Miners must validate each transaction on the bitcoin network using computers to crack complex mathematical problems. Once they do, they can permanently add a new block of information to the blockchain, including all recent bitcoin transactions, completing the payment process
Unfortunately, not everyone who attempts to solve problems on the network gets rewarded. Only the first to the punch receives bitcoin in compensation, disincentivizing effort. Furthermore, it takes time for computers to actually solve problems and add new blocks to the blockchain, delaying transactions even more.
Fortunately, there is a solution: the Lightning Network. This protocol operates as an added layer on top of bitcoin, helping to speed up transactions.
What Is It?
You can think of the Lightning Network as a direct peer-to-peer transaction method that temporarily negates the need for miners to add new blocks to the bitcoin blockchain to complete payment. Transactions can occur outside of the bitcoin network, eliminating the blockchain’s scalability issues. (At launch, the bitcoin network could only process around seven transactions per second, well below either MasterCard or Visa’s capabilities).
How Does It Work?
The Lightning Network creates a small peer-to-peer payment channel between two trustless parties who want to exchange in Bitcoin. Once in place, buyers and sellers can send as many transactions as they want between each other, creating a mini ledger for paying for small goods, such as coffee or sundries from a corner store.
To create a payment, the buyer must allocate Bitcoin to the Lightning Network. Once they do, the receiver then invoices them for the amount requested. They can continue requesting funds for future transactions so long as the buyer has a positive balance.
Critically, when parties exchange on the Lightning Network, they don’t have to inform the main blockchain. And because they don’t need to seek approval by all nodes in real-time, transaction times speed up dramatically.
Once all transactions on the Lightning Network are complete, it consolidates them into a node and sends them to Bitcoin’s mainnet for conventional recording. Dozens of small transactions arrive on the primary ledger in bulk, rather than one at a time.
- No minimum payments
- Lower fees
- 100 percent anonymous transactions
- Significantly faster than conventional bitcoin transactions
- Buyer dependent on the seller to transfer funds rapidly
- Offline transactions not supported
- Lower fees may damage the long-term viability of the bitcoin network
Despite concerns, the use of the Lightning Network is on the rise. According to recent estimates, there are now more than $110 million worth of assets locked into the scheme, indicating increased usage.
Having only been introduced in 2018, the Lightning Network is still relatively new. Because of this, DeFi integrations and cross-compatibility with existing bitcoin-related services and e-wallets are limited. However, in the future, that will change. For instance, various crypto exchanges are working on bringing the technology to traders, allowing them to make faster transactions and withdraw smaller amounts, instantly and cheaply.
Watchtowers, third-party services comprising multiple specialized nodes, are also going to become more prevalent. These constantly monitor channels, eliminating the risk that comes with leaving them unattended, in exchange for a small fee. If they detect any malicious activity, they will automatically freeze funds and then return them to the buyer, even if they are offline.