May 8, 2024

Lightning Network: Bitcoin's Scalability Solution

Lightning Network: Faster, cheaper Bitcoin transactions. Learn how it solves scalability

Lightning Network: Bitcoin's Scalability Solution

What Is The Lightning Network And Why Does It Matter?

Conceived in 2015 and finally launched in 2017, the Lightning network is a game-changer in the advancement of Bitcoin and addressing its scalability challenges.

As revolutionary as the Bitcoin network is, it’s not without its limitations. It may boast unbelievably robust security and live up to its promise of true decentralization, but these perks come at a price: scalability.

Enter the Lightning network.

What is the Lightning Network and How Does It Solve Bitcoin's Scalability Problem?

Bitcoin cannot handle more than a few transactions per second, making it unsuitable for use as a payment system, since thousands of digital and point-of-sale transactions take place around the world every moment.

Bitcoin’s inability to scale to this many transactions per second is due to something called “The Blockchain Trilemma,” where only two of three characteristics can be maintained on a network. The Lightning Network provides a solution to the scalability issue without compromising Bitcoin's decentralization or security:

  • Decentralization - How many points of failure there are in the network.
  • Security - How resistant the network is to attack.
  • Scalability - How many transactions the network can handle within a given period.

Satoshi Nakamoto prioritized the first two, which made Bitcoin inherently weak when it comes to scalability.

Conceived in 2015 and finally launched in 2017, the Lightning network is a game-changer in the advancement of Bitcoin. It solves what may have been the final hurdle in making bitcoin a viable currency.

Known as a “layer-2 solution” because it is built on top of the Bitcoin main network, the Lightning network allows for orders of magnitude more transactions per second by taking them off the main network and only settling whenever a channel closes.

How Does Lightning Work?

The Lightning network functions by opening payment channels between participants, using smart contracts to facilitate payments without the need for a trusted third party.Smart contracts operate like vending machines: An input will automatically produce an output, without a third party needing to oversee the process. On Lightning, the smart contracts hold funds of bitcoin, which each participant puts up in advance.

Routing Payments: How Lightning Finds a Path

Participants can transact back and forth, with only the Lightning balances being updated. Not only this, but the Lightning network also allows transactions between participants with mutual connections.

These chains can stretch indefinitely, allowing people to transact with participants distantly connected by potentially infinite people.

For example, suppose Tim has a connection with Lisa, and Lisa has a connection with Chris. In that case, Tim and Chris can transact with each other despite not opening up a separate channel.

The final results of the transactions are then finalized on the Bitcoin network when the payment channels are closed. In this way, transactions can occur almost instantly, without waiting for blocks to be mined on the Bitcoin network, and without the accompanying fees.

Lightning Network Payment Channel

Let's break down how a Lightning Network payment channel works with a simple example:

Participants : Two parties who want to transact frequently (e.g., Alice and Bob)

Funding Transaction : Alice and Bob lock a certain amount of Bitcoin into a multi-signature wallet on the Bitcoin blockchain.

Off-Chain Transactions : Alice and Bob can make numerous transactions between themselves, updating the balance within the channel without broadcasting each transaction to the main Bitcoin network.

Channel Closure : When Alice and Bob decide to close the channel, the final balance is recorded in a transaction on the Bitcoin blockchain.

Why Does It Matter?

For Bitcoin to become a globally used financial network, with bitcoin becoming the globally adopted currency, it needs to be able to handle a truly significant number of transactions every single second.

The reason that you’re able to buy something with your debit or credit card almost instantly isn’t because the transaction is actually being confirmed that quickly. Instead, a trusted third party (your bank) is telling the vendor that you have enough money, and the bank will oversee the transfer of funds later.

Near-Instant Bitcoin Payments

If bitcoin is to achieve global adoption as a medium of exchange, the Bitcoin network needs to be able to confirm transactions just as quickly as traditional methods while maintaining its commitment to avoiding the need for trusted third parties.

Without a layer-2 solution, it doesn’t come close to the necessary throughput. Lightning dramatically reduces the congestion on the Bitcoin network by moving transactions onto the second layer, reducing fees for users and increasing speed to the levels needed for daily transactions.

Because transactions are only recorded on the main network when the Lightning payment channel is closed, Bitcoin becomes a settlement layer, operating more akin to institutions such as Fedwire, which don’t handle day-to-day payments but settle the net outcomes.

With Lighting, Bitcoin becomes a viable financial network in a way it never could on its own, facilitating Bitcoinization around the globe.

In Conclusion

The Lightning network is the final piece of the puzzle for the Bitcoin network, allowing it to maintain its commitment to decentralization and security while making it scalable to the number of daily transactions around the world.

Since the final settlement is recorded on the main network, users still benefit from the security and decentralization afforded by Bitcoin.

By taking transactions off the main network and handling them on a separate layer, Lightning substantially increases the number of transactions that can be handled within a given time period.

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