Bitcoin is great in many ways. It’s border-less and decentralized. It provides an efficient way to transfer money anywhere in the world without the need for banks. It puts you in charge of your money.
However, despite all these plus points bitcoin does have certain drawbacks.
Transaction speeds can be slow. On average only 7 transactions are processed every second. Compare this to Visa which can process over 65000 transactions per second and you realize just how slow bitcoin transactions are.
Transaction fees can be high. Blocks on the network can only contain 1MB of information. If there are a lot of transactions, miners will process the ones with the highest fees first. If you haven’t paid a high enough fee your transaction could be left waiting for days.
These issues mean that it’s difficult to use bitcoins for micro-payments. Micro-payments are everyday payments such as buying groceries or gas. Using bitcoin to buy your cup of coffee is just not feasible at the moment. You could end up waiting ages until your transaction is confirmed. Your coffee will be cold and the transaction fee may be higher than the price of the coffee!
Lightning Network offers a solution to these problems.
What is Lightning Network
Lightning Network is a second layer solution built on top of the Bitcoin blockchain. If the blockchain is the first layer, Lightning Network is the second layer. Lightning Network enables users to send transactions within payment channels that work outside the bitcoin blockchain.
This makes the transactions super quick and much cheaper.
The Benefits of Lightning
Bitcoin does have problems with scalability. The more transactions there are, the slower the network becomes.
Back when bitcoin started out there were few transactions usually carried out by passionate enthusiasts. However, bitcoin use has been steadily increasing over the years and at the time of writing, there are roughly 281,727 transactions every 24 hours.
As bitcoin adoption becomes more widespread the number of transactions taking place daily will surge. If the network struggles to cope with an increase in transactions, fees will increase and transactions may not be confirmed for days.
Lightning has the potential to solve these scalability issues by enabling multiple transactions to take place off the main blockchain.
Low Transaction Fees
Bitcoin fees can be very variable and at times can be extremely high. With Lightning, transaction fees are minimal. This means you can carry out small transactions, even as small as one Satoshi! A Satoshi is the smallest unit of bitcoin, it is one hundred millionth of a single bitcoin (0.00000001 BTC)
Lightning Network promises fast transaction times. Transactions could be settled in seconds or even instantaneously. If Lightning achieves mass adoption it could provide stiff competition to Visa and Mastercard.
The Downside of Lightning
Ease of Use
Bitcoin is not the easiest system for beginners to handle. Lost passphrases, lost passwords, confusing fees and complex addresses are just some of the difficulties faced by new users. Smartphone wallets have made great strides in helping beginners transact with bitcoin. But there are few smartphone apps available to help make lightning easy to use.
There are some concerns that well funded nodes with lots of payment channels may become very powerful. These nodes could potentially monopolize the network and cause the system to become more centralized. The complete opposite of what Bitcoin is all about.
New research has shown that Lightning Network may have privacy issues. Researchers probed the channels of the network by sending different sized payments. They were able to find the balance held within the channel fairly easily and with no expense incurred.
How Does Lightning Work
Alice and Bob want to send bitcoins to each other. They open a payment channel and deposit bitcoins. This initial transaction is broadcast to the Bitcoin blockchain. Within this channel, they can transfer bitcoins as many times as they want. The transactions are basically a redistribution of the bitcoins within the channel.
When either Alice or Bob want to leave the channel their last transaction is broadcast to the bitcoin blockchain. Alice and Bob could have made limitless transactions within this channel but only 2 transactions are sent to the blockchain.
What if Bob tries to back out of the payment channel without honoring the transactions?
If Bob decides to cheat, his initial deposit gets sent to Alice. This harsh penalty acts as a deterrent against fraud.
The Network Effect
The above example only describes transactions between two parties. What happens if you want to send payment to someone but you don’t want to open a channel with them? This is where the Network effect comes into play.
Alice would like to buy coffee from a coffee shop using bitcoins. Unfortunately, she doesn’t have a payment channel set up with the new coffee shop she wants to try out.
Using Lightning Network Alice can transfer bitcoins by jumping through other interconnected payment channels. The only requirement is that the payment channels must have enough bitcoins in them to cover her transaction and the other transactions routing through.
This Network effect makes it possible to send micro-payments throughout the world quickly and cheaply.
This is a very general overview of Lightning just to give you an idea of its potential. In reality, it is a lot more complex than the way it has been described here. Having said that Lightning Network does have the potential to shake up the existing financial system. It enables money to be sent anywhere in the world without using banks or third parties. It could provide an opportunity for the world’s 1.7 billion unbanked to access financial services.
Lightning Network could also be the catalyst that triggers mass adoption of bitcoin and cryptocurrency. If payments can be made almost instantly, worldwide and without high fees the argument for using cryptocurrency is extremely compelling.
Lightning Network still has a way to go before it is rolled out completely. At the moment it is still in testing and its adoption has been slow.
However, I am interested in tracking its progress and look forward to seeing its effect on the crypto community.