Bitcoin Revolution through the Lightning Network
Bitcoin Insights #5
This issue is about Lightning ⚡️, a second layer solution for Bitcoin that solves the scaling problem, reduces transaction costs and improves privacy.
Bitcoin block size and number of transactions
Bitcoin is often accused of being too slow and too expensive. This is due to the fact that a new block of transactions is finalized on schedule every 10 minutes, with the block size traditionally limited to 1 MB. Since the introduction of SegWit (Segregated Witness) on 24 August 2017, the maximum has been 4 MB, with the largest block to date reaching 3.96 MB. The number of transactions per block varies depending on the size of the individual transactions, which is determined by the number of inputs and outputs. The average size of a transaction is 250 bytes. Between 1,980 and 4,200 transactions are usually recorded per block, resulting in an average transaction rate of 3.3 to 7 transactions per second (TPS). Since SegWit, the transaction rate has been closer to 7 TPS. By comparison, Visa processes around 1,700 to 2,000 TPS, with a maximum capacity of over 65,000 TPS.
Bitcoin transaction costs
Due to the limited block size and the resulting low number of transactions per block, the cost of Bitcoin transactions can be comparatively high, especially when network utilization is high. The fees that miners receive can be set individually for each transaction. Higher fees increase the likelihood that miners will preferentially include the transaction in the block. So if you want your transaction to be included in the next block, you should pay a higher fee in times of high network utilization. For example, on April 20, 2024, the average transaction fee reached $91.89, an increase of 2,645% compared to the previous month. After the Bitcoin halving, fees briefly rose to over $240 per transaction. The highest single case known to date was a transaction fee of $3.1 million for a single transaction in November 2023, but this is considered a mistake. Historically, average transaction fees have mostly been between $0.50 and $2.50, often even below $0.50.
Lightning as a layer 2 solution
To solve Bitcoin’s “scaling problem”, the Lightning Network (LN) can provide a remedy as a layer 2 solution. The philosophy that creates the LN was as old as Bitcoin itself. In fact, Satoshi Nakamoto designed the code for what eventually paved the way to move bitcoin between the LN and the Bitcoin blockchain.
The concept of the Lightning Network was first proposed in 2015 and finally implemented in 2018. This is a secondary layer that builds on top of the primary Bitcoin blockchain (layer 1) and carries out transactions outside the blockchain. This relieves the main Bitcoin network. Payment channels between participants are used, whereby transactions are carried out off-chain and only the final state is written to the blockchain. This enables almost instant transactions at significantly reduced fees and increases the scalability of the Bitcoin network, which also allows microtransactions. Theoretically, the LN can process millions of transactions per second.
Analogy between going to a restaurant and Lightning
An example to illustrate this: you go to a restaurant and order drinks, food and dessert one by one. These individual orders are noted down but not yet paid for — these are effectively Lightning payments. Only at the end of the restaurant visit does the bill arrive and payment is made — this corresponds to the settlement of all Lightning transactions on the blockchain.
Lightning adoption
To look at the adoption of Lightning, you can look at the number of payment channels. There are currently over 50,000 channels operated by around 13,000 Lightning nodes. In August 2023, an estimated 6.6 million transactions were processed via the Lightning network, an increase of 1,212% compared to August 2021. The publicly routed transaction volume amounted to around USD 78.2 million in August 2023.
The network capacity currently stands at around 5,150 BTC or 290 million US dollars. It is estimated that between 279,000 and one million wallets actively use the Lightning Network.
Privacy and anonymity in the Lightning Network
Due to its architecture, the Lightning Network offers a higher level of privacy than the Bitcoin network. It uses onion routing, where each node only knows the previous and next node, which increases the anonymity of transactions. Users can open private channels whose details are not publicly known. Around 30% of the channels in the Lightning Network are private. The capacity of a channel is public, but the exact balances of the individual parties within the channel are only known to these parties.
There is also the option of anonymity. With route-based anonymity, no intermediate station knows the complete route or the identity of the sender and receiver. In addition, there are so-called off-path payments: observers who are not directly involved in a transaction cannot find out any details about transactions that take place via channels in which they are not involved.
Lightning — the perfect solution?
The Lightning Network has established itself as an effective solution for scaling Bitcoin transactions, with a growing number of channels and nodes as well as an increasing user base. It offers significant advantages in terms of transaction speed and cost. At the same time, it offers a high degree of privacy and anonymity through techniques such as onion routing and private channels, although some information such as channel capacity is public.
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Philipp J.A. Hartmannsgruber holds a master’s degree in Finance & Accounting. He is a Board Member of the Blockchain Bundesverband (Bundesblock). In 2019 he founded PJAH Consulting, a bitcoin-consultancy.
