The Lightning Network is a “Layer 2” payment protocol that operates on top of a blockchain-based cryptocurrency (like Bitcoin). It enables fast transactions between participating nodes and has been touted as a solution to the Bitcoin scalability problem. It features a peer-to-peer system for making micropayments of cryptocurrency through a network of bidirectional payment channels without delegating custody of funds. Lightning Network implementation also simplifies atomic swaps.
Normal use of the Lightning Network consists of opening a payment channel by committing a funding transaction to the relevant base blockchain (Layer 1), followed by making any number of Lightning transactions that update the tentative distribution of the channel’s funds without broadcasting to the blockchain, optionally followed by closing the payment channel by broadcasting the final version of the transaction to distribute the channel’s funds.
The design of Lightning Network
The payment channels allow participants to transfer money to each other without having to make all their transactions public on the blockchain. This is done by penalizing uncooperative participants. When opening a channel, participants must commit an amount (in a funding transaction, which is on the blockchain). Time-based script extensions like CheckSequenceVerify and CheckLockTimeVerify make the penalties possible.
“If we presume a large network of channels on the Bitcoin blockchain, and all Bitcoin users are participating on this graph by having at least one channel open on the Bitcoin blockchain, it is possible to create a near-infinite amount of transactions inside this network. The only transactions that are broadcast on the Bitcoin blockchain prematurely are with uncooperative channel counterparties.” The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments paper.
The Lightning Network is made up of bidirectional payment channels between two nodes which combined create smart contracts. If at anytime either party drops the channel, the channel will close and be settled on the blockchain.
Due to the nature of the Lightning Network’s dispute mechanism which requires all users to watch the blockchain constantly for fraud, the concept of a “watchtower” has been developed, where trust can be outsourced to watchtower nodes to monitor for fraud.
Pros and Cons
As for the pros and cons of the Lighting Network there are plenty at the moment. But let’s start from the pros. Transaction speed. You won’t have to wait for several confirmations of every transaction you’re trying to make. The transactions will be almost instant no matter how busy the network is.
Lower transaction fees. As the transactions will actually take place within the Lightning Network the fees will be minimal and will make Bitcoin to be used as an efficient payment method for small transactions like a coffee or a beer.
Scalability is also a huge pro the Lightning Network will offer as it will enable Bitcoin or and other cryptocurrencies to as least 1 million transactions per second compared to the 24 thousands transactions Visa currently have.
Cross-chain atomic swaps will enable users to send money from one blockchain to another without the need to trust a third-party for that. And last but not list security and anonymity. With Lightning Network most of the transactions happen outside the main blockchain, so all the micropayments made with it, will be almost impossible to trace.
As for the cons there some notable examples for the time being. Complexity of the channels is one of them. Lightning Network is conceptualized as sort of a web of channels which, once established, should theoretically allow for smooth transactions. However, there is no telling what will happen if the route becomes more complicated. If the transaction needs to go through a number of intermediate channels, the fees will add up.
Channel caps is another drawback of the network. At it’s current version the channels are capped meaning that the amount of Bitcoins stored in the wallet by the two users upon establishing a channel is the maximum amount of funds in that channel. This is far from ideal, because it creates a situation where some users might need to choose between having liquidity within the Lightning Network channels and having liquidity outside of them, on the main blockchain.
Hubs is one more con the Lightning Network. There are have been concerns voiced over forming “hubs”. Hubs are a sort of nodes with a lot of capital that the majority of transactions will go through. Many see this as further centralization of the network, but it is unlikely that such “hubs” will be able to make any significant profit of the transaction fees.
For the time being Lightning Network is hard to use and only advanced users can really get the most out of it. What we can hope for is that Lightning Network will keep on growing and advancing in it’s technical aspect and be more user friendly in the future. As for today, some major companies like Amazon will start accepting payments through Lightning Network, making a step towards mass adoption of it.