Bitcoin, being the most popular and outstanding crypto project ever, is setting trends and driving the crypto industry towards the development of solutions aimed at maximising the reduction of transaction fees and augmenting network performance and scalability.
Seven transactions per second was the design speed of the Bitcoin system. It was not possible to scale the protocols or increase the number of transactions per unit of time. The bandwidth required improvement ten years after the first virtual coin was introduced. The scalability issue with Bitcoin was addressed by the creation of the Lightning Network (LN) payment protocol, which runs over the distributed ledger of the cryptocurrency.
This article intends to provide a comprehension of the BTC Lightning Network and how it works. You will also learn what outstanding advantages the Lightning Network has and its significant disadvantages. At the end of the article, there will be a guide on investing in the Bitcoin Lightning Network.
Key Takeaways
- The availability of participating nodes and the underlying Lightning Network is a layer 2 solution designed to solve the scalability issue of the BTC chain.
- Lightning Network is based on a system of nodes that perform deals between different networks of different blockchain networks.
- Investing in the Lightning Network is done by purchasing BTC on any crypto exchange or by launching a separate Lightning node using special software. A node that stops responding or goes offline may cause problems for the payment system using routing.
What is Bitcoin Lightning Network and How Does it Work?
The Bitcoin blockchain was flooded with meme coins in the BRC-20 token format in early May, resulting in high transaction fees and congestion. A high level of traffic on the network has forced Binance, the world’s largest crypto exchange, to temporarily suspend Bitcoin withdrawals twice a day until it can restore an acceptable level of capacity for users to withdraw their coins. Exchange representatives have indicated that their development team is working on integrating transfers via a Lightning Network innovation, which they described as “ideally suited to such situations”.
The Lightning Network (LN) protocol is a scaling system for the BTC public ledger that acts as one solution to its limited bandwidth. It can be used to conduct almost instantaneous coin transfers with minimal fees. The protocol concept was first introduced in a white paper titled “The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments” in 2015. It was authored by developers J. Poon and T. Dridja. Since the emergence of Lightning Network, the developer community has been working collectively to improve both the protocol and the applications and tools supporting LN format transactions.
Imagining Bitcoin’s operation as a huge highway where countless vehicles (transactions) compete for limited space, the LN protocol acts as a dedicated lane that allows you to bypass the congested main road. This is achieved by creating dedicated payment channels where transactions (open transaction and closing transaction) can take place instantly, with minimal LN commissions and without having to write each one to the Bitcoin shared ledger.
The Lightning Network offers a new network, a second layer, where users can pay each other peer-to-peer without making transactions on the BTC’s blockchain for each payment. Users can pay each other on the Lightning Network as often as they want without creating additional Bitcoin transactions or charging fees within the chain. They only use the Bitcoin system blockchain to initially load Bitcoin onto the Lightning Network and for settlement, i.e., to remove Bitcoin from the Lightning Network.
As a consequence, many more BTC payments can occur off-chain, with only the initial load and final settlement transactions having to be validated and stored by BTC Lightning Network nodes. In addition to reducing the burden on nodes, settlements on the Lightning Network are cheaper for users. After all, they do not have to pay blockchain fees and are more private for users because they are not published to all network participants and are not stored permanently.
Although the Lightning Network was initially conceived for the Bitcoin system, it can be implemented on any shared ledger that meets some basic technical requirements. Other blockchains, such as Litecoin, already support the Lightning Network. In addition, several other blockchains are developing similar second-layer solutions to help them scale.
The Bitcoin Lightning Network aims to provide instant and inexpensive transactions while achieving a throughput of approximately 1 million transactions per second.
As of today, the Lightning Network for Bitcoin has been finalised. Many crypto exchanges and platforms are involved in its implementation, and the result of the development team’s efforts can be seen right now. Given the scale of this project, its specific properties (characteristics) give this network several interesting advantages, among which are:
1. Scalability
The scalability of the Lightning Network is unrivalled thanks to its off-chain architecture, which allows it to process millions of transactions per second, avoiding network congestion. This makes it ideal for micropayments and high-frequency transactions that require low fees and high Lightning transaction speed.
Payments in Lightning typically go through multiple payment channels to reach their destination. We usually see payments through up to four or five hops (routing nodes). Assuming each hop takes one second, a payment passes in four to five seconds. If the payment requires zero hops, i.e., if a shared payment channel with the recipient is used, the payment will be processed in a fraction of a second.
2. Speed (Instant Payments)
Due to high-speed data transfer protocols between nodes, the Bitcoin shared ledger based on the Lightning system has a high speed of processing transactions between multiple crypto addresses. As operations are taken off the main public ledger and carried on in layer-2 blocks, they are much faster and more efficient due to a two-party consensus mechanism known as a payment channel. Furthermore, because the network can process payments in parallel if 1,000 pairs of nodes are running at 1,000 TPS, the network performs 1,000,000 TPS.
3. Micropayment Support
The smallest part of Bitcoin is satoshi (0.00000001 BTC). The Lightning Network allows payments even smaller than satoshis. Unlike the Lightning Network, Bitcoin has a minimum transaction output of more than 100 times greater. Achieving this use case is critical to the chain’s usability since Web3 applications like gaming increasingly rely on fast micropayments.
The Lightning Network creates quick micropayments, but they can only be profitable if they can be completed at extremely low transaction costs. The blockchain typically loses market share to rivals due to inefficient transaction processing.
4. Low Energy Requirements
The Lightning Network reduces the energy its nodes consume since transactions are taken off the chain. The energy required to support these off-chain transactions is significantly lower than it would be on the Bitcoin network; therefore, it has significant implications from the sustainability perspective.
As a result of the criticisms of environmental, social, and governance (ESG) investors seeking good energy credentials with their investments, Bitcoin is becoming increasingly unpopular. Lightning Network also helps Bitcoin’s reputation from an ESG perspective because it reduces energy consumption and takes the bulk of transactions off its distributed ledger.
5. Low Transaction Fees
Because Lightning Network transactions do not rely on the main distributed ledger, they are generally subject to lower fees than those on the main blockchain. In addition, micropayments are particularly advantageous due to the high cost of on-chain transactions for transfers of small values. In the context of everyday transactions, where cost efficiency is paramount, Lightning Network is an attractive solution due to its lower transaction fees.
Various studies have shown that LN’s median fees are significantly lower than traditional payment networks. Sending value through the Lightning Network has a typical commission charge of 0.0029%, which is 1,000 times less expensive than traditional payment processors like Mastercard or Visa.
6. Enhanced Privacy
To ensure a high level of security for the Lightning Network, a protocol-based solution such as “Basis of Lightning Technology 12” (BOLT 12) has been developed, the proposed recent update of which not only improves privacy but also provides many other valuable features.
There are also independent solutions such as lnproxy, an account privacy tool, and LNURL, a set of tools for enabling communication between various Lightning applications and services over the Internet. Thanks to these solutions, each Lightning node will give everyone the privacy they should have by default.
Considerable Disadvantages About the Bitcoin Lightning Network
Due to the compelling benefits described above, the Lightning network has a large stake in the Bitcoin project’s efforts to reduce transaction costs and increase blockchain bandwidth. However, there’s always a spoon of tar in a barrel of honey, and such a network is not without its flaws. Let’s look at the main ones below.
Channel Liquidity Features
LN works by establishing a payment channel between two parties with liquidity establishment, where only the first and last transactions are counted in the Bitcoin blockchain. Any number of transactions between the first and last will occur off-chain. Because of the lack of restrictions within the blockchain, all intermediate transactions happen much faster.
Liquidity and bandwidth issues can be limiting, especially for large-scale adoption or large transactions. This issue is probably rooted in the scalability of the LN. However, the need for channel liquidity poses a challenge. To transact, users must have sufficient funds locked in the channels. This requirement can limit the usability of the Lightning Network, as it may not be suitable for users with limited liquidity or those who engage in infrequent transactions.
Centralisation Issues
Centralisation problems arise not only from controlling watchtowers but also from the existence of several large nodes created by organisations, leading to dominance in the network. Such a consequence of growth could undermine the decentralised network nature of digital assets and potentially lead to difficulties such as censorship or transaction control. At the moment, there is no definite solution to this potential concern.
Network’s Reliability
The availability of participating nodes and the underlying infrastructure are prerequisites for the operation of the Lightning Network. A node that stops responding or goes offline may cause problems for the payment system using routing. Even with ongoing attempts to increase network dependability, user experience and general network confidence can still be negatively impacted by sporadic outages or node unavailability.
Moreover, nodes must always be online because there is a possibility that if a node drops out of the chain, another user can close the payment channel, appropriating all the funds for themselves. However, the network provides time to dispute transactions.
Complexity
Using the Lightning network is a complex process that requires knowledge of these systems’ specific terms and operations. In terms of user experience, there is a perception that the Lightning Network, being a layer 2 solution, creates additional complexity compared to traditional transactions. That is, the network is not yet simple and convenient enough for mass adoption. Setting up and managing payment channels, finding payment routes, and maintaining sufficient Lightning Network channel liquidity can be challenging for users unfamiliar with technical documentation.
Bitcoin’s Price Volatility
Bitcoin’s volatility is a big problem not only in terms of crypto trading on the spot and other markets but also in terms of conducting transactions on the Lightning Network. This issue is due to the fact that when the price of the coin changes significantly, the value of the transaction also changes, as well as its fees. This can be an obstacle when making large-volume payments.
On the other hand, specialised services are offering their products for working in the LN that allow you to conduct a thorough analysis of crypto wallet statistics and keep a record of all operations in the network. One of the brightest examples of such solutions is Lightning Labs, which allows transferring funds in seconds between different addresses through individual payment channels.
How to Invest in the Bitcoin Lightning Network
The Lightning Network is considered to be a relatively new technology that requires refinements in terms of usability for mass adoption, privacy, avoidance of unfair channel closures, and others.
However, the Lightning Network can grow significantly from protocol enhancements to the underlying blockchain, such as Schnorr Signatures and Taproot, to address privacy and security concerns. There are also several proposed extensions to the LN protocol, such as Eltoo, to improve penalty and scaling mechanisms and Channel Factories for more efficient channel handling.
It’s worth noting that the support for LN by many crypto wallets also plays in favour of the technology’s development. This allows more and more Bitcoin holders (and beyond) to utilise the network for their own purposes.
Speaking about the process of investing in Lighting Network, it is worth noting that it is quite simple and consists of several important steps. Meanwhile, there are two ways to invest in this network.
Purchasing and Holding Bitcoin
The easiest way to invest in the Lightning Network (LN) is to buy and hold Bitcoin assets. There is a simple correlation here: the more people who support Bitcoin, the higher the demand for the network will be. Today, buying Bitcoin can be done on any crypto exchange or platform, regardless of its fame and brand. Having any custodial or non-custodial wallet can store the currency while taking full advantage of the new network, such as high-speed transaction processing and minimal operation charges.
Running a Lightning Node
The second way to invest in this network is to start a Lightning node. Lightning nodes are infrastructure operators, and each is assigned a unique identifier on the network. Only nodes are capable of processing transactions. Their number has been growing steadily since the early days of the network, albeit at different rates. Since the network is a very dynamic construct, their number changes daily.
In order to run a Lightning node, it is necessary to acquire specialised equipment that will meet all the necessary requirements of the system responsible for the launch and configuration of the node. Then, it is necessary to install special software, configure it and start the node. In addition, a mandatory requirement is the presence of a wallet for transactions with crypto assets.
Conclusion
Lightning Network is a new step in developing the first crypto coin, marking an attempt to make it fast and secure, offering low transaction costs and high scalability in the future. Undoubtedly, the Lightning project will evolve and modernise as its integrations and applications grow yearly, increasing the demand for blockchain technology. The same applies to the security and usability requirements that the ledger’s network of the main crypto coin on the market must meet.
