Bitcoin Lightning Network

12 years ago, Satoshi Nakamoto launched the Bitcoin Network which laid the foundation for other cryptocurrencies to exist in the space. Although Bitcoin was revolutionary for its time, it was far from perfect and was plagued by the problem of scaling. Bitcoin was designed to handle only 7 transactions per second and as the network grew in size, it was apparent that it would be difficult to sustain the trend.

As an answer to Bitcoin’s flaws, the Lightning Network was designed to offer an improvement to the speed of transactions. In addition to flipping the script for speed, the Lightning Network takes impressive steps at improving privacy and anonymity for users. Since its launch, it has grown by leaps and bounds, reaching several milestones in a short span of time. 

Widely considered as Bitcoin’s best bet in competing with a rapidly changing cryptocurrency landscape, the Bitcoin Lightning Network still has some factors militating against it.

What is The Bitcoin Lightning Network?

In technical terms, the Bitcoin Lightning Network can be described as a second layer protocol that is built on top of the Bitcoin blockchain to allow users to transfer BTC through their digital wallets. It is a peer-to-peer mechanism for facilitating payments through bidirectional payment channels without the need to delegate custody of funds.

In other words, the Lightning Network is like having a direct channel between two parties that allows them to carry out transactions between them without the need to record every single transaction on the blockchain. 

This provides the parties with an almost instantaneous transaction and reduces the amount that is payable as fees to the barest minimum.

History of The Bitcoin Lightning Network

Barely 6 years after Bitcoin launched, the problem of scalability could no longer be ignored. Bitcoin had soared in its market capitalization to reach $10.90 billion while daily volumes stood in the region of $32 million. 

Adoption was slowly picking up while the lag in transactions and fees remained a source of concern for the community. On January 14th, Joseph Poon and Thaddeus Dryja teamed up to publish the Lightning Network’s white paper. The 59-page document laid down the groundwork for the subsequent development of the network.

The growth of the Lightning Network spawned the famous Bitcoin Lightning Torch of 2019. The event saw the “torch” passed 292 times before reaching the hardcoded in a move that showed just how global the network had become.  

Since then, the Lightning Network has received endorsements from the figureheads of the cryptocurrency community like Jack Dorsey, Chanpeng Zhao, Andreas Antonopoulos, and Elizabeth Stark amongst others. 

How The Lightning Network Works

The Lightning Network is a Layer 2 protocol that is based on the bitcoin blockchain. It leverages Bitcoin’s already existing infrastructure and security with the ultimate goal of improving the scalability of the network. Andreas Antonopoulos referred to it as a “second layer routing network.”

Parties seeking to leverage the utilities of the Lightning Network will have to create a channel. The creation of the channel will require the users to commit an amount referred to as the funding transaction. 

To create a channel, users will have to make a multi-signature wallet, which they can all access with their own private keys. After the creation of the multi-signature wallets, users will have to deposit BTC in the wallet, and then, the stage is set for them to carry out several transactions between them.

Funds can be moved between the parties under the channel with the maximum limit being the amount committed to the channel when it was opened. A balance sheet is updated by the parties through the use of their private keys. 

The algorithm uses the balance sheet to decide who receives and how much they should receive and upon closing of the channel, the information is recorded on the blockchain. This has the benefit of merging several transactions and rolling them into one transaction before recording them on the blockchain, thereby saving time and costs.

To ensure additional security for transfers a Hashed Timelock Contract (HTLC) is deployed. The HTLC is basically a channel contract that is enforceable through the blockchain and is usually designed to be revocable. 

The use of CheckLockTimeVerify creates the possibility for penalties which makes every party act in good faith throughout the transactions. Watchtowers nodes have also been deployed to monitor the network for fraudulent activity

The Advantages of The Bitcoin Lightning Network

The Bitcoin Lightning Network offers significant benefits to the bitcoin ecosystem. The most profound advantage that it offers users is the speed of transactions. The Lightning Network offers users speed that cannot ordinarily be gotten on the normal bitcoin blockchain. 

Transaction speeds on the Lightning Network are settled in less than a minute while some transactions can take place in less than 5 seconds. On average, the Bitcoin network takes 10 minutes to confirm a transaction and this can vary wildly which makes the speeds offered by the Lightning Network to be groundbreaking.

Another advantage that it offers is that of “granularity”, meaning that users can make payments in denominations that are less than one satoshi. For example, millisatoshi’s are payable to intermediary nodes for routing fees. 

Privacy is taken a notch higher by the nature of transactions on the network because details are not publicly recorded on the blockchain. Funds may be rerouted through other channels which obfuscate the source and destination of the transaction.

The Network provides an answer to the persistent question of scalability on the blockchain. It removes the limitation of the number of transactions per second on Bitcoin and takes it to unprecedented heights. It is said that the Lightning Network can allow up to 1 million transactions per second while the Bitcoin network can only handle 7 transactions per second.

The Disadvantage Of The Lightning Network

For all the positivity around the Lightning Network, it is still a work in progress as certain drawbacks affect the network. The most profound of the drawbacks that affect the Network is Bitcoin’s price fluctuations that make it difficult for the asset to perform its role as a medium of exchange.

Another source of concern for users of the network is the security gaps that exist through its use. The first ambit of the security problem is that staying online for such an extended period of time puts the nodes at risk as to the computer that stores the private keys. Offline transactions are possible but it comes with its own attendant risk as it creates the opportunity for a Fraudulent Channel Close

Bad actors may create numerous channels and trigger them to expire simultaneously which will cause congestions on the blockchain. This poses a critical risk as funds can be pilfered as a result of the congestion. Thaddeus Dryja noted that this “may be the greatest systemic risk” of using the Lightning Network.

Another downside of using the Bitcoin Lightning Network is the fees that are associated with it. Fees are incurred in the opening and closing of a channel and there is also the need for routing fees for payments to be moved between channels. One might argue that the fees are insignificant but yet they still exist and might deter some persons from embracing the Network.

Metrics of The Bitcoin Lightning Network

The Bitcoin Lightning Network has steadily risen in popularity since its inception and continues to grow. In April, the nodes on the Network were 10,000, and fast forward to August, the nodes are now at well over 22,781 BTC. In the last month alone the Network has grown by as much as 20% as 1,821.29 BTC are locked in over 56,000 channels.

The Network has seen its adoption rates increase in South America and El Salvador’s decision to legalize Bitcoin has also led to an increase in the use of the Network in that country. In 2020, the Lightning Pool was launched, giving users the ability to earn yield, and this served as an incentive for further adoption.

Exchanges are not left out as they have also adopted the Network. Bitfinex is one leading exchange that supports the network, allowing for deposits and withdrawals. OKEx, Kraken, and OKCoin have also integrated the Lightning Network which allows users of their platforms to make both BTC deposits and withdrawals.

Conclusion

Satoshi Nakamoto’s invention has changed the financial landscape of the world after the asset class he made surged to reach a market capitalization of over $1 trillion. The increasing adoption laid bare the scalability problem that plagued Bitcoin. 

Enter the Bitcoin Lightning Network and its unique approach to the scalability dilemma. The Network practically changed the game for Bitcoin as it offers unprecedented speeds, privacy, and lower fees. These features have led to increased adoption for the network and have also led to the setting of metrics that are simply impressive.

Although it has its own drawbacks, it is still a work in progress that has immense potential to significantly improve the Bitcoin Network.

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