What is the Lightning Network? — AAX Academy
Can you pay for coffee using Bitcoin yet? For some people, this is the ultimate sign of adoption — it tells people, Bitcoin is money.
Of course, this is just one perspective.
Some would say, Bitcoin is a store of value and apart from larger transactions, it is not really meant to be spent directly. Holders who want to spend their Bitcoin are better off exchanging it for some stablecoin and using that. But there is another way of thinking about it.
In our previous article, we wrote about ‘ sovereign money ‘ and the role Central Banks play in managing the money supply. Bitcoin is kind of like the Central Banks: money between them doesn’t move very fast and often only in bulk. On top of this layer, we see another layer of commercial banks, and on top of this one, we see even faster payment layers such as VISA and MasterCard.
In the crypto-world, Bitcoin is seen as a first layer. On top of this, a range of second-layer solutions can be built to make micro-payments more feasible.
So how does the Lightning Network work?
The Lightning Network is essentially a network of decentralised nodes that allows for sending a huge number of transactions extremely fast and for a negligible fee (even sub-satoshi level). First proposed by Thaddeus Dryja and Joseph Poon in 2015, the network was designed to solve one of the biggest problems that cryptocurrencies face, scalability.
Specifically, the network allows users to set up their own payment channels. This means that thousands of small and medium-sized transactions can take place, away from the main blockchain. Payment channels basically function like a tab. You can pay for things, and after an agreed period of time, the bill will be settled on the blockchain.
Currently, the Bitcoin network can process, on average, between 3 and 7 transactions per second (tps). If Bitcoin wants to become a viable means of payment it has to start competing with already existing solutions. One of them is, of course, VISA which processes around 4000 tps and can handle spikes up to 65 000 tps quite easily. The good news is that the Lightning Network can potentially scale to millions of tps and dramatically increase the transaction speed. That is exactly why the technology started attracting a lot of attention.
Do we really want to pay for things with Bitcoin?
As Bitcoin rises in value, it becomes clear what the real difference is between inflationary and dis-inflationary/ deflationary assets.
‘Fiat money’ like the US dollar loses value over time. This means keeping it in a bank account, over the long term, is a bad idea. Up until a few years ago, banks would pay out interests to incentivize users to hold on their dollars, but as we all know: interest rates are dead.
What this means is that apart from emergency savings, holders of fiat money will want to get rid of their excess funds, either by investing their money in the stock market, real estate or crypto, or by spending it and buying that next ‘hot thing’ — and indeed, some would argue this is what makes fiat money good for the economy.
Bitcoin, however, generally appreciates in value. There is only a limited supply and as more people buy Bitcoin and place more and more of their wealth on the Network, the price is expected to keep rising.
This type of money incentivizes holders to keep holding — why spend your Bitcoin on a coffee, when the next day, for the same amount, you could get two coffee; or when five years later, you can buy a house? Proponents of this school of thought, prefer borrowing fiat against their Bitcoin.
But even if, perhaps, users of Bitcoin will be reluctant to spend it, the Lightning Network is still worth developing.
The beauty of the Lightning Network is that it can not only provide a better alternative to already existing payment systems, but also facilitate the creation of the completely new types of applications.
Have you ever realised you kept paying a subscription fee, even though you barely used a service? What if the service instead of a monthly fee was charging you by a minute or maybe even by a second? This type of business is currently not a viable option due to high fees for processing card transactions. How about receiving your salary every hour (or even every minute) instead of once or twice per month. This is where the Time Value of Money comes to play.
With the Lightning Network micropayments become a new possibility. This opens the world to a new concept of ‘streaming money’, a new way of transacting that was hard to imagine before.
Originally published at https://academy.aaxpro.com on March 22, 2021.
