In today’s post, we are going to take a look at the Lightning Network, a layer 2 blockchain technology that aims to become the payment network for cryptos such as Bitcoin (BTC). The goal is to provide faster and cheaper transactions than can be achieved on the underlying blockchain.
For the usual disclosure, I am not a financial advisor, I don’t even work in finance at all. My day job is as a telecommunications software engineer. Treat everything you read here as some educational resources and not financial advise.
What Is The Lightning Network
The lightning network is a layer 2 payment protocol that runs on top of other blockchains in parallel. It’s primary goal is to address two major issues with cryptocurrencies such as Bitcoin (BTC), which is scalability and transaction costs. It’s network is made up of decentralized nodes, to facilitate micropayments, something that has not been feasible on the larger blockchains for awhile.
Instead of every transaction needing to be done directly on the blockchain, and thus incurring a network fee, the lightning network will setup a payment channel between two parties, who both put up a certain amount of crypto. These two parties can then exchange the amount that is stored in this wallet, back and forth with each other, and not incur any additional fees. These transactions also only exist within the payment channel, and are not tracked on the blockchain. At some point, a closing transaction will be done which will settle out the wallet between them, and put a transaction onto the blockchain to update the actual balances accordingly.
Why Do We Need The Lightning Network
The Lightning Network, or at least something similar to it, will be needed before we can see a cryptocurrency like Bitcoin (BTC) being able to be used for small payments, like ordering a coffee or paying for a meal. Currently, we take the time it takes to process a transaction on the blockchain, plus have the necessary confirmations blocks to also go through, add a dash of the bottleneck in the number of transactions that fit within a block, and then we throw in the transaction fee, and it’s just not feasible to use it for small payments.
The Lightning Network addresses these by having two parties open a payment channel between them, which can be used to perform multiple transactions, up to the limit of however much crypto was put into the payment channel when it was created. This addresses multiple issues, as the time it takes to setup the payment channel only has to be done once, and then further transactions can completed very quickly.
Payment channels can also be chained together to form the larger network, allowing funds to move between multiple wallets to arrive on the other side, generally choosing the shortest and fastest path. The would allow a trustless system where payments can move between different channels seamlessly in order to arrive on the other side.
There are also only two transactions that occur on the actual blockchain, when the payment channel is opened/funded, and when it is closed/settled, so this cuts down on the transactions that occur, so the transaction fees are also minimized.
There are also some features that are planned, like atomic swaps, which would allow you to convert one crypto into another directly, providing both shared the same underlying encryption algorithm.
There are of course cryptos out there that aim to address these things directly, such as Bitcoin Cash (BCH), which uses a larger block size to allow for a greater transaction speed and lower costs, by just having more transactions go through at the same time.
While slow adoption has kept the Lightning Network from blowing up, someday some layer 2 solution like it is going to need to exist if a crypto such as Bitcoin (BTC) is going to stand a chance at being used as a large scale payment system. El Salvador will be a good test of that as they adopt it as legal tender, and let’s hope it is up to task. If not, Bitcoin (BTC) may end up being just a store of value like gold, and something like Bitcoin Cash (BCH) takes over as the preferred choice for day to day purchases.
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Originally Posted On My Website: https://ninjawingnut.xyz/2021/07/02/lightning-network/