What is the Lightning Network?
The Lightning Network is the flagship solution to Bitcoin’s scaling problem: a second-tier network secured on the Bitcoin blockchain, enabling high volumes of near-instant, low-cost payments.
Bitcoin is an incredibly secure and reliable way to transfer value. The core protocol has never been hacked and it is routinely used to send millions of dollars at a time. However, that reliability and security comes at a price. Bitcoin is slow, and – for small amounts of money – it is prohibitively expensive. Fees have fallen to historically-low levels but average transaction fees are still in the region of $0.12 – not something you’d want to tack onto the price of a coffee or other everyday purchases. Moreover, the network can only handle a few transactions per second, meaning it cannot possibly compete with conventional payment systems like Visa.
The Lightning Network is the flagship solution to this scaling problem. It is a ‘second tier’ platform that operates on top of the Bitcoin protocol.
Leaving aside the tech for a moment, Lightning works (at least conceptually) a little like bank clearing and settlement. There are many commercial banks and every day customers make millions of transactions – some between accounts in the same bank, others between banks. These largely cancel each other out; money leaving one bank is offset by money from other transactions coming into other customer accounts. At the end of the day, settlement occurs: the net differences between the banks are settled up and zeroed by adjusting their balances with the central bank.
The Lightning Network does something similar, with the Bitcoin blockchain acting as the central bank for settlement. Many, many transactions can take place within LN’s payment channels, and ultimately be secured on Bitcoin’s blockchain with a single transaction.
You can read more about how Lightning Network works here, but it is based on two-party ledger entries on the Bitcoin blockchain called ‘bidirectional payment channels’. Both users need to agree when funds are spent. Each party creates but does not broadcast entries to the ledger, updating previous entries to reflect the desired balance.
They can update their individual allocations for the ledger entry by creating many transactions spending from the current ledger entry output. Only the most recent version is valid, which is enforced by blockchain-parsable smart-contract scripting. This entry can be closed out at any time by either party without any trust or custodianship by broadcasting the most recent version to the blockchain.
LN can therefore support very high volumes of instant, low-cost transactions – effectively solving Bitcoin’s scaling problem. This powerful functionality has made the Lightning Network extremely successful and popular, and it has grown rapidly in a short time.