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Bitcoin Lightning Network ~ Part 1

This story is written by our Web3 VC cohort.

Source: Coindesk

What is the lightning network?

The Lightning Network (‘LN’) is a layer-2 protocol built on top of the Bitcoin blockchain. It is designed to facilitate microscopic Bitcoin transactions, which would ordinarily be too inefficient to process on the Bitcoin blockchain due to high gas fees, lack of node validator incentive, and network congestion. It is like a Bitcoin credit card network enabling high-speed, high-volume payments with low fees. To put it into scale, the LN has the theoretical capacity of processing 1 million transactions per second (‘TPS’), compared with the Bitcoin blockchain’s 7 TPS and Visa’s TPS in the tens of thousands.

The concept of the Lightning Network was initially proposed by Thaddeus Dryja and Joseph Poon in February 2015 as a solution to Bitcoin’s scalability problems. In 2016, Dryja and Poon founded the Lightning Labs, a company dedicated to advancing the Lightning Network.

Why is it needed?

At its core, Bitcoin is a system that keeps evidence of all transactions on a worldwide replicated public ledger. Every partaking computer (node) is able to see, validate and store each transaction as long as it meets the storage, process, and bandwidth requirements.

Bitcoin mining diagram. Source: https://dyn.am/bitcoin/

Maintaining the network secure involves a high use of electricity due to the fact that miners need to run the Bitcoin software on an individual computer and connect to other computers that run the same software. This software calculates “hashes” which help solve a mathematical puzzle. This process helps verify transactions, reward miners for their work and bundle the transactions in blocks of data. The whole process is also called “Proof of work” and can be used as a way to reach a consensus between network participants.

The energy needed to maintain the Bitcoin network has been compared over the years with the energy consumption of entire smaller countries. Some people view this as wasteful while others see it as necessary for the safety of a potential global payment network.

The increased popularity of Bitcoin and particularly the demand for transactions have put the network under congestion pressure, creating queues for transactions once the block size limit has been hit. Since many users are willing to pay a higher fee for validators to prioritise their transaction in the next block, some transactions with lower fees may hang around a long time before receiving confirmation.

In high demand periods for the network, this contest for fees may cause some smaller-value transactions to become uneconomical seeing as the cost of transacting may surpass the value transacted.

To realise the vision of Satoshi Nakamoto about Bitcoin becoming a “peer-to-peer electronic cash system” that can be used as a viable global currency, one of the functions Bitcoin has to accomplish is becoming a medium of exchange. To do that, one of the requirements is to scale up and accommodate more transaction throughput. Currently, although the Bitcoin infrastructure arguably offers a higher degree of decentralisation and security, it cannot rival the performance of traditional infrastructure built by major banks and credit card companies.

Since July 2015, with the inception of Ethereum, Bitcoin has gained competition within the Blockchain industry. Ethereum’s proposition involves smart contract capability but also a higher degree of scalability allowing around 20 transactions per second (TPS) as opposed to approximately 6 TPS for Bitcoin. Given the upcoming on-chain scaling solution (sharding) and “Layer 2” scaling solutions (optimistic and zero-knowledge rollups, sidechains or plasma), Ethereum is heavily trying to improve the performance of the network.

Apart from Ethereum, Bitcoin is facing competition from a multitude of cryptocurrencies (Cosmos, Solana, Ripple, etc.) that allow for a higher degree of scalability. Therefore, to maintain its market position Bitcoin has to come up with solutions.

To increase the adoption of Bitcoin, one important aspect is to attract small and medium-sized enterprises to use the network. One way to do it is by offering lower fees for transacting than what they pay at the moment and faster transaction finality.

One of the solutions to this problem could be an increase of the block size limit, adding space for more transactions and implicitly lowering the transaction fees. Increasing the block size will have an impact on the cost to run a node since operators will need greater bandwidth, processing, and storage capabilities. Having an increased cost for running a node may decrease the number of operators, especially since node operators are not compensated for their participation. Ultimately, this situation can have the detrimental effect of centralising the system by allowing only a small number of better-financed node operators to participate.

According to (Poon & Dryja, 2015) for Bitcoin to achieve the performance level of Visa (around 47,000 TPS) it would require blocks of 8 GB size (from around 1–2 MB currently). Considering that at the time of this writing (02.08.2022) there are about 747,000 blocks in the Bitcoin blockchain, running a full node will require around 6 Petabyte storage. Therefore, validating the state of the ledger will only be accessible to a few node operators.

Another possible solution to the problem described above has been introduced by Joseph Poon and Thaddeus Dryja with the publication of “ The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments”.

Although LN has the potential of easing up the traffic on the Bitcoin network, it does not have a direct impact on improving the environmental impact of the network.

Meet the cohort authors

Ellen Tang

Ellen has extensive experience in the traditional finance space, ranging across Portfolio Management, Trading, Compliance, Audit, and Risk business areas. She has been taking an interest and investing in various blockchain projects since 2017. Ellen also runs a Personal Development Coaching practice and posts investment-related videos on my YouTube channel Investing With Ellen.

Alexandru-Iulian Iurea

Recent graduate in Computing Technologies with a strong interest in Blockchain technology. Alexandru’s journey in this space dates back to the end of 2017 when he discovered what he considers to be 3 of the most important values of any system, decentralisation, security and performance, being combined to generate enhanced solutions.

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