The Lightning Network by Tyler Kurtz
Bitcoin has become very popular over the past decade as a method to exchange money, but also to benefit from the volatility of the coin’s price. In recent years the Lightning Network was created as a more efficient way for users to exchange money on a smaller scale with anyone in the world in a matter of seconds. In order for the network to become more useful in the future, it would be vital for people to gain a better understanding of how bitcoin works, the potential benefits, and its risks. Below we answered a few different questions to help better portray what the Lightning Network actually is and how it has the potential to revolutionize the way we all exchange money.
- What is the Lightning Network?
The Lightning Network is essentially a second layer above the Bitcoin blockchain that allows individuals to establish payment channels between one another and can occur away from the main blockchain, all while benefiting from the blockchain’s security and decentralization. The network was originally created for smaller and every day transactions between two parties with no third party involvement, along with the purpose of making transactions much faster and cheaper to be more accessible to the public. In layer 1 of the Bitcoin blockchain there can only be about 3-7 transactions per second that can run through at a time, prohibiting an immediate transfer of money between people whereas the Lightning Network can handle millions of transactions per second. With the network, anyone in the world can transfer money to someone else within just seconds in the form of SAT’s (Satoshi’s) which represents one hundred millionths of a Bitcoin. The median transaction fee while using the Lightning Network is about 1 Satoshi.
- How does it work?
The Lightning Network operates by individuals inputting any amount of Bitcoin into what is called a multi-signature address. This address creates a payment channel between the two parties exchanging money. After the payment channel is established between the two, a third party who already has a payment channel with one of them, can use the existing channel to pay the first party. In a hypothetical situation, if there are four people who are all connected by their own payment channel, the first person can only pay the fourth person an amount that is lower or the same as the amount each individual has locked up in their payment channels. When the first person transfers $100 worth of Bitcoin to the fourth, the second and third person will first receive that money and then transfer their own to the next person, almost like a chain reaction that happens within seconds. After a transaction between the two parties occurs, an updated smart contract or a balance sheet of the transaction is created, which represents the receipt for the transaction. The Lightning Network essentially helps to decongest the network by initiating off channel or side chain transactions. Some of the apps you can use to move Bitcoin into the Lightning Network include, Cash App, Blue Wallet, Muun Wallet, Wallet of Satoshi, and Breez, which is typically for more advanced users who prefer to set up their own non-custodial wallet.
- What are the advantages and disadvantages of the network?
Some of the advantages of using the Lightning Network over the original Bitcoin blockchain in layer 1 is the overall speed of the transaction. As mentioned above, the layer 1 blockchain has a capacity of running only 3-7 transactions per second whereas the Lightning Network has the ability to process millions of transactions per second. Along with the speed of each transaction, instead of paying increased transaction fees, the Lightning Network has minimized its average fee to about 1 Satoshi which is less than a penny. Some of the other benefits to the network is that it enables micropayments, increases user anonymity, reduces the overall data in the blockchain, the payment channel between two parties can remain open indefinitely or until closed, and finally, there is no third party that controls people’s funds during any transaction. Some of the disadvantages to the Lightning Network are the potential security risk with offline transactions not being supported, the inability to always perform larger transactions because individuals do not have enough Bitcoin locked up in their payment channel for others to use, and also Bitcoins extreme volatility. The Lightning Network is also very reliant upon the other peer because the payee needs to sign the recovery transaction before receiving the payment, and the reduction in fees have been damaging to the sustainability of Bitcoin’s network.
- How can it be used today and speculate on how it could be used in the future?
Using the Lightning Network today can be scary for many people due to the lack of knowledge behind Bitcoin and how the layer 2 concept actually works. However, it is possible that once people and businesses recognize the rapid speed of each transaction and that more money can be saved for both parties that the Lightning Network can be very beneficial. When compared to Visa, they charge about a 2.5 to 3% fee per transaction to businesses whereas the Lightning Network transaction fee is close to zero. As a result, it has been found that some vendors are offering their products at a cheaper price than usual because by using the Lightning Network, neither party has to pay for any overhead of the legacy financial system. Specifically some companies charge an extra 10 to 20% in fees to account for the fraud on the legacy financial system which can be prevented when completing transactions through the Lightning Network. Some companies like Shopify, which is already partnered with tens of thousands of stores, recently partnered with Strike which is an online wallet where anyone can deposit or withdraw money from the Lightning Network for free. This gives stores all over the ability to accept someone’s bitcoin and transfer it into their own currency. Moving forward into the future, more stores will begin using the Lightning Network as a form of payment as it becomes more popular.