Bitcoin and other cryptocurrencies will pave the way for the future of the payments industry, according to those in the know. The lightning network is one such crypto technological advancement, with the central goal to speed up crypto transactions.
The idea of a revolution sweeping a well-established sector which has long taken its customers for granted is appealing to many. But if you navigate the forums of crypto enthusiasts online, you’ll hear about the growing pains of the crypto-inspired rebellion. Cryptos are supposed to be a faster way to transfer money, unencumbered by the usual lethargic banking networks.
But, during particularly busy times, some blockchains have been incredibly slow, taking several hours and sometimes days to process certain transactions, which also have costly fees attached.
Those waiting times and extra fees are in line with the traditional bank transfers this community so loathes, and that’s precisely the motivation behind the creation of the lightning network. In this article, we’ll define what the lightning network is and consider its benefits, as well as analyse how it works.
Lightning network definition
In a 2015 white paper, Joseph Poon and Thaddeus Dryja presented their lightning network idea as the solution to optimise the speed of transactions on Bitcoin’s blockchain as well as decrease their costs. The main idea is that this network will sit on top of the blockchain and will settle payments between users with private channels without registering them on the primary ledger.
So, for example, imagine I want to send you one Bitcoin (BTC). I carry out that payment, which is added to the main blockchain in a block made up of several other transactions. Each block is like a blank spreadsheet that can only take a certain number of operations.
If I send you that Bitcoin during a busy period, and I’m aware of it, I can set a high transaction fee. With a high transaction fee, my operation has a better chance of being part of the next block because it will provide a better reward to the miners validating the data.
However, other people might also be aware of this and pay even higher transaction fees to have their transactions processed swiftly. Roughly speaking, this is how bottlenecks in transaction processing arise in cryptocurrencies. In the long run, this isn’t an efficient way to operate in the payments industry.
The lightning network is an off-chain network that allows users to set up private channels between themselves to record their transactions, which will only become part of the blockchain once the channel is closed and the final balance settled. Its underlying idea is that not all transactions need to be recorded on the blockchain.
How does it work
Let’s consider an example. Let’s imagine you and I have a series of payments among us coming and we’ve been selected to test the lightning network. The first step is to open our payment channel, recording it on the blockchain. It can remain open for as long as we like and we’ll only have to alter the blockchain when we close it.
The channel is like a deposit box to which we’ll both add one Bitcoin. This opening transaction sets the box, which is like a special safe recorded on the main blockchain, and only our joint permission allows for funds to be moved.
If I need to send you 0.5 BTC, we’ll both agree that out of the 2 BTC in the deposit, 1.5 BTC is now yours, and only 0.5 BTC belongs to me. This process can go on with several other operations, and in each, we transfer ownership rights of the 2 BTC to one another so that it reflects the total balance of transactions among us.
We can conduct as many transactions as we like using this network and only the final balance will be recorded on the public ledger used by everyone else. Since we’ll only have two touch points with the main blockchain, transfer between us will be lightning fast.
This idea is also applicable to link users that otherwise would not be connected, by chaining different private channels to form as many lightning-fast payment lanes across the network as possible.
The rise of the lightning network
The lightning network has the potential to supercharge the cryptocurrency industry, and eradicate any doubts regarding its supremacy over traditional banking. With effective microtransactions and no more latency and scalability issues, cryptos will lead the payments industry.
In March 2018, the Stellar CTO Jed McCaleb announced that the Stellar Network would be implementing a protocol inspired by the lightning network, and around the same time the concept was endorsed by mobile payment entrepreneur Jack Dorsey. The lightning network then went live in April 2018, and up to August 2018, it had a monthly growth rate of about 15%.
By the end of November 2018, the lightning network hit 450 BTC network capacity – a remarkable 300% growth rate for the network that only reached 125 BTC capacity on November 14th, 2018.
450 BTC represents more than $1.6 million of transaction throughput, that is now possible across a network of more than 4,200 nodes. Transactions up to the capacity can be instantly confirmed across the network, for fees as low as one Satoshi.
As it stands today, the lightning network is one of the biggest deployments of a multi-party smart contract in the world, and it’s certainly achieving it’s goal of revolutionising the payments industry.
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Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.