The Lightning Network - Will It Push BTC to 100k and Beyond?

The Lightning Network - Will It Push BTC to 100k and Beyond?

By ga38jem | Crypto Events | 23 Oct 2021


So with the recent Bitcoin explosion I wanted to write an article about the lightning network. It is well known that the Bitcoin blockchain lacks scalability and that is what the lightning network wants to address. In this article we will take a look at the functionality of this network, how it could adopt and what potential issues could be.

 

What is the Problem?

In order to understand the functionality of the lightning network, we have to understand some Bitcoin basics first. I am pretty sure that most of you are familiar with them but for the articles sake I will reiterate them real quick. Like I mentioned in the introduction the main issue with the Bitcoin blockchain is that its speed or scalability is not very high, allowing only around seven transactions per minute. This is due to the average block size and block time. The Bitcoin network is a blockchain which is a distributed record of transactions that is shared by all computers connected to the network. These transactions are batched into blocks. Each block is only one megabyte large this means that around 2700 transactions can fit in each block.

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Because of this limited space, there are transaction fees to incentivize the computers verifying the transactions. You already now it, they are called miners. When you divide the block creation time of about 10 minutes you would get about seven transactions per second.

Now given these facts, a simple solution could be to increase the block size or increase the block time or even both. This is what many Bitcoin forks have done. The problem with this solution is that it compromises the security of the network. If the block size is too large, only a handful of computers would be able to store the full history of the BTC transactions. If the block time is too fast it limits the number of computers that can verify transactions on time. There would be another solution, and this would be to process the transactions somehow outside of the bitcoin network. And this is exactly where the lightning network comes in.

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Functionality of the Solution

So this is probably the part that you all came for so let’s look at the functionality of this lightning network. Unlike most layer 2 networks this network is not a blockchain. Instead it consists of a series of interconnected payment channels created by two parties on the bitcoin network. This can be explained in more detail by an example.

Let’s assume you have a store that you are going every day. Because you visit the store every day the owner of this store does not always make you pay at the end of every shopping. The owner keeps a record of how much money you owe him. Additionally, you are helping out in this store part time. This would keep the owner also on his record. At the end of each month he asks you to pay the difference of what you still owe him minus the benefits you got through helping out in the shop. This payment record with the owner would not be all that different from the payment channels that we would find on the lightning network.

This would mean that the owner and you have agreed on settle the difference by paying it out in BTC an you both agree that you will use the lightning network. This would result in the creation of a payment channel on the Bitcoin Blockchain. This involves something called a multi signature wallet. This would work like follows. First, both of you have to deposit a BTC amount into this multi-signature wallet. This amount must be worth the same or more than you expect to transact next month. This transaction then creates a payment channel which allows you to transact the BTC between each other instantly as many times as desired for next to nothing.

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The reason for the low transaction fees is that the transacted currency is not the real BTC but a digital “IOU” (I owe you) of payments like the physical “IOU” record when you use regular money. Putting it a different way: We are just adjusting the end amount of BTC that both of the transactors would get when the payment channel is closed at the end of the month. It might help to think of it as sort of receipt. And because we are only passing around digital data the real limiting factor to this are the computer hardware and the internet speed. This would make transactions on the lightning network very fast. When the month is over the BTC in the multi-signature wallet is sent back to each of your own BTC wallet addresses based on the balance of the final digital “IOU”. This would result in two Bitcoin transactions on the Bitcoin Blockchain. The initial deposit at the beginning of the month and the payout which I mentioned right now. This would also result in the closure of the payment channel. Note that these payment channels could also be kept open as long as you want and can be closed by both or just one party.

The interconnections of this network make the lightning network a global network and not just a two-way street between two people. Let’s assume there is another regular costumer of this store. This other customer has a BTC payment channel open with the store owner as well. Furthermore, he has a payment channel open with your local barber. Let’s also assume that you would like to try out this barber but you don’t want to open up another BTC payment channel with him. Here, the abilities of the lightning network come in handy! Instead of figuring out a way to open up a payment channel with the barber your BTC payment for the hair cut can make it to the barber via the payment channels that connect you both together. In this case: You -> Store Owner -> other customer -> Barber. This payment would find the quickest way of reaching its target, like a real lightning within the atmosphere.

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Furthermore, the payment channels are secured by a technology called hashed time locks. Without getting too technical this involves exchanging a secret code with the end recipient first before nay BTC is sent. Once that password is successfully exchanged the corresponding amount of BTC is transferred. The more payment channels there are the faster and more far-reaching the lightning network is. This connectivity means it is possible for the whole planet to use BTC as digital cash.

Growth & Adoption

With all theses features, it is no surprise that this network has grown exponentially over the past months. This pace of adoption picked up when the wallet developer “ZAP” released the now famous strike app. Zap is the company that helped the government of El Savador make BTC legal tender. This could also be seen in the graphics below. The BTC adoption in El Savador started in September and there you can see an exponential rise of the toral value locked in the network because of the rising transactions.

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With this being said the adoption since the beginning of the year has picked up pace due to several big companies and exchanges adopting this network to their payment channels. One of these exchanges is Kraken.

 

Potential Issues

Now all of this sounds too good to be true. And the thing that I learned so far is that nothing good comes without a drawback. The lightning network has had its fair share of issues and not all of these have been resolved. More than a handful code vulnerabilities have been spotted since the network launched. That said, the biggest problems are not technical. Unfortunately, they are structural. For starters: Depositing BTC into a multi-signature wallet to create a payment channel makes that BTC much harder to sell since it often needs to be transferred to the Bitcoin blockchain first before it can be exchanged for fiat. This will become less of an issue over time as more fiat pathways like exchanges integrate the lightning network. Further on this note, if the price off BTC suddenly pumps or dumps very extremely it could be a possibility that a lot of payment channels could be closed because the participants would sell their BTC because of profit or panic. Another problem is that the amount of the BTC on the node has to be equal or larger than the BTC amount being send. This makes it very hard to send a big amount of BTC.

When you combine these problems with the cost of opening and closing payment channels you end up with a lightning network that is remarkably centralized with most traffic taking place through custodial intermediaries that are not that much different from banks. This has historically been one of the biggest criticisms of the lightning network. But this has also been improving as time goes on.

This brings up the question. If it is not very beneficial to have these payment channels open, what brings the individuals and institutions to provide this service? When a product is for free, the users are the product. In the case of the lightning network it is likely that most of the companies operating custodial lightning wallets and services are closely tracking their users transactions which is probably happening on the lightning network itself through so called “watchtower nodes”. The thing with these nodes is that they can only track the transactions going in and out of this particular node which , in my eyes, makes the tracking very much senseless.

 

Conclusion

To conclude this article, I want to say that I tried my best to keep everything as short as possible. I really hope it was more or less understandable. With this being said I really think that we are on the edge of the next step in the technological evolution, and it excites me to be part of this evolution. Like always, feedback is very much appreciated and welcome!

 

Published by ga38jem on

Publish0x|LeoFinance|Steemit|read.cash

On 23rd October 2021

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ga38jem
ga38jem

Hi there! I am a very active person and like to do a lot of sports. One of my hobbies is also the crypto market and I like to write about recent events and trends :)


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