Over the years, the demand for cryptocurrency is building. People believe that bitcoins are the future of our financial system, like the blockchain technology used by Bitcoin is considered to be the safest method to make a transaction. But, transactions on the crypto world are different from those made by credit and debit cards. The payment provider VISA processes about 4,000 transactions per second and has a capacity to process up to 65,000 transactions per second. While Bitcoin, on the other hand, can process only seven transactions per second with a block size of 1MB. Therefore, Bitcoins have a scalability issue. If Bitcoins had to be used as a medium of transaction, it would take a very long time to process a lot of transactions. Also, the transaction fees on the Bitcoin network have increased drastically and have hit an all-time high of $30. Hence, to solve the issue of scaling in the digital currency, the developers came up with a new technology called the “Lightning Network.”
What is the Lightning Network?
The Lightning Network is a system which is used to process a transaction instantly and also reduce the fees of the transaction. From the introduction of this technology, people can send and receive payments instantly without any hassle. This system is designed such that the transactions are kept away from the main blockchain network, which is the reason for reduced fees. Therefore, using Lightning Network, Bitcoins can be used as a day to day currency.
How does the Lightning Network technology work?
The working the Lighting Network is as follows:
- A multi-signature wallet is set up by the sender/receiver, which holds some amount of Bitcoins.
- The wallet address and the balance sheet (smart contract) is registered to the public Bitcoin blockchain network. A balance sheet is an agreement contract that proves how much of the available Bitcoins belongs to whom. This complete process is known as the payment channel.
- Once this payment channel is set up, both the parties can make an unlimited number of transactions without any contact of the blockchain.
- After every transaction, both the parties sign on the updated multi-signature wallet to always know how much Bitcoins belongs to whom.
- Note that, the balance sheet is updated continuously but is not uploaded on the blockchain network. Both the parties only keep a copy of the balance sheets.
- Once all the transactions are complete, the payment channel is closed, and the most recent balance sheet is updated on the blockchain to complete the transaction. Once the transaction is confirmed, both the parties receive their share of the amount.
An example on the working is given on getting the concept cemented. Let’s say Jon wants to buy coffee from a cafeteria daily. He wants to make transactions using Bitcoin. If he makes the payment in the traditional manner, he’ll end up paying more transaction fees than the cost of the coffee.
This is where Lightning Network comes into play. With the help of this technology, Jon sets up a payment channel to pay for his coffee daily. So, both the parties, i.e., Jon and the cafeteria deposit Bitcoins into a multi-signature address. Since Jon is the one paying for the coffee, so, only he deposits money into the address. Once the Bitcoins are deposited, a balance sheet is made to update how many Bitcoins has been debited from Jon and credited to the cafeteria. Every time Jon buys a coffee, the balance sheet is updated and is signed by both the parties. Jon can keep ordering coffee until he has Bitcoins in the multi-address. If he does not want to buy coffee anymore, the payment channel can be closed either by him or the cafeteria. All they have to do is, to take the most recent balance sheet and broadcast it to the blockchain network. Once the balance sheet (smart contract) is validated by the miners, they release out the funds to both the parties. This completes the transaction on the blockchain network. Hence, this will create only one single transaction on the main blockchain network. Therefore, by paying just one transaction fee, both the parties can make an unlimited number of transactions. Moreover, this reduces the load on the main blockchain network as it requires only two transactions, one to open the payment channel and another to close it. Most importantly, it is incredibly safe, as well. With the feature of both the parties signing the balance sheet, it ensures only the latest balance sheet is sent to the main blockchain network. Also, both the parties do not have to depend on each other as both of them have the authority to close the payment channel.
What about the spread in the network?
Imagine, if Bran (a friend of Jon) wants to buy coffee from the cafeteria, so, Bran need not open another payment channel. If Bran and Jon already have a payment channel between them, Bran can transfer Bitcoins to Jon, and Jon can in turn transfer it to the cafeteria and complete the transaction. Therefore, instead of having separate direct channels, you can have interconnected networks. Also, this network can extend to any length. For example, if Robb and Bran have a payment channel established, he can buy coffee from the cafeteria through Bran and Jon.
What are the hurdles that come along?
Dependency: Imagine in a three-way connected network; if one of the peers is unresponsive, the other peers have to wait until the peer responds. Hence, in extensive networks, there is more dependency.
Inefficient for large payments: Considering the previous example, let’s say Bran wants to buy an expensive product from the cafeteria. And, if Jon does not possess that much amount in the payment channel between him and the cafeteria, the transaction cannot happen. Therefore, it is not ideal for large payments.
When will this technology go live?
Well, there is a proof-of-concept implementation happening on the Bitcoin Testnet. Also, it has been experimentally implemented many times on the Bitcoin Mainnet and has come into the real business in a few countries as well. The network is also expected to grow in the coming years as technology advances.