The Lightning Network is a scalability solution built on top of Bitcoin, allowing users to quickly send and receive small amounts of Bitcoin with minimal fees. In simple terms, the Lightning Network functions as a second-layer solution for the Bitcoin network.
The Lightning Network conducts transaction processing off-chain, with only the final transaction result confirmed on the blockchain. This enhances the transaction efficiency of the Bitcoin network, enabling users to complete payments at reduced costs and faster speeds.
Bitcoin's native network can process only about 7 transactions per second, while everyday electronic payment systems can handle tens of thousands of transactions per second. This results in a subpar payment experience within Bitcoin's native network. The Lightning Network, on the other hand, conducts transactions off-chain and confirms the final results on the blockchain, significantly boosting transaction speed.
Bitcoin transaction fees follow a competitive bidding model. Users must pay a certain fee for each transaction, and miners prioritize and process transactions based on the fees offered. Transactions with higher fees take precedence, while those with lower fees are processed later. This means that during congested periods on the Bitcoin network, users may need to pay higher fees for their transactions to be executed promptly. In the past, average transaction fees on the Bitcoin network have reached as high as $60, and this year, due to the popularity of BRC-20 tokens, average fees briefly surpassed $30.
Due to the slow transaction speed and high transaction fees on Bitcoin's native network, using Bitcoin for everyday payments is not cost-effective. However, the Lightning Network has changed that. On the Lightning Network, transaction fees for a $100 transaction will not exceed 1 cent, greatly reducing transaction costs and making Bitcoin a feasible option for everyday payments.
Everyday payments often involve small, frequent transactions. Over the past three months, the average transaction fee on the Bitcoin network has hovered around $2. When the cost of fees may exceed the price of the item you are purchasing, Bitcoin becomes an impractical choice for payment.
The Lightning Network significantly reduces transaction fees, rendering the impact of fees on the price of your purchases negligible. This lowers the threshold for using Bitcoin in transactions.
The Lightning Network operates through payment channels, where users establish peer-to-peer payment channels to form the Lightning Network.
To conduct transactions, both parties establish a payment channel between themselves by sending funds from the initial transaction to a multi-signature address. This multi-signature address is managed using private keys from both parties and requires their signatures to create new transactions.
This multi-signature wallet serves as a duplicate record of the assets. Transactions generated by both parties are recorded in this duplicate. When the channel is closed, the results recorded in the duplicate are broadcast to the blockchain for final settlement, and the remaining balance is recorded on the blockchain.
Let's illustrate this with a simple example:
A and B want to transact via the Lightning Network. To do this, they must first establish a payment channel and store funds in the wallet for this payment channel. The wallet is jointly managed using the private keys of both A and B, and it can only be opened upon confirmation from both parties.
As mentioned earlier, the multi-signature wallet serves as a duplicate record of the assets. Transaction records between A and B are stored in this duplicate. When A and B no longer engage in transactions and choose to close the payment channel between them, the final transaction result between A and B is sent back to the Bitcoin network for confirmation.
Now, let's introduce a slightly more complex scenario by introducing a new participant, C.
A and B want to transact via the Lightning Network, but in this case, they do not have Lightning Network established between them. However, C has separate payment channels with both A and B.
In this situation, A and B can route their transaction from A to C and then from C to B, with C acting as an intermediary. While A and B cannot transact directly, C eliminates the need for them to establish a new payment channel between themselves.
The transaction ultimately occurs between A and B, but it is facilitated with the assistance of C, allowing C to set and collect a certain routing fee for facilitating the transaction between A and B.
4.1 Entry Costs: There are costs associated with entering the Lightning Network, making the process of transferring funds onto the Lightning Network relatively expensive.
4.2 Liquidity Issues: If your counterparty has no balance in the channel, you will not be able to receive or make payments. While specialized Lightning Network service providers now address this liquidity problem, it introduces potential centralization issues.
4.3 Vulnerability to Hacks: Payment channels, wallets, and application programming interfaces (APIs) are all susceptible to hacking attacks.
Despite its existing shortcomings, the Lightning Network continues to develop rapidly. As of now, there are over 16,000 Lightning Network nodes, and its promotion and popularization have made significant contributions to payments and social domains.
Social project Damus supports Lightning Network payment and tipping features. Digital payment platform Strike, in collaboration with Shopify, Blackhawk Network, and NCR, has established a Bitcoin payment system that allows merchants to swiftly receive USD after customers pay with cryptocurrencies. Following El Salvador's recognition of Bitcoin as legal tender, the Lightning Network has been promoted for use within the country.
The emergence of the Lightning Network represents a significant step toward enabling Bitcoin for everyday payments. Current issues are actively being addressed by Bitcoin community developers to further enhance the Lightning Network.
In conclusion, when we discuss second-layer networks, we often refer to Layer 2 networks on Ethereum. If you are interested in learning more about Ethereum Layer 2 networks, feel free to give "Understand Ethereum Layer 2 in One Easy Example" a read.