I pay increasingly close attention to the developments in Bitcoins life cycle. We have seen just how correlated the crypto markets are to the price of Bitcoin and thus as a trader in this space BTC is very important to understand.
Many speculators, investors, technologists and newbies to the market question what Bitcoin is actually good for. I always say its a great store of value but people demand more as its price, and the stakes, keep rising.
When Bitcoin hit the scene in 2009, it was thought of as a new kind of money. But as more people started using Bitcoin, the network became slower and more expensive; now, high fees have effectively priced out less costly uses of Bitcoin like buying groceries. Over the last several years, the developer community has considered a couple solutions to the problem, one of them being the Lightning Network.
You may have heard about the Lightning Network already, because an alpha version for public testing was released on January 10, and what may be the first-ever Bitcoin purchase was conducted using it on Saturday; it was a VPN service. This made a lot of people very excited, because even though the Lightning Network isn’t ready for mainstream use, it seems like it’s getting closer.
If the Lightning Network succeeds, then Bitcoin could become faster and cheaper to use, allowing it to make a stronger case for itself as being the supreme blockchain versus newer competition like Ethereum and Bitcoin Cash. But just what the hell is it?
A Bitcoin transaction is best thought of as a message that’s posted to the blockchain, which is a ledger secured by computers that have to do some serious math to add the next entry. Bitcoin is slow and expensive because every message, no matter how small, has to be computed and shared with all of the computers in the network.
It’s a pretty wasteful system, but what if you could post only the most important messages to the Bitcoin blockchain, and in batches as opposed to real-time? If that were implemented, the thinking goes, the way we use the blockchain now might one day seem like drilling a new oil well just to pump a tank’s worth of gas. So, developers Joseph Poon and Thaddeus Dryja proposed the Lightning Network in 2015.
The Lightning Network lets Bitcoin users create “payment channels” with each other. In these channels, Bitcoin transactions can be sent without the normal wait times, because the transactions aren’t committed to the Bitcoin blockchain. Instead, the Lightning Network keeps record of transactions without finalizing them, and later sends a message describing only the final balances of the channel to the Bitcoin network as a regular transaction, closing the channel and securing the balance on the blockchain.
This system cuts down on the number of messages that the Bitcoin network has to process, since only these important messages finalizing many smaller ones are included in a Bitcoin block—chronological entries that, together, make up the blockchain.
In practice, it looks something like this: Sara connects with her friend Dave, whom she frequently sends money to, over the Lightning Network to set up a payment channel. To begin, one (or both) of them puts up an initial amount of Bitcoin that “funds” a coded contract that’s shared between them. That contract is broadcast to the Bitcoin network as a transaction and the funds are secured on the blockchain.
Now, Sara and Dave can spend as much as they’d like from that contract balance by creating new transactions to and from each other. These subsequent transactions aren’t recorded on the Bitcoin blockchain, though—instead, the changes are recorded in a micro-ledger shared between Sara and Dave. This is a payment channel, and for as long as it’s open transactions between Sara and Dave are instant, since they don’t have to wait to be included in a block of Bitcoin data, a process that can take anywhere from ten minutes to hours.
The payment channel is “closed” later (the Lightning Network’s contracts largely depend on time delays) when a transaction detailing the ledger’s final balance is broadcast to the Bitcoin blockchain. Many transactions may have taken place between Sara and Dave in the time the channel was open, but the Bitcoin blockchain only records two: the creation of the payment channel, and its closing.
It’s important to remember that this is all being done with real Bitcoin transactions, they’re just not secured in a block on the blockchain except for the first and last entries. The balance isn’t “real” until it hits the blockchain, though, so it’s all funny money (well, funnier than usual) until the payment channel is closed out. Until then, a payment channel is just a running list of IOUs. Trippy, right? There’s more.
Creating a new payment channel for every transaction would be just as wasteful as requiring the blockchain to compute every little message. This is where the Lightning Network gets the “network” part of its name.
Payment channels are linked together, and new transactions can be routed through existing payment channels instead of creating a new one every time. Not only are Sara and Dave’s transactions happening in their payment channel, then, but other people’s transactions as well. This isn’t a charity: routing a Lightning Network transaction incurs a fee paid to the channel owners, but it’s predicted to be extremely small.
The end result is a network of payment channels that can process potentially huge amounts of Bitcoin transactions without needlessly stressing the blockchain. If the Lightning Network becomes large enough, the effect could be less congestion on the Bitcoin blockchain and lower fees. Many (or even most) Bitcoin transactions would be happening on the Lightning Network, and only finalized on the blockchain.
There’s more to the Lightning Network in terms of nitty-gritty details, but after reading the above you should be armed with the high-level knowledge you need to know what’s going on amid all the hype.
And yeah, another thing: Hype. It’s important to remember that the Lightning Network is highly experimental (even more so than Bitcoin itself). It is still in the alpha stage, even though the network is currently live for public tests. Basically, it’s a “buyer beware” kind of deal at the moment. There’s no telling when the network will be enterprise-grade, although the recent Bitcoin purchase conducted using the Lightning Network is encouraging.
Finally, we already know what happened to another scheme that Bitcoiners had hoped would alleviate some of the blockchain’s technical woes: A code change called “segwit.” In August of last year, Bitcoin’s code was updated to accept segwit transactions with much fanfare. But to date, segwit has not been widely adopted and in turn hasn’t made much of a dent. And many remain skeptical about “off-chain” solutions like the Lightning Network, instead preferring “on-chain” scaling that processes every transaction individually but increases the size of blocks, theoretically reducing congestion.