What is the Lightning Network: Lightning network explained

If you’ve wondered what is Lightning Network, and if you should use it, this will help you

Bitcoin is the single biggest name in the world of cryptocurrency. Both the blockchain and the coin itself have become synonymous with crypto. However, there are problems with the blockchain, issues which something called the Lightning Network aims to solve. The Lighning Network itself is problematic, however, according to some. 

What is the Lightning Network?

Let us start off by imagining the Bitcoin blockchain as a single layer. On this layer, you can send and receive the bitcoin cryptocurrency. However, you can only send and receive the crypto to and from people who are already on the network itself. If you want to transfer money and you are not on the blockchain, or the person you want to transfer money is not on the blockchain, then you are out of luck and unable to make the transfer. This is where the Lightning Network comes in. 

The network effectively allows people to send and receive money to and from parties that are not on the Bitcoin blockchain. This means that the worlds of Bitcoin and bitcoin transactions are opened up further. There is also a practical application to the network, too. Transactions on the blockchain can be very slow, which is not only frustrating, but also means people might end up losing money as the value of bitcoin changes. Lightning is designed to be a lot quicker than regular transactions, meaning users should save money in the long run.

How to use the Lightning Network

So, how does the Lightning Network work? By storing bitcoin in a Lightning Network wallet, using what is known as a multi-signature address, users can agree to pay a retailer a set amount of the crypto, in a similar way to buying a gift card from a certain shop.

When the agreement to pay for an item is made, the transaction is secured and recorded on a balance sheet rather than the main blockchain which, at least in theory, makes it very fast. More transactions can be carried out in the same way using bitcoin.

When the payment channel is closed by either party, spent coins are transferred to the retailer, the balance sheet is verified by miners and a single transaction is recorded on the blockchain, Bitcoin.

The network, which operates by creating a network of such payment channels, means fast transactions are possible between users and retailers. With fewer transactions to verify, the load on the main blockchain should be eased and fees can be kept to a minimum.

In El Salvador, the Latin American country that accepts bitcoin as legal tender, McDonald’s takes payments in crypto via the Lightning Network.

Lightning Network infographic
The Lightning Network explained – Credit: Currency.com

How it happened

The idea of the Lightning Network first came to light in 2016, when researchers Thaddeus Dryja and Joseph Poon published a paper arguing that Bitcoin had a scalability problem that, in effect, meant transactions were slower than they should have been. The paper said: “If each node in the bitcoin network must know about every single transaction that occurs globally, that may create a significant drag on the ability of the network to encompass all global financial transactions.

“It would instead be desirable to encompass all transactions in a way that doesn’t sacrifice the decentralisation and security that the network provides.”

Poon and Dryja argued that there was no need for every node on the blockchain to know about every transaction. They said: “By deferring telling the entire world about every transaction, doing net settlement of their relationship at a later date enables Bitcoin users to conduct many transactions without bloating up the blockchain or creating trust in a centralised counterparty.

“Trusting third parties to hold all of one’s funds creates counterparty risk and transaction costs. Instead, using a network of these micropayment channels, Bitcoin can scale to billions of transactions per day with the computational power available on a modern desktop computer today. 

“Sending many payments inside a given micropayment channel enables one to send large amounts of funds to another party in a decentralised manner.”

The researchers continued with their idea and, in 2018, the bitcoin Lightning Network was launched in its beta form.

Arguments against Lightning Network

While the network has blossomed since then, there have been some criticisms of the system. One of the most notable critics of the network is a pseudonymous blogger who calls himself Mr Whale.

While normally people using alternative names can be overlooked, we have to remember that the founder of Bitcoin, Satoshi Nakamoto, uses a pseudonym himself.

First, Mr Whale argues that the network simply is not scalable enough. He says: “As of now [September 2021], the network can only process around 2,800 Bitcoin, which is around 0.0001% of Bitcoin’s total supply. With the billions worth of Bitcoin being transacted daily, this just isn’t realistic at all.

“Payment channels on the Lightning Network also need to be opened and closed by expensive L1 bitcoin transactions. The network can process ~2000 transactions/block and produces ~144 blocks/day, meaning that opening up a payment channel for everyone on earth would take ~72 years, assuming that no one died or had children during that time.”

Mr Whale also cites a paper that notes research carried out between 12 January 2018 and 17 July 2019 on the Lightning Network indicated that about 10% of the nodes on the network controlled around 80% of the money on the network. This meant that, according to the paper: “Originally designed to allow for cheaper and faster transactions without sacrificing the key feature of Bitcoin, ie its decentralisation, it is evolving towards an increasingly centralised architecture.”

Mr Whale commented: “This is dangerous because if most of the bitcoin is held by only a few nodes, the network is more vulnerable to hackers because removing these routing nodes would leave gaping holes.”

In other words, according to the researchers, the bitcoin Lightning Network risks making the blockchain more centralised, which would be against what both the blockchain and the cryptocurrency were set up to do. 

There were also concerns that Bitcoin’s volatility was an issue that would, ultimately, meaning the Lightning Network would not work properly. Mr Whale said: “The price volatility makes it challenging for companies to use Bitcoin as a method of payment when pricing their products to sell to their customers or even to purchase inventory from their suppliers.

“The Lightning Network claims to have no fees, which would be amazing had their network not been fully centralised, and had Bitcoin not been one of the most volatile assets on earth."

We put Mr Whale’s comments to Lightning Network, but did not receive an immediate response.

FAQ

In July 2021, Yahoo Finance reported that there was 1,821.29 BTC across the network. This figure may have gone up since then. 

If you want to invest in the Lightning Network, you can start by buying and holding bitcoin in a wallet that enables the network. You can also operate the nodes on the network if you want to make the system work for you. 

If you want to pay with the Lightning Network, then you should use a network-enabled wallet and find a service provider who accepts payment in bitcoin via the network. 

The material provided on this website is for information purposes only and should not be regarded as investment research or investment advice. Any opinion that may be provided on this page is a subjective point of view of the author and does not constitute a recommendation by Currency Com Bel LLC or its partners. We do not make any endorsements or warranty on the accuracy or completeness of the information that is provided on this page. By relying on the information on this page, you acknowledge that you are acting knowingly and independently and that you accept all the risks involved.
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