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What is the Lightning Network?

What is the Lightning Network?

The Lightning Network is a protocol ‘layered’ on top of the Bitcoin blockchain.  Think of it as an expansion pack for your favourite video game.  Bitcoin can function without the Lightning Network, but the Lightning Network cannot function without Bitcoin.

Why do we need it / what problem does it solve?

In its current state, Bitcoin does not function as originally intended.  With the rapid rate of growth seen in recent years, the network is suffering from increasing levels of congestion.  This means that Bitcoin as we know it is not scaling well.

With miners being presented with so many transactions, how do they prioritize which transaction to complete first?  The solution thus far has been for the sending party to pay a transaction fee larger than the next person in line.  This has resulted in a bidding war of sorts – fighting for the attention of miners.  These high transaction fees are not worrisome if you are transferring large sums of money.  After all, who wouldn’t pay an extra few dollars to ensure their 20 BTC transaction arrives just that much quicker.  This however makes using the network for small, micro-transactions impractical.  Who is going to want to pay a fee larger than the cost of their morning coffee, and have to wait hours for the transaction to be approved?  Your morning coffee just turned into your afternoon coffee, and you now need to work overtime to pay it off.

Enter the ‘Lightning Network’.  Aptly named, it is a solution with the goal of making these transactions ‘lightning fast’.  By simply addressing the speed of the network, it has a multi-pronged effect.  If the speed of transactions can be improved, then the congestion on the network will be eliminated.  You will no longer be vying for the attention of miners – thus eliminating the bidding wars, and reducing transaction fees until they are negligible.  In addition to this, there is increased privacy in the process.  Although not a true privacy coin, it is a great improvement over the current method of broadcasting everything on the main blockchain.

Aside from the technical reasons for why a solution such as Lightning Network is needed, there is also a need to gain more public trust.  As resilient as Bitcoin may be, it has taken a beating in the past year, with disagreements on the future direction of the coin.  This has resulted in multiple hard-forks over this time, and simply led to a lessening of trust in the biggest cryptocurrency.  If Bitcoin can’t get their act in gear, what hope does the rest of cryptocurrency have?  A seamless, successful integration of the Lightning Network will do wonders for restoring a lot of lost faith in this wonderful project.

How does the Lightning Network Work?

As stated before, the Lightning Network is a protocol functioning on top of the Bitcoin blockchain.  The benefits of this (speed/fees/privacy), are attained by introducing off-chain payment channels.  Currently, any transaction that takes place on the Bitcoin network, is recorded in fine detail on the blockchain.  Everything is being recorded on-chain.  By moving this data off-chain, the congestion on the main network is greatly reduced.

A single payment channel can be thought of as a pool of money created between two parties.  Upon opening a channel, each party contributes to the pool.  This is recorded on-chain.  These two parties can then send/receive money between one another multiple times.  It is only once they part ways and ‘close the channel’, that the final balance of money for each is recorded on the blockchain.  The multitude of transactions completed between the two that resulted in the final balance is redundant data, which is no longer needed.

The Lightning Network utilizes a decentralized network of multiple payment channels in unison.  This is achieved using something called HTLC (hashed time-locked contracts), and multi-sig wallets to perform these off chain transactions.

Simply put, if Alistair wants to send money to Clinton, but they do not have a channel open between themselves, how can they facilitate a transaction between one another without opening a direct channel?  To do so, they find a common intermediary between one another that has a channel open with each.  In this example, they each have a channel opened with their mutual friend Bertha.  They would then utilize Bertha (who would receive a nominal fee for staking coins) to facilitate the transaction.  Rather than Alistair sending money straight to Clinton, the money will hop to Bertha, who will forward it to Clinton.

This is where increased privacy comes into play.  Lightning network will utilize something dubbed ‘Onion Routing’.  In the above example, the data packet representing value being sent from Alistair to Clinton is said to ‘hop’ from Alistair to Bertha to Clinton.  Similar to peeling layers off of an onion, each hop is a different layer.  The Lightning Network strives to achieve up to 20 hops per transaction.  Each party only knows who sent the data packet, and once they peel their layer upon receiving the data packet, the next party that it will forward the data to.  It does not know if the sender is the origin point, or if the recipient is the final destination.  They can only see the hop immediately before and after their point of participation.  They could be the 2nd hop in a 20 hop process, or the 13th, or the 19th.

As the network grows, less channels will need to be opened, as the likelihood of having a shared channel between the sender and recipient is increased with a potential 20 hops in between.  By using many degrees of separation between senders/recipients, the much loved decentralized nature of the blockchain is maintained.

This whole process of completing transactions off-chain, utilizing multiple hops along the way, achieves the goal of increased transaction times through a reduction of congestion. In addition to this it achieves reduced fees by eliminating the resulting bidding wars from said congestion.  Finally, privacy is attained by introducing Onion Routing.

By basically ‘trimming the fat’ off of the multitude of transactions that take place every day, Bitcoin can take a huge step forward.  Instead of making block sizes bigger (a proposed solution seen in Bitcoin Cash), the amount of data recorded on the main chain is reduced.  Lightning Network doesn’t add lanes to the main highway, it creates on/off ramps leading to secondary highways, thereby reducing traffic on the main highway.

How will the Lightning Network be Implemented?

The implementation of the Lightning Network should be relatively seamless.  This upgrade to Bitcoin is not contentious like the soft and hard forks of days past.  It is generally agreed upon that this is the best next step for Bitcoin.  Unlike a hard fork (changes to the source code that cannot be retroactively applied to the existing main chain, such as the block size jump seen in Bitcoin Cash), and a soft fork (changes to the source code that can be retroactively applied to the existing main chain, such as the upgrade seen with Segregated Witness), Lightning Network does not alter the existing source code.  As stated previously, it is a layered solution that functions on top of the existing blockchain.  This ability to function as a 2nd layer also means that activation is relatively easy.  Lightning Network does not require a certain percentage of miners to agree before implementation.  Although miners may not like the idea of the Lightning network (reduction in congestion means less fees, and less money in their pockets), this could be a good thing.  Mining has become an expensive venture, and more centralized than preferred in the past year.  This will help bring more decentralization by allowing intermediaries to take part in the transaction process by staking coins, and collecting fees themselves along the way.  Anyone, at any time, can begin hosting a Lightning Network node.  For the end user, nothing is needed on their part other than utilizing a wallet that is Lightning Network enabled.  To take advantage of this network, they simply need to be interacting with a node that has implemented the upgrade.

Is anyone else using the technology?

This may all sound revolutionary, however the Lightning Network is nothing new.  This concept was successfully introduced, and has been in use for some time on the Litecoin network.  We have seen that this can successfully work.  Litecoin has shown us that.

In addition to this technology already being implemented on Litecoin, it has been in development by multiple companies on the Bitcoin blockchain for months.  These companies got together and agreed upon a set of parameters that would ensure interoperability between the various means of implementation that each would develop in the coming months.  These parameters are known as ‘BOLT’.

When will it be implemented?

As of early January 2018, many nodes began testing Lightning Network.  There have even been a few trailblazers that have decided to test the functionality on the main net such as VPN provider Torguard.  Although the test hasn’t been 100% perfect, everything is very promising with over 400 nodes showing adoption now.  These users, however, must recognize that the code is not a finished product.  Those currently using the Lightning Network run the risk of losing funds as bugs are discovered and fixed.  It is these individuals that will find the bugs, and work out the kinks so that hopefully in the coming months, a finished product is ready for widespread deployment.

What effect will it have on alt coins and itself?

This is unknown.  This could become a boon to other Alt-coins, as it can allow for atomic swaps to occur.  Or it could hurt others, as Bitcoin becomes more flexible, and more powerful, reducing the need to look for a solution elsewhere.  Only time will tell.

Why do we care?

Love it or hate it, Bitcoin is the big dog that is known above all other cryptocurrencies by the world.  The success of many Alt-coins is currently dependent on Bitcoin.  Although this won’t always be the case, Bitcoin currently underpins the entire crypto sphere.  Lightning Network will be a step towards making BTC a functioning digital currency (right now it is only practical for very large sums of money, as micro transactions simply take too long to process), rather than simply a store of value.  A large step at that.