What is the Lightning Network?

Super-fast transactions and low fees: the Lightning network aims to solve Bitcoin's scalability and efficiency problems. But what exactly is the Lightning network? How does it work? What advantages does it offer compared to on-chain transactions and what should you keep in mind when using Lightning?

The most important in a nutshell

  • The Lightning network allows users to transfer bitcoin at extremely low fees and instantly.
  • Lightning could help Bitcoin become a global medium of exchange without sacrificing the security or decentralization of the Bitcoin network.
  • Although Lightning is fully functional, it is still in the experimental stage and should not be used for storing or transacting large amounts of money.

Bitcoin's scalability

Bitcoin's blockchain can only process an average of 7 transactions per second. That's not enough to make Bitcoin a suitable platform for handling the millions of transactions people make every day. And yet, it was designed that way on purpose. The reason for this lies in what is known as the blockchain trilemma. A blockchain can only credibly achieve 2 of the 3 goals below. Since Bitcoin is intended to be a global monetary system, the focus is clearly on decentralization and security, at the expense of scalability. Accordingly, Bitcoin has a relatively low transaction throughput.

Bitcoin Trilemma

Thus, if Bitcoin is to become a medium of exchange, payment systems must be developed that allow users to transfer Bitcoin quickly and inexpensively. The Lightning Network is such a payment system. It can already keep up with the well-known industry giants of payment service providers in terms of transaction volume. 

The basics

Super-fast transactions and low fees - the Lightning network potentially makes Bitcoin the payment method of everyday life. It is a decentralized system in which transactions are processed via payment channels outside the Bitcoin blockchain. Bitcoin, as mentioned, focuses on decentralization and security in order to be able to represent a monetary system that is as unchangeable as possible, which is why scalability and transaction speed in the protocol initially had to take a back seat. The Lightning network tries to solve exactly this problem of Bitcoin.

In the Bitcoin blockchain, every transaction is stored until eternity. Bitcoin scales slowly, and that is a good thing. This is the only way to guarantee the necessary security. Each block can only store a limited amount of transactions. This limitation keeps the required storage space of the individual nodes low, which prevents centralization of the network. This is what makes decentralization and security possible in the first place.

The Lightning Network is a second-layer protocol designed to enable off-chain bitcoin transactions that are not recorded in the blockchain. Since they are not recorded in the blockchain and thus do not require mining, Lightning payments are extremely fast and cheap.

With Lightning, two parties open a payment channel with each other. The Bitcoin contained in this channel are fixed until settlement, which is why an enormous number of fast transactions can be made in this channel. Think of it like a beer mat: a line is drawn for every drink, but the bill is only settled at the end of the evening.

Lightning Channels

Alice and Bob can make as many transactions back and forth as they want, as long as they don't exceed the capacity of their channel. But even more exciting, when Alice wants to send a transaction to Charlie, Bob can serve as the communicator because he has opened a payment channel to both parties. In keeping with Bitcoin's architecture, this too can be done without the two having to trust him. The Lightning transaction seeks the best path through the entire network.

A Lightning channel is thus a bidirectional payment channel with a certain maximum Bitcoin capacity. The basic building blocks of the Lightning network are nodes, which are network nodes, and the aforementioned payment channels that allow nodes to communicate with each other. Of course, not every node is connected to the exact node it wants to send a payment to.

So-called routing allows transactions between two unrelated parties to be handled through a set of pre-existing channels.

Work is ongoing daily to further develop Lightning to further simplify access in everyday life.

You can learn more about Lightning nodes and Lightning addresses in our blog article "Lightning Deep Dive". You can also find a more detailed explanation in this video on the Blocktrainer channel.

What are the advantages?

Anyone who has watched the fees for on-chain transactions, especially in recent weeks, quickly realizes that the Bitcoin blockchain is not made for recording all global microtransactions. Bitcoin is a digital money system that handles international transfers of value.

It is quite understandable that not every purchase of the morning coffee has to be stored in a decentralized cash book used worldwide. The Lightning network can be understood here as a payment system built on the Bitcoin digital money system. Lightning transactions are usually: 

  • Super fast - A transaction is completed in a few seconds. 
  • Very low cost - Lightning transactions usually have extremely low fees in the single digit Satoshi range.
  • Excellent scalability - millions of transactions per second are possible. In theory, the Lightning network can easily keep up with well-known payment service providers such as Visa and Mastercard.

What do I have to pay attention to?

The Lightning network is still at a very early stage, so we don't recommend using your Lightning wallet for your entire Bitcoin savings, insofar as they are a higher amount. Think of it like a piggy bank: at some point the piggy bank is full and it's a higher amount, so you take the money to the bank.

This is exactly how you buy bitcoin via Lightning every now and then in the future, and once you reach a certain amount, you perform a normal on-chain transaction and send the bitcoin to your (usually more secure) hardware wallet.

Still have questions about the Lightning network? Just contact our support or join our Telegram community where we discuss all kinds of Bitcoin topics.

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