What is the Lightning Network?

By October 7, 2022October 10th, 20224 minute read

The Lightning Network is an additional layer added to the blockchain of Bitcoin (BTC) that permits off-chain transactions or exchanges between parties outside the blockchain network. The 2nd layer comprises various payment channels between parties or Bitcoin users. In a two-party transaction technique known as a Lightning Network channel, parties can send or receive payments from one another. By managing transactions outside of the blockchain mainnet (layer one), layer two increases the scalability of blockchain applications while still utilizing the mainnet’s robust decentralized security paradigm.

Scalability is a significant barrier to the widespread adoption of cryptos. However, when scaled properly, a blockchain network can process millions to billions of transactions per second (TPS). In this sense, the Lightning Network allows for novel use cases like quick micropayments that address the age-old question of “can you purchase pizza with crypto?” by reducing processing times and associated costs (energy costs).

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Why is a Lightning Network required?

Part of the reason for creating the Lightning Network was to make Bitcoin operate more like the virtual currency that Satoshi Nakamoto had in mind. At a low cost, it executes transactions “off-chain” significantly more swiftly and cheaply than Bitcoin’s primary blockchain. Additionally, lightning transactions use less energy than those on the main network.

The Lightning Network (layer 2) has a theoretical capacity of millions of transactions per second, but the main Bitcoin network (layer 1) routinely handles less than ten transactions per second.

The Transaction Fee

Using the lightning network does cost an amount in terms of transaction fees. They combine bitcoin transaction fees for opening and shutting channels with routing expenses for sending payment data between lightning nodes. These fees, which only amount to a few rupees, are negligible compared to the standard bitcoin network transfers.

How does the Lightning Network work?

Using this protocol, two parties can establish a peer-to-peer payment channel, such as a customer and a pizza shop. Once formed, the channel enables them to send a limitless number of cheap, almost instantaneous transactions. Users can use it as their own private ledger to pay for even smaller goods and services, like pizza, without having their transactions affect the Bitcoin network.

The payer must lock a particular quantity of Bitcoin into the network in order to establish a payment channel. The receiver can invoice any amount of Bitcoin after it has been locked in. The customer has the option to continually add Bitcoin if they wish to keep the channel active.

Both parties can conduct transactions with one another by means of a Lightning Network route. Some transactions on the Bitcoin network are treated differently than regular transactions. For instance, only the main blockchain is updated when two people open and close a channel.

Without informing the main blockchain, the two parties can transfer money between themselves forever. This method greatly reduces transaction times because all transactions within a blockchain do not need to be approved by all nodes. By connecting separate payment channels between the parties, Lightning Network nodes that may route transactions are created. The Lightning Network is the result of numerous payment systems being connected.

Smart contracts and multi-signature scripts are used by the lightning network to carry out this objective on a more technical level. An initial transaction, referred to as a funding transaction, is created when one or both parties fund a channel. In a typical multi-signature scenario, two master keys (one public and one private) are first exchanged. The exchange facilitates the acquisition and use of currency.

However, the signatures are not sent in the case of a lightning node. This is done to prevent the main blockchain from recognizing the spending of the financial transactions. Instead, a single key is traded between the two parties, which is then employed to verify spending transactions (also known as commitment transactions) between them.

With other nodes on a lightning network, the two parties can conduct an endless number of commitment transactions. When the channel between them is shut off, they exchange master keys.

What happens?

  • Some bitcoin (supplied by at least one of both parties) are stored in a multi-signature wallet that has been set up.
  • The public bitcoin blockchain is updated with the wallet address. In order to establish how much of the bitcoin deposits belong to each participant, a balance sheet (smart contract) is created.
  • The information that the blockchain keeps is not necessary for the two parties to undertake any number of transactions.
  • A revised balance sheet is signed by both parties after every transaction.
  • The revised balance sheet is retained by both parties.
  • Both parties may use the most current balance sheet to pay their halves of the multi-sig wallet in the case of a dispute or the closure of the payment channel.

All of the aforementioned actions will be carried out automatically for the end user. Direct transactions between users are possible thanks to Bitcoin’s Lightning networks. They are not required to advertise their business. The two parties can save money and time by managing their own payment tracking instead of interacting with the blockchain.

Conclusion

The Lightning Network, like all other blockchain-related advancements, is a dynamic idea that has the potential to alter Bitcoin’s blockchain fundamentally. The network might not, however, be the solution to all of Bitcoin’s issues. Additionally, if new network upgrades and alterations are made, potential issues with the Bitcoin ecosystem may also appear. Future advancements in technology will be heavily reliant on research and development.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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