The Lightning Network is a second layer added to the Bitcoin network, allowing transactions between parties outside of the main blockchain, called off-chain transactions. Lightning Network has often been touted as a revolutionary element in the evolution of cryptocurrency. It is designed to speed up transaction processing times and reduce costs associated with the Bitcoin blockchain. The Lightning Network was designed by two developers, Thaddeus Dryja and Joseph Poon in 2015.
Although the Lightning Network has seen growth and development since its inception, challenges remain. Bitcoin price fluctuations have prevented crypto from becoming a widespread payment method for consumer and business transactions. There are also costs associated with using Lightning Network.
Here we highlight what the Lightning Network is designed to solve and three problems it faces. We also review recent developments that could impact and improve the network in the future.
Key takeaways
- The Lightning Network is a second layer added to the Bitcoin network, allowing transactions to be carried out outside the blockchain.
- The Lightning Network is designed to speed up transaction processing times and reduce costs associated with the Bitcoin blockchain.
- However, the Lightning Network still incurs costs and may be subject to fraud or malicious attacks.
- Bitcoin price fluctuations may prevent crypto from becoming a popular payment method, thereby limiting the use of the Lightning Network.
Understanding the Lightning Network
As Bitcoin increases transaction volume, more are processed on its blockchain network. This poses problems because blockchain, in its current state, is not designed to scale or process the volume of transactions being made.
Bitcoin's Scalability Problem
The Bitcoin blockchain and network are designed to process a block approximately every 10 minutes. Transactions are sent to a work queue, where they are prioritized based on the amount the user paid in fees. The more transactions, the longer the queue.
As a result, Bitcoin faced a scalability problem, meaning there are challenges when the network tries to process more transactions simultaneously. For Bitcoin to process more data, the network must scale, allowing more transactions to be processed faster and more efficiently.
This network latency has led to higher transaction fees as miners take longer to validate transactions as users pay more to prioritize them.
What it is designed for
The Lightning Network is a separate blockchain that operates in conjunction with the Bitcoin blockchain. In a nutshell, the Lightning Network allows participants to transfer bitcoins between each other much faster using payment channels. Channels can remain open for further payments or closed after the transaction is complete. Instead of waiting for the mainnet to finish its queue for the payment to be transferred (which sometimes takes over an hour), the Lightning Network allows users to send and receive payments in seconds .
1. It doesn’t solve Bitcoin’s transaction fee problem
Lightning Network is often touted as a solution to the problem of rising Bitcoin transaction fees. Its supporters claimed that transaction fees, one of the direct consequences of the overcrowded Bitcoin network, would decrease once the technology removed transactions from the main blockchain.
But Bitcoin congestion is one of the many factors that influence its transaction fees. When the Lightning Network was integrated in 2018, expectations for lower costs and faster transactions were high among users, but as the chart below shows, average Bitcoin transaction fees have increased. There could be many reasons for this, but it demonstrates how ineffective the Lightning Network was at reducing fees.
Blockchain.com
Lightning Network Fees
In addition to standard on-chain transaction fees, users are charged for opening a channel with a routing node. The routing node operator charges a fee for providing the Lightning channel to the mainnet. The fee consists of a base fee and a tariff, both chosen by the operator. The base fee remains consistent unless manually changed, and the rate is a percentage of the transaction value.
So a node operator could set the base fee at one satoshi and the rate at 0.1%. If a user wants to send 1,000 satoshi through this node, they will need to pay 2 satoshi to the node (fees on the Lightning Network can be measured in milli-satoshi increments, so payments can actually be very small).
Lightning fees are generally low because hosting a node is a competitive business. Fees should be low enough to attract users, but high enough to provide benefits to the host. If they are too low, there may be no reason to operate a node; if they are too high, users will likely choose a cheaper node.
Interestingly (and regardless of node fees), by design, the Lightning Network has fees built in to try to reduce overall fees.
2. Staying online at all times makes nodes sensitive
Lightning Network nodes must be online at all times to send and receive payments. Since the parties involved in the transaction must be online and use their private keys to connect, it is possible that the coins could be stolen if the computer hosting the node were compromised.
Offline transaction risk
Going offline creates its own set of problems on the Lightning Network. According to Dryja, it is possible for one of the two parties in a payment channel to close the channel and pocket funds while the other is away. This is called fraudulent channel closure. There is a time limit for contesting the closure of a channel, but a prolonged absence of either party could cause this time limit to expire.
Malicious attacks
Another risk to the network is congestion caused by a malicious attack. If payment channels become congested and there is a hack or malicious attack, participants may not be able to get their money back quickly enough due to congestion.
According to Dryja, “forced expiration of many transactions may pose the greatest systemic risk when using the Lightning Network.”
If a malicious party creates many channels and forces them to expire simultaneously, which would broadcast across the blockchain, the congestion caused could overwhelm the block's capacity. A malicious attacker could use congestion to steal funds from parties who cannot withdraw their funds due to congestion.
3. Bitcoin Price Fluctuations
The Lightning Network is also expected to herald the viability of Bitcoin as a medium for everyday transactions. Customers can open payment channels with companies or people with whom they frequently transact. For example, they can open payment channels with their owner or favorite e-commerce store and transact using bitcoins.
However, Bitcoin has less appeal as a traditional payment method than as an investment instrument. The increase in trading volume is mainly attributed to an increase in trading volume. In other words, the popularity of Bitcoin among traders and investors is increasing its popularity. volatility– or price fluctuations – as well as network congestion and the influence on tariff increases.
Recent Lightning Network Developments
There remain challenges with Bitcoin's Lightning Network and its ability to increase scale while simultaneously reducing transaction fees. However, the core technology team incorporated new use cases and researched additional features. As a result, significant developments have taken place in an attempt to improve the network.
Larger payments via Lightning Network
Lightning had initially limited the channel size to a maximum of 0.1677 BTC, but in 2020 it was announced that the constraints would be removed so that customers could have larger channels. These “Wumbo” channels are designed to increase usage and utility of Lightning Network for consumers and businesses.
Cryptocurrency Exchanges
One of the most promising initial use cases is for cryptocurrency exchanges and financial services platforms. For example, Kraken and Block's Cash App have integrated the Lighting Network. In September 2023, Coinbase CEO Brian Armstrong announced that the exchange would integrate the Lightning Network. As one of the largest cryptocurrency exchanges, this is a significant development for the network.
Watchtowers
Watchtowers are third parties that work to prevent fraud within the Lightning Network. For example, if Sam and Judy are making a transaction and one of them has malicious intentions, they may be able to steal the other participant's coins by shutting down the channel.
So, let's say Sam and Judy made an initial deposit of 10,000 BTC and a transaction of 3,000 BTC took place in which Sam purchased goods from Judy. If Judy logs out of her system, it opens the door to possible fraud. Sam could broadcast the initial state, meaning they both get their initial deposits back as if no transactions had been made. In other words, Sam would have received goods worth 3,000 BTC for free.
This process of closing the channel based on the initial state versus the final state in which all transactions were carried out is called fraudulent channel closing. The watchtower monitors transactions and prevents fraudulent channel closures by forcing the offending party to close. It broadcasts a revocation transaction and makes them lose their channel balance to the other party.
Is the Lightning Network part of Bitcoin?
The Lightning Network is a layer 2 (a blockchain that assists a main blockchain) to the Bitcoin blockchain. It was integrated into Bitcoin in 2018.
How do you use the Bitcoin Lightning Network?
To transact using the Bitcoin Lightning Network, you will need to use a Lightning-enabled wallet.
How fast is the Bitcoin Lightning network?
The Lightning Network would be capable of processing millions of transactions per second. The main Bitcoin blockchain can process around seven per second.
The essential
The Lightning Network is a tool that could make a significant difference to the Bitcoin blockchain. However, the network might not solve all the challenges facing Bitcoin. Although improvements are being made, potential new issues exist within the cryptocurrency ecosystem as it is an ever-evolving technology.
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