What is Lightning Network?

Photo by Mariano Carpentier on Unsplash

Lightning network, as suggested by its name, is designed to make payment fast and also cheap. In Q4 2017, Bitcoin network faced serious network congestions as it gained popularity amongst investors. Transaction fee on the Bitcoin network went up to over US$40 at its peak with more than 200k unconfirmed transactions on the network, bringing the scalability issue into light.

The Lightning Network is meant to be a solution for the scalability and transaction fee issue. It is invented by Joseph Poon and Thaddeus Dryja. Joesph is also the co-author of Plasma, a scalability solution for Ethereum.

How does Lightning Network Work?

To put simply, lightning network is a system that allows people to take some transactions offchain, thereby reducing the loading of the main network. As the main network is not as congested, the transaction fee would come down.

1. In order to perform transactions offchain, the transacting parties will first need to open a payment channel between them.
2. Since transactions on lightning network happens offchain, in order to ensure enforceability and authenticity (that the transacting party actually has the amount of bitcoin for the transaction), the two parties (at least one of the two parties) first need to lock away certain amount of bitcoin in a multi-signature wallet.
3. The wallet address is logged onto the public Bitcoin blockchain. It shows the amount of bitcoin deposits in the wallet and who these bitcoin belong to.
4. Now the payment channel has been setup. The two parties would keep a balance sheet and start transacting with each other. These transactions are updated on the balance sheet of the two parties which is mutually signed by both of them
5. These transactions in the payment channel are kept offchain, i.e. the balance sheet is not verified by the blockchain mainnet. The two parties transact with each other based on the amount locked away. Since these transactions are not verified by the mainnet, they can be processed fast.
6. Either party could close the payment channel at any point. When the payment channel is closed, the latest balance sheet will be enforced on the mainnet and the transacting parties will receive their respective balance.

A Further Analysis

The above procedures show how two parties could transact on lightning network. One may ask a legitimate question — if a payment channel needs to be opened for every new party one intends to transact with, wouldn’t it be very cumbersome?

In fact, the beauty of the lightning network is that you do not need to establish a direct payment channel with every person. Let’s say you have a payment channel with Jack, and Jack has a payment channel with AA flower shop, you don’t need to setup a payment channel with AA flower shop to buy flower from them. In other words, everyone on the lightning network could transact with each other via only a few indirect intermediaries.

Lightning network allows instant payments and mirco-payments which were not possible on the Bitcoin mainnet. Since transactions done on the Lightning network is offchain and is tracked only by the balance sheet, it also improves the privacy of transactions.

At the point of writing, lightning network is in testing stage. However it has already gained a lot of positive reviews. If it could be successfully implemented, it will definitely improve Bitcoin’s functionality as a payment currency substantially.

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