Scalability has been a concern for Bitcoin as it processes just around seven transactions per second. It was all fine in the beginning until Bitcoin gained popularity, then transactions take a longer time to process with higher transaction fees incurred. Experts in the financial industry deemed that Bitcoin wasn’t able to host the global economy, comparing to what Visa is handling, 24,000 to 50,000 transactions per second. But things took a turn for the better after the launch of the Lightning Network in 2018; concerns on Bitcoin’s scalability were addressed, with the potential of handling at least 1 million transactions per second.
How does the Lightning Network work?
Lightning is a decentralized network in the blockchain enabling instant payments across a network of participants, peer-to-peer. A “second layer” protocol is added to the existing Bitcoin’s blockchain, allowing the users to create payment channels between any two parties on that extra layer. These channels can exist for as long as required, and because they’re set up between two people, transactions will be almost instant, fees will be extremely low or even non-existent.
The first step in any transaction on the Lightning Network begins with a channel. A channel connects two nodes and allows them to pass Bitcoin to each other. Channels in the Lightning Network are built using multisignature addresses with which both parties may interact.
Firstly, users will have to create a multisignature wallet where they can access with their private keys. Then, they deposit an amount of Bitcoin, say 3 BTC, into their wallet. Thereafter, they can perform unlimited transactions between the wallets. For example, if Eric wants to send 1 BTC to Clara, Eric will need to transfer the ownership right of that amount to Clara. Then, both Eric and Clara will use their private keys to sign for an updated balance sheet.
The actual distribution of funds happens when the channel gets closed. The algorithm uses the most recently signed balance sheet to determine who gets what. If both Eric and Clara decide to close the channel after one transaction, Eric will get 2 BTC, and Clara will get 4 BTC (Cointelegraph).
You don’t have to set up a dedicated channel to send funds to someone. Instead, you can send payment to someone using channels that you are already connected with. And the system will automatically find the shortest route. This makes the buying of daily necessities using Bitcoin possible without incurring high fees. The Lightning Network enables users to conduct numerous transactions outside of the main blockchain and then record them as a single one. That said, large transfers that require decentralized security will still have to be conducted through the base layer.
Development of the Lightning Network
The Lightning Network was first proposed by Joseph Poon and Thaddeus Dryja in 2015 (Investopedia). In recent years, three teams have been carrying out the development of the Lightning Network: Blockstream, Lightning Labs, and ACINQ. Each of them is working on their own implementation in different programming languages. Fortunately, all three major implementations can work seamlessly with one another.
Seven major crypto exchanges and trading desks such as OKEx, Okcoin, Bitfinex, and River Financial have integrated Lightning into their platforms, with the Kraken exchange’s integration in the works for this year.
An outstanding feature of the Lightning Network is its cross-chain atomic swaps, which transfer cryptos between different blockchains. This makes the swapping of any crypto to a different one possible without using crypto exchanges. The first test of tokens exchanges between Bitcoin and Litecoin has already proved to be a success.
How does it impact your business?
The Lightning Network reduced the time and fees to send Bitcoin. It also facilitates secure and anti-double spending transactions before they get recorded on the Bitcoin blockchain (Coindesk).
In April 2021, the Lightning Network recorded a milestone of 10,000 nodes and had 45,000 payment channels holding 1,158 BTC. In July, we see a 20% increase, jumping to 1,821.29 BTC. The number of nodes more than doubled to 22,781, while the number of channels jumped to 56,103. The growth can be attributed to the recent news of El Salvador adopting Bitcoin as a legal tender since it’s proved to be a low-cost solution to transfer small amounts of Bitcoin.
In the market, there are players rewarding volunteers from contributing liquidity to the network. Lighting Lab’s liquidity marketplace, Lightning Pool, allows users to lease liquidity on payment channels. This allows new channels to be opened up to users who do not have any connections to the network to begin with. In return, volunteers earn BTC rewards.
The Lightning Network is going to transform the way people interact and use Bitcoin, enabling Bitcoin to be used as a form of payment in shops, cafes, bars, and more. This also allows merchants to enable cost-efficient small-value transactions.
To sum up, the Lightning Network enables lightning-fast blockchain payments without having to worry about block confirmation time, guaranteeing payment speed of milliseconds to seconds. Besides, security is enforced by blockchain smart-contracts without creating an on-blockchain transaction for individual payments. The crypto market is going to make a huge step towards being able to compete with traditional payment systems like Visa, Mastercard, and PayPal.
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