What is Lightning network
Massimiliano Silenzi
Enlightenments
9 Min read
The Lightning Network is a layer-2 payment protocol that runs on top of the Bitcoin blockchain. Lightning aims to provide a faster and cheaper way to transact on the Bitcoin network by enabling off-chain transactions. The main goal of the Lightning Network is to increase the scalability of the Bitcoin network. This is achieved by creating a network of payment channels between users that allows them to transact with each other without having to broadcast every transaction to the blockchain.
1. The Bitcoin Scalability Issue
Certain characteristics of Bitcoin (e.g. PoW consensus, block size and block size), which make it very secure and decentralized, also limit its ability to handle a high number of transactions per second. This scalability problem results in a bottleneck that can cause high fees and slow confirmation times [2]. It is estimated Bitcoin can only process 7 transactions per second [3] (compared to Visa which claims it can process up to 65.000 TPS).
2. How Lightning Network Resolves the Scalability Issue
The Lightning Network resolves the scalability issue by creating a network of payment channels between the users. These channels allow users to transact with each other without having to broadcast every transaction to the blockchain. Instead, they can update the balance of the channel on the Bitcoin blockchain only when they want to close the channel. This significantly reduces the number of transactions that need to be confirmed on the Bitcoin blockchain, thus allowing very fast transactions at extremely low fees [1].
3. How Lightning Network Works
The Lightning Network works by creating a network of payment channels between users. As explained, these channels are off-chain, meaning that they are not recorded on the Bitcoin blockchain (they are on a separate network). Users can transact with each other within these channels, updating the balance of the channels as they move funds between each other. When a user closes a channel, the updated balance is broadcasted to the Bitcoin blockchain. This process of closing a channel is called a “commitment transaction” and it confirms the final state of the channel on the blockchain [3].
4. Lightning Network Payment Example
An example of a Lightning Network payment would be two users opening a payment channel between them. Once the channel is open, they can make multiple transactions with each other, updating the balance of the channel as needed. For instance, User A has 3 Bitcoin and User B has 0.5 Bitcoin. User A sends 1 Bitcoin to User B, and the new balance of the channel is 2 Bitcoin for User A and 1.5 Bitcoin for User B. They can continue to make transactions back and forth within the channel, without having to broadcast each transaction to the blockchain. When they are ready to close the channel, they will broadcast the final balance of the channel to the underlying Bitcoin blockchain, which confirms the transactions that took place within the channel [5].
4.1 Buying products and services with Lightning Network
The Lightning Network offers different advantages for users looking to buy goods or services with Bitcoin. Transactions on the Lightning Network are fast, with near-instant confirmation times, and low cost. The fees on Lightning are approximately 1 satoshi (< 0.01 USD) [18], while the average on-chain Bitcoin transaction fee was as high as 4.74 USD in 2022 [19]. This makes Lightning a cost-effective and efficient option for buying goods and services. LN is especially suitable for micropayments, enabling users to make small, frequent transactions (useful for buying game credits, apps, products from online content creators, and products and services from micro-merchants) [1]. If you want to use the Lightning Network to buy gift cards from a wide range of global brands such as Nike, Amazon, and Apple or games such as Freefire, PUBG, and many others you can use the CryptoRefills platform. If you are not 100% familiar with using the Lightning Network you can find step-by-step instructions here on how to set up your Lightning Wallet and perform transactions to buy with Bitcoin from CryptoRefills via Lightning.
5. Lightning Network Enabled Wallets
In order to use the Lightning Network, users need to have a Lightning Network-enabled wallet. These wallets are designed to interact with the Lightning Network and allow users to open and close channels, make and receive payments, and manage their funds on the network. Some popular examples of Lightning Network wallets include Blue Wallet, Eclair Wallet, and Zeus Wallet [6].
6. Opening and Closing Lightning Network channels
Opening a payment channel on the Lightning Network requires users to fund the channel with Bitcoin. They can do this by sending Bitcoin from their regular Bitcoin wallet to the funding transaction of the channel. Once the channel is funded, it can be used for making transactions. Closing a channel can be done by broadcasting the final balance of the channel to the blockchain [7]. The process of opening a channel usually takes about 10 minutes [8].
7. Lightning Network Adoption
The Lightning Network has seen increased adoption in the past years. Lightning Network’s unique channels grew from less than a thousand channels in January 2018, to 33.000 unique channels in January 2021 [9]. On January 19th, 2023, the Lightning Network sees 77.243 unique channels [9], with an average capacity per channel of 6.488.636 sats per channel (appr. 1.532 USD per channel) and a total network capacity of 5.308 Bitcoin (appr. 110.514.383 USD) [9].
Due to the speed and low fees, Lightning Network is particularly suitable for using Bitcoin for everyday purchases and small transactions. Data from CryptoRefills Labs Report shows that in 2022, 42.1% of the crypto-consumers (people that use crypto to buy goods and services) consider themselves either knowledgeable or very knowledgeable about the Lightning Network [10]. This is a 10 percent increase in one year, as this ratio was 38.3% in the 2021 report [11].
Other interesting data from the CryptoRefills labs Report shows that in 2022 nearly 60% of crypto-users who consider themselves knowledgeable about the Lightning Network favor it as a payment option. Interestingly, half of the crypto-users would choose a store over another if the former offered payments via the Lightning Network [10]. This percentage is even higher (69.7%) among those knowledgeable about the Lightning Network. Additionally, those who use Lightning Network and other layer-2 protocols purchase crypto more often than the general crypto-consumer population [10].
There are different factors driving the adoption of Lightning Network. On one hand, the user demand for faster and cheaper payments, especially for everyday purchases drives consumer interest into the solution. The adoption of the Lightning Network has seen significant growth since El Salvador officially recognized Bitcoin as a legal tender, as reported by Bitcoin Magazine [12]. The investment on the offer side has also contributed to the growth of the ecosystem and demand, with exchanges like Bitfinex accepting Lightning Network deposits and withdrawals [12], companies like Strike receiving large funding to build services leveraging the Lightning Network [14], and gift card platforms like CryptoRefills operating Lightning Nodes and accepting Lightning Network payments for gift cards and mobile credit top-ups since early 2019 [15].
New generation Lightning wallets, easier to fund and operate, such as Phoenix wallet, also contribute to a smoother user experience, especially for the less tech-savvy and thus even wider adoption.
8. Advantages of the Lightning Network
The Lightning Network has several advantages over traditional on-chain transactions. Some of the main advantages include lower transaction fees, faster confirmation times, and increased scalability. Additionally, the Lightning Network allows for more privacy as it enables users to transact off-chain, which reduces the amount of data that needs to be recorded on the blockchain [16].
9. Lightning Network Criticism
Despite the many advantages of the Lightning Network, it also has its fair share of critics. Some argue that the network is still in its early stages and is not yet ready for mainstream adoption. Others point out that the network is still relatively centralized and that it could be vulnerable to attacks or failures if key nodes or channels were to go offline. Additionally, the process of opening and closing channels can be complex and requires a certain level of technical knowledge. Furthermore, the network’s routing mechanism has been criticized for its lack of decentralization, and some have raised concerns about the potential for censorship on the network [5] – [17].
It is worth noting that despite the ongoing development and criticism, the adoption and usage of the Lightning Network has been increasing and has shown to be a reliable and efficient solution for small and fast transactions on top of the Bitcoin blockchain.
Sources:
[1] Poon, J., & Dryja, T. (2016). The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments. Retrieved January 23, 2023, from https://lightning.network/lightning-network-paper.pdf
[2] NewsBTC. (2022, December 29). New Record for Bitcoin Lightning. Retrieved January 23, 2023, from https://newsbtc.com/news/bitcoin/bitcoin-lightning-network-capacity-strikes-new-all-time-high/
[3] Croman, Kyle; Eyal, Ittay (2016). “On Scaling Decentralized Blockchains” (PDF). Financial Cryptography and Data Security. Lecture Notes in Computer Science. Vol. 9604. pp. 106–125.
[4] Visa, “Visa Fact Sheet: What you need to know about one of the world’s largest payment companies”, Visa Inc., retrieved on January 14th, 2023 athttps://www.visa.co.uk/dam/VCOM/download/corporate/media/visanet-technology/aboutvisafactsheet.pdf
[5] Kaloudis, G., (2021, September 23). An in depth look into the lightning network as a bitcoin scaling solution. Retrieved January 23, 2023, from https://www.coindesk.com/reports/an-in-depth-look-into-the-lightning-network-as-a-bitcoin-scaling-solution/
[6] Beigel, Ofir (2023, January 24). Best Lightning Network Wallets. Retrieved January 26, 2023, from https://99bitcoins.com/bitcoin/lightning-network/wallets/
[7] Acheson, N., Nguyen, H., Biggs, j., Tan., E. (2022, December 6). What is Bitcoin’s Lightning Network? Retrieved on January 23, 2023 from https://www.coindesk.com/lightning-network-how-to-use-it
[8] Mamoria, M. (2017, November 15). Lightning Network, Explained. Cointelegraph. Retrieved on January 24, 2023 from https://cointelegraph.com/explained/lightning-network-explained
[9] BitcoinVisuals. (n.d.). Lightning Network. Retrieved from January 30, 2023 from https://bitcoinvisuals.com/lightning
[10] Çabuk, U. C., & Silenzi, M. (2022). Cryptocurrencies in Retail: Consumer Adoption Report 2022. CryptoRefills Labs.
[11] Çabuk, U. C., & Silenzi, M. (2021). Cryptocurrencies in Retail: Consumer Adoption Report 2021. CryptoRefills Labs.
[12] Bitcoin Magazine, (2022, September 7). The state of lightning one year after El Salvador’s bitcoin adoption. Retrieved on January 2023 at https://bitcoinmagazine.com/technical/lightning-ballooned-since-el-salvador-bitcoin-bet/
[13] Partz, H. (2022, April 15). Binance and Coinbase silent on Bitcoin Lightning: Community tries to understand why. Cointelegraph, retrieved January 2023 from https://cointelegraph.com/news/binance-and-coinbase-silent-on-bitcoin-lightning-community-tries-to-understand-why
[14] Coindesk. (2022, September 27). Jack Mallers’ Crypto Payment Firm Strike Raises $80M.Retrieved on January 2023 https://www.coindesk.com/business/2022/09/27/jack-mallers-crypto-payment-firm-strike-raises-80m-series-b/
[15] CryptoRefills. (2019, July 19). “Lightning Payment on CryptoRefills”. Retrieved on January 24th, 2023 https://www.cryptorefills.com/blog/lightning-payment-on-cryptorefills/
[16] Cointelegraph (n.d.). “What is the Lightning Network in Bitcoin, and how does it work?”. Retrieved on January 21 https://cointelegraph.com/bitcoin-for-beginners/what-is-the-lightning-network-in-bitcoin-and-how-does-it-work
[17] Henslee J., Resnick Z. (2022, August 29). “Why The Lightning Network Doesn’t Work”. Unbounded Capital. Retrieved on January 21st, 2023 https://unboundedcapital.com/blog/why-lightning-doesnt-work
[18] Le Claire D., Rule S., (2022, June 10). The State of Lightning Network Adoption. Nasdaq. Retrieved 2023, January 24 https://www.nasdaq.com/articles/the-state-of-lightning-network-adoption
[19] YCharts. Average Bitcoin Transaction Fee. Retrieved 2023, January 30 https://ycharts.com/indicators/bitcoin_average_transaction_fee