The Lightning Network is a way of handling transactions without the need to verify them on the blockchain. It’s designed to speed up verification times and to allow more transactions to take place at the same time.
Bitcoin has been hampered by its own popularity. Thanks to the way the blockchain is designed, the speed of transactions is slow and the cost of transactions has gone up.
Researchers, developers and the Bitcoin community have been trying to come up with a way of allowing Bitcoin - and other cryptocurrencies - to accommodate more transactions. Their best efforts yet are focused around something called the Lightning Network.
There are two limitations we need to explain when it comes to blockchain.
The first is speed.
If your transaction doesn’t make it into the current block, it joins a queue. That queue can take anywhere from a few minutes to a day to process.
That limits the blockchain’s use as a medium to process quick transactions, like buying a cup of coffee. No one wants to wait around for the network to verify you’ve got the cash.
Bitcoin’s network - and others - is built upon a consensus protocol called proof-of-work.
This is where miners expend energy trying to solve a difficult puzzle. To help offset the cost of equipment and energy used in that calculation, miners charge transaction fees.
When the system is small, and the amount of transactions needing verifying are few and far between, the network works well and transaction costs are low. As the network grows however, so does the cost of transaction fees.
At its recent peak in 2017, to process one transaction on Bitcoin - whether it was for $1 or $1000 - was $28. That makes Bitcoin un-economical as a form of currency. That’s where the Lightning Network comes in.
We've got a whole article explaining more about Bitcoin's limitations.
Find out more about it here.
The Lightning Network is a system of channels allowing people or companies to move money between each other without needing to use the blockchain to verify the transaction.
It bears resemblance to the current settlement system used by companies like Visa and Mastercard. When you pay for something it’s not instantly settled.
Instead, there’s a quick verification of funds from the buyer and the request from the seller - giving the green light for a transaction to take place.
The settlement of the funds happens later, in some cases days or weeks later.
The idea was first proposed by Thaddeus Dryja and Joseph Poon, the founders of the Lightning Network, in a 2015 white paper.
The idea was to create a settlement layer on top of the blockchain, freeing up the core network from processing individual transactions.
Let’s say you want to transact with your local coffee shop. First, you’d need to send some Bitcoin to a wallet that requires more than one signature or key to release the funds.
These are commonly referred to as multisig wallets. These multisig wallets allow people to control when funds are released - and helps prevent double spending.
By doing this, you create a balance sheet. Every time you buy a cup of coffee you create a new balance sheet and sign it with your public key to reflect what’s left in your wallet, and what’s in your coffee shop’s wallet.
If you don’t want to buy coffee anymore from that coffee shop, you can close the channel, and the resulting balance sheet is committed to the blockchain as a permanent record.
Payment disputes can also be settled by referring to the last signed balance sheet between the two parties.
What happens if you don’t have a direct channel with the next place you want to buy something from? The network will find the shortest route between you and the shop via others in the network.
It’s already live! A version was launched on Bitcoin in March 2018, but it’s being used by technical users and developers to help iron out any bugs as adoption grows.
The popularity of cryptocurrencies and transacting on them has, within just a few short years, put increasing stress on the blockchains they’re built on.
While there have been smaller changes - and some cases forks - to help the networks get quicker, the Lightning Network, if successful could help open the door to widespread adoption of cryptocurrencies and their applications.