distributed ledger called a blockchain. Blockchains enable anyone in the world to agree on the "current state" of the ledger without trusting any 3rd parties. This is truly revolutionary from both a computer science perspective as well as increasing our social scalability as a species.

However, blockchains must make design tradeoffs which lead to limitations in certain areas of their functionality. Bitcoin decided to prioritize security and decentralization at the cost of transaction throughput.

This means blockchain’s like Bitcoin are relatively slow, expensive, and all transactions are public. This makes competing with Visa on transaction throughput impossible on the base layer of Bitcoin. However, Bitcoin doesn’t compete with Visa on the base layer, instead Bitcoin is building scaling technology in "layers" just like how our internet is built. Also, to be fair, Visa is a 2nd or 3rd layer network that runs on top of fiat currencies held by banks such as USD.

There are two ways for blockchains to scale: on-chain scaling (enables linear growth) or off-chain scaling (enables exponential growth). "Off-chain" simply means the transactions take place in a seperate network (Lightning) and periodically settle to the blockchain.

Lightning network is an example of off-chain payment channel scaling. This approach enables multiple protocols to work together and each can specialize for their desired use case. This allows the Bitcoin blockchain to focus on robust security and the lightning network can focus on scalable payments. This "modular approach" mimics how our current internet is built.

A popular analogy for Lightning is when you open a tab at the bar – you can purchase 3 beers and only settle one transaction at the end of the night.

What Is the Lightning Network?

Lightning Network is an open-source payment routing protocol that sits on top of Bitcoin. A mature Lightning Network addresses the majority of bitcoin’s perceived weaknesses as a medium of exchange.

Implications of a mature Lightning Network:

Bitcoin can theoretically scale to infinity.
All transactions will have increased privacy (through onion routing).
Transaction fees will be so low that you can send microtransactions.
Confirmation times will be near instant (as fast as you can send the 1s and 0s).
Potentially, other coins (such as LTC) that have the Malleable Transaction fix (e.g. SegWit) can connect to the Bitcoin Lightning Network through cross-chain atomic swaps.

Lightning Network is developed for the Bitcoin network but similar networks can theoretically be implemented on top of other blockchains. In fact, there are several similar "payment channel implementations" in various stages of development such as Ethereum’s Raiden network.

Background

The original Lightning Network white paper was published by Joseph Poon and Thaddeus Dryja in 2015-2016. Currently, there are multiple teams developing Lightning Network implementations, all working under the shared interoperability standard known as BOLT. This standard ensures that all Lightning implementations can integrate smoothly.

The three primary teams working on Lightning are Lightning Labs, Blockstream, and ACINQ. Each implementation is coded in a different programming language and has slightly different priorities. For instance, ACINQ focuses on mobile functionality for Lightning. However, these teams work closely together, and the average user won't be able to discern which implementation they are using.

The Functioning of Lightning Network

Lightning network uses a network of peer-to-peer "payment channels" powered by smart contracts. Two individuals begin by opening a payment channel by creating a Hash Time Locked Contract (HTLC) multi-signature transaction on the blockchain.

Once the channel is open, participants can send money back and forth instantly with low fees. Each transaction updates both participants’ "temporary balance." Whenever either party wants to leave the channel, they can broadcast the final balance to be recorded on the blockchain.
Things start to get interesting when you combine thousands of payment channels together in a single network. Lightning is capable of routing payments from person A to person B even if they do not have a direct payment channel together. This effectively enables lightning users to send and receive bitcoin between anyone in the network, instantly, for near zero fees.

While the technical specifications get really complicated, luckily all the complexities will be abstracted away from the end user. Lightning offers tremendous UX improvements to bitcoin and soon the end user only needs to download an app before sending and receiving transactions like you would with Paypal, Venmo, etc.

Current Status (live on mainnet)

Lightning Network has been live on the Bitcoin Mainnet since January of 2018. In the last year, the lightning network has grown to more than 6,800 active nodes, 30,000 channels, and a total lightning network capacity of more than $2.7 million USD (700+ BTC).

However, the developers still consider it to be in Beta. In other words, feel free to play around with Lightning, however it’s not recommended to use large amounts of money just yet. The community uses the hashtag #reckless to emphasize this point.

Luckily, the Lightning Network is getting easier to use all the time. Here are a few ways to get started with Lightning.

Pierre Rochard’s Node Launcher makes it easy to set up your own Bitcoin full node and Lightning Node without using the command line.
Casa’s plug and play Node is the easiest way for non-technical people to set up a Bitcoin Full Node and Lightning Node at home. Just like setting up your home Wifi router.
Lightning Joule is a browser extension wallet that connects to your Lightning Node. Great UX and very similar to Ethereum’s MetaMask.
If you want to play around with Lightning Transactions, you can play chess, Tip your friends satoshis on Twitter, or make graffiti art on Satoshis.place.

Risks, Concerns, and Speculations

The Lightning Network is still in its infancy. To really understand the potential, we need to look to the future. In this section we’ll cover some risks, concerns, and speculate on the future potential.

Risks & Concerns

While I’m very optimistic about the future of Lightning, there are still some risks and concerns we should discuss.

Currently the Lightning Network capacity is still dominated by a small amount of "power users." Luckily power users cannot really attack the network, but it would be good to see the channel capacity become more decentralized over time.

Lightning Network offers the ability to improve the UX of Bitcoin, however currently the network is very clunky. It’s not very complicated for current Bitcoin users, however it’s nowhere near ready for a brand new person to be onboarded directly to Lightning. If technology UX progresses as it did with the internet, the UX improvements are only a matter of time.

Speculations

Speculating on the future of Lightning is exciting but everything should be taken with a healthy dose of skepticism as the future is unknown.

Developing on the Bitcoin protocol is very challenging and only a few hundred people are actively contributing at any one time. While the core contributors to Bitcoin are some of the most intelligent developers on the planet, it would be nice to onboard more developers to the Bitcoin ecosystem.

The Lightning Network is much easier to build on which offers a tremendous opportunity to attract new developers. While Ethereum is undergoing an uncertain multi-year transition to PoS, we’re going to see many former Ethereum developers come over to Bitcoin’s Lightning Network. One prominent example is Will O’Beirne who created the Lightning Joule browser extension mentioned above. Check out Chaincode Labs Residency if you’re interested in learning how to build on Lightning Network.

Another interesting benefit to Lightning is the increased privacy. This increased privacy is enabled because Lightning payments are routing through The Onion Routing Protocol (TOR). This prevents anyone in the network from seeing who is sending or receiving transactions – a massive privacy improvement over the fully public Bitcoin blockchain.

If Lightning Network continues to expand, significant scalability and privacy improvements will be brought to Bitcoin. In this scenario, the demand for generic privacy coins will decrease as Bitcoin becomes more secure and moderately private. However, at present, Lightning transactions are not as private as Monero or Zcash.

Andreas Antonopoulos has suggested that Lightning Network offers "a very high degree of privacy."

In a future with a mature Lightning Network, generic currency tokens that only offer "fast transactions" will be redundant. Bitcoin via Lightning will be more reliable, secure, affordable, and quicker than any other currency claiming to provide "fast transactions."

Some upcoming Lightning Network features to watch out for are AMP, Splicing, Channel Factories, Watch Towers, and new transaction mediums like Mesh Networks, HAM Radio, and Satellite transactions.