Joseph Poon and Thaddeus Dryja came up with an innovative idea in their whitepaper The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments. They proposed a way to make Bitcoin highly scalable from 8 transactions per second(TPS) to about a million TPS.
Since then, it has caught a lot of attention and development work in going to make lightning networks a reality. In this article, we will discover behind scenes of the lightning network.
Problem with current Bitcoin system-
- TPS is very low: Currently, Bitcoin blockchain can handle 7 to 10 transactions per second. Other payment systems like Visa can handle up to 65000 transactions per second. That hinders the scalability and adaptability of Bitcoin.
- Mining fees: The mining fee can go high, which makes micro-payment economically infeasible.
Let’s try to understand it with a real-life example. Consider a situation where you are in a grocery shop. You buy some groceries, and then you made a payment in bitcoin. Because of the mining fee, you paid an additional amount to mine your transaction in about 10 minutes(it is the time interval in which blocks are produced in Bitcoin). You finished your shopping, and when you were returning, you remembered you forgot to buy some stuff. Therefore, you went back to the shop to get them, and then you have to repeat the whole process once again. You were compelled to spend more Bitcoins and more time for the simple task of buying groceries.
So how Lightning Network solves this?
Lightning network is a layer two solution built on top of Bitcoin blockchain to facilitate speedy micro-payments with almost negligible using payment channels technology.
In our example, if we use the Lightning network, the process will be completely different and faster. Initially, the shopkeeper and you would deposit a certain amount of Bitcoins called Funding Transaction to open a payment channel. The amount deposited is usually equal to lower than the amount you want to transact in the channel.
According to the whitepaper, you can do endless transactions inside the channel. In the example, when you forgot to buy something, you can return and buy them without any delay or paying anything extra Bitcoin.
So, both you and the shopkeeper could make a channel for one week, make as many transactions as possible for a week and then settle it by closing the channel at the end of the week. The final transaction recorded at the time of settlement is known as Closing Transaction, which is the final state that will be recorded in the Bitcoin network.
It is essential to keep in mind that only two transactions will be recorded in the Bitcoin main network. One while opening a channel and the other one while closing the channel.
Payment Routing in Lightning Network
When these channels are interconnected with each other, it forms a network which we all know as Lightning Network. Using this, you can send your bitcoin transactions faster to anyone in the network. All you have to do is to find a path from your node to the destination node. The path should have enough capacity, i.e., the fund you are sending much be less than or equal to the funding transaction.
Consider the situation in which you want to buy a cake from a pastry shop. You don’t have a payment channel with the shop’s owner. But the grocery shop’s owner has a channel with the pastry shop’s owner. You can pay the amount to the pastry shop without opening a new channel with the pastry shop. This process incurs a fee called the routing fee. This fee is paid to the nodes, which are a part of the path.
Since, Lightning network uses a P2P encryption protocol called onion protocol, the intermediates who are a part of the path won’t be able to know the transaction data.
Advantages of Lightning Network
- The throughput of the network will go up.
- It will make Bitcoin scalable like traditional online payment systems.
- Cross Chain transactions will be faster than before.
The Lightning Network enables commercial payments through Bitcoin and presents a future where Bitcoin can replace fiat payment and can potentially replace traditional payment systems. In the next few articles, we will go deep into the Lightning network technology and development activities around it.