The developers of LN hope to leverage the number and speed of payments significantly, by settling Bitcoin transactions on a new layer, outside of the Blockchain. The Lightning Network promises to scale the Blockchain’s capabilities on such a level, and it will be able to compete with established payment companies, like VISA and Paypal.
Initially introduced in 2015 by Joseph Poon and Thaddeus Dryja, the Lightning Network was proposed as a solution to the issues that occurred, as Bitcoin’s popularity increased exponentially. The LN takes the improvement SegWit offered to the Blockchain (improving the block capacity,) a step further. Bitcoin’s transaction volumes have increased so much (along with the fees included,) that have made micropayments unattractive. Fees can, frequently, be higher than the amount of the transaction and the Lightning Network aims to deal with this problem efficiently.
How Does the Lightning Network Work?
When two parties want to transact with each other, they can open a “payment channel” by locking equal amounts of money in a Smart Contract. This payment channel will open a record in the Blockchain by creating a 2-2 multisignature address, that will remain open for as long as the two parties want to transact. Their transactions will then be executed instantly by a Peer-to-Peer connection on the off-chain layer, as the nodes’ supervision of the network will not be required. This channel will only close again when both parties decide to close it forever, and the miners in the Blockchain will then verify the record.
The two parties can execute an infinite number of transactions with each other, but the miners will only be compensated for the opening and closing transactions only. In other words, they will get rewarded for every activity that happens on-chain. In the case of a dispute by one of the parties, the balance of the Smart Contract can be verified by the latest, mutually-signed entry. This will also prevent transaction signatures from being tampered, as bad actors would be penalized, providing the counterparty with the ability to retrieve their funds and terminate the channel.
Additionally, as multiple channels will be created, one can send a payment to a user with whom he is indirectly connected. For example, if users A-B and B-C have open channels with each other, user A can send a payment to user C, by asking B to send the requested amount to C. If user B has sufficient funds for the requested amount will send the money to user C, and then user A will reimburse user B. The vision is to create a huge network where all the users will be interconnected (by only a few hops away,) able to execute payments instantly, eliminating delays during network congestions. Transaction fees are significantly lower in the Lightning Network, as the intermediary nodes are compensated with an amount (a few Satoshies) which is proportional to the transaction.
Lightning Network Pros & Cons
Transactions will become super-fast, as they will be conducted Peer-to-Peer and will not require validation by the miners, relieving the Blockchain from high congestion.
Bitcoin will turn into a powerful transactional tool, as micropayments will now become easier. Cross-chain transactions will become available, and an exchange will not be required.
Transactions take place off-chain; hence privacy and anonymity are improved.
Payments in the LN can only be performed online, and the funds in payment channels are locked and topped up in advance. Additionally, transactions can be significantly delayed until an alternative route is found if a node fails.
The Lightning Network is not convenient for large payments because it would be necessary for each node (hop) to have sufficient funds until the transaction is terminated. In case a route is not available, and a payment hub is used instead, Bitcoin will lose its fundamental essence and become a centralized payment service.
Bitcoin’s sustainability is maintained by the miners who are incentivized for their contribution with transaction fees. These fees are going to keep the network running even after all Bitcoins have been mined. While one of the major benefits the Lightning Network will offer to the users, is minimizing the fees applied on each transaction in the Blockchain, it could also jeopardize the operability of the network in the future. As mining will become costly in time, miners’ motivation will decrease and will discourage them from dedicating their computational resources to keep the Blockchain running.