An Introductory Guide to Lightning Network: All You Need To Know

25 August 2021 | Updated: 25 August 2021

If you have had questions about the hype surrounding Lightning Network is or what it does, look further because this article will lay your concerns to rest.

Bitcoin (BTC) was originally designed as an electronic peer-to-peer payment solution. However, the benchmark cryptocurrency has since grown to become a reliable means of exchanging value without involving centralized institutions. Although Bitcoin offers a wide array of use cases, it remains troubled by a significant setback; scalability.

This problem has sparked concern in the cryptocurrency community since the early days of Bitcoin. While several solutions have gotten presented over the years, one of the most outstanding Bitcoin scalability enhancers is the Lightning Network (LN).

In this article, we examine what the Lightning Network is, its benefits and shortcomings, and how it could solve the scalability issue plaguing the benchmark cryptocurrency.

What is Scalability?

Before we jump into the ins and outs of the LN, let us take a quick look at the scalability problem and why it matters to the progress of Bitcoin. The Bitcoin network has a low throughput capacity and can only carry out seven transactions per second at best. That said, in an event where over seven users try to send funds at the same time, those offering higher network fees get to see their transactions go through first.

This could become problematic when users On the network spike significantly like during the 2017 bull run. At its peak, the network fees exceeded $55 per transaction. This is the scalability problem faced by the Bitcoin network.

What is the Lightning Network?

The Lightning Network, proposed by Thaddeus Dryja and Joseph Poon in 2015, serves as a second layer (layer 2) to the Bitcoin network, intending to solve scalability-related problems. The primary objective of the LN is to provide a lasting solution for microtransactions in the BTC network, which should facilitate transactions at lightning speed regardless of the number of users running transactions at the same time.

To use LN, users have to first open an off-Chain channel, make some BTC deposits, and carry out transactions while paying minute fees until they decide on the relevance of the channel. Once operations are completed, the user can close the channel and send the final balance to the main network for confirmation in a single transaction.

How Does the Lightning Network Work?

To explain how LN works, let’s look at an analogy to put the operational procedure into context. Jack owns a restaurant, and Jill enjoys dining at this restaurant. Jill is ready to eat there every day with the condition that she pays in Bitcoin. However, considering how volatile and expensive network fees are, Jack and Jill, agree to use an open channel between both parties on the Lightning Network.

After this channel gets created, a unique BTC address directing transactions to this channel emerges. Now, Jill deposits some BTC into this address to guarantee the availability of payment at all times. A deposit activates the usability of the channel. Whenever Jill dines at Jack’s restaurant, the transaction gets recorded in the channel, which facilitates instant payment with negligible fees.

Should both parties decide to terminate their collaboration for whatever reason, they can close the channel. At the close of the channel, all the transactions facilitated are summarized and delivered to the main chain in a single transaction. This dramatically reduces transaction fees on the network, compared to paying network fees on every single transaction.

Pros and Cons of the Lightning Network

As with most human inventions, the Lightning Network presents both meaningful benefits and operational downsides. Listed below are a few of them:

Advantages

Low Transaction Fees

Transaction fees on the LN are a fraction of fees charged on the mainnet for single transactions. The full network fee only gets paid at the close of the channel. o

Fast Transaction Speeds

The LN allows users to facilitate transactions at lightning speeds regardless of the number of active users on the network at any given time.

Scalability-Oriented

According to the LN website, the technology can facilitate billions of transactions in a single second. Such a limit should cater to the ever-growing number of BTC users without compromising the mainnet network in any way.

Facilitation Of Cross-Chain Transactions

The LN is not limited to Bitcoin or any one cryptocurrency. The technology allows for the direct transfer of different cryptocurrency between parties, given that the chains Support the same cryptographic hash function.

Disadvantages

Deposit Caps

Parties on an open channel on the LN can only transfer within a set limit on the network.

Limited Coverage

The LN has a lot of real-world coverage to carry out, given the limited number of nodes deployed on the network.

Complicated Routing

As the network continues to grow, routing between nodes becomes more difficult.

Offline Transaction Risks

The LN whitepaper notes that channel-tied funds can get stolen by one party, while the other is offline or away. However, affected parties can contest fraudulent transactions to reverse stolen funds. Nonetheless, there is a time constraint on the contest feature.

Conclusion

Despite the solvable flaws of the LN, the technology presents an indisputable solution to the scalability issue in the cryptocurrency (Bitcoin) industry. And although new crypto projects do not have scalability problems, no other cryptocurrency can compare to the adoption rate, utility, and importance of Bitcoin in the digital world.

That said, as long as Bitcoin remains relevant—which is a given—and scalability problems persist, LN remains a critical tool for facilitating microtransactions on the network.

 

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Azeez Mustapha

Azeez Mustapha is a trading professional, currency analyst, signals strategist, and funds manager with over ten years of experience within the financial field. As a blogger and finance author, he helps investors understand complex financial concepts, improve their investing skills, and learn how to manage their money.