What is the Lightning Network? Why is it being talked about so much? Here’s a brief intro to this new development in the Bitcoin ecosystem and how you can use it to your advantage.
Bitcoin’s blockchain and the tokens exchanged via this chain, Bitcoins themselves, are what we call the first layer of this cryptocurrency. The blockchain and the mining guarantee the integrity of the Bitcoin network.
What if we could go beyond the simple exchange of coins using the Bitcoin blockchain? What if second layer applications could be built on top of the first layer, adding functionality to the system?
That’s exactly what the Lightning Network (LN for short) is: one of the first applications built on top of the Bitcoin blockchain! The Lightning Network is actually just a group of Bitcoin users who’ve opened transactions between themselves. Two people agree on opening a transaction between them, just as if they were sending each other some funds. But this transaction simply stakes a certain amount of Bitcoin between 2 people and does nothing else. This is called a “channel” and the amount of Bitcoin staked between these 2 parties is the amount that can be transacted in that channel at any given time. The transaction speed depends only on the speed with which signals can be sent between these 2 parties, which at today’s broadband rates are more than enough to guarantee hundreds of transactions per second, tens of times more than the raw Bitcoin protocol.
As you can see, the success of the Lightning Network depends on enough nodes adhering to the network. If there’s a path between any two given people through the Lightning Network, then the network becomes able to handle most Bitcoin transactions. Since transactions going through these channels do not get recorded on the blockchain, but only the opening of the channel does, the blockchain is spared all this traffic and fees collapse. This is how LN has been able to lower fees for Bitcoin transactions: by tilting the supply and demand curve towards lower fees. Miners must choose transactions with any fees instead of only the higher ones.
There’s one disadvantage we’ve just mentioned: miners make less and may drive hash power to other cryptocurrencies. This is an expected effect of lower fees and is actually healthy for the Bitcoin ecosystem. A balance will be found between mining interests and user interests in lower fees. Lower feeds guarantee higher transaction volumes and wider adoption of Bitcoin, which in turn will increase the amount of transactions and consequently increase profits for miners. It is an informal consensus that wider adoption with lower fees is better for Bitcoin in the long run than fewer transactions with lower fees.
Here’s a great LN Q&A by Bitcoin expert Andreas Antonopoulos:
Some of the criticism of Lightning Network includes the argument that it is a centralizing tech. (Antonopoulos addresses this and several other points on the above video – definitely worth watching.) In fact, millions of Bitcoin transactions already happen off the blockchain. For instance when a robot executes hundreds of buy and sell orders in a centralized exchange like Bitfinex or Bittrex, those transactions happen on a private channel inside the exchange and never reach the blockchain until a withdrawal is made. In a way, these transactions that happen within the exchanges are analog to the transactions that happen between peers in the Lightning Network. The transactions within the channel happen in a private manner and do not get recorded on the public blockchain. In essence we already use private channels whenever we trade cryptocurrencies on centralized exchanges.
We hope this brief intro to Lightning Network has given you a better idea of how this technology works and how creative applications can be built on top of the first layer Bitcoin blockchain. LN is just the first such 2nd layer application to reach mass adoption and in the near future we will probably see many innovative ideas gain popularity, perhaps leveraging 2nd layer solutions to create even richer abstractions forming the 3rd or 4th layers of Bitcoin. LN proved that a dynamic network of peers can collaborate through the existing Bitcoin network. How popular it’ll become and how widespread its adoption will be, as with everything else related to Bitcoin, depends on the community.