Bitcoin Lightning Network: A Complete 2022 Guide For Beginners

Key Points:

  • Key Terms That You Need to Understand
  • Key Takeaways
  • Issues Related to Scalability
  • How the Lightning Network Works
  • Advantages of Lightning Network
  • Fee for Using Lightning Network
  • Problems Associated With Lightning Network
  • The Future of Cryptocurrencies
  • Conclusion

Key Terms That You Need To Understand:

  • Lightning Network

Lightning network is a term that has gained popularity recently. It is software that runs on top of blockchain to increase its transactions processing speed. It falls in the category of second-layer solutions. It was introduced by Elizabeth Stark, an American citizen and an Alma mater of Harward Law School. It is being used by different cryptocurrencies, but Bitcoin is the one that needs it the most because its transaction time is much higher. There are various lightning networks available on different blockchain networks. 

  • Scalability

Scalability or scalability problem is the capacity of Bitcoin to process transactions between nodes in a given time. Before the introduction of the Lightning network, traders were concerned about the low transaction processing speed of Bitcoin. Bitcoin’s blockchain can handle seven transactions per second, while with the addition of a lightning network, the speed boosts to 1 million transactions per second. 

  • Second Layer Solutions

Any set of solutions built on top of an existing blockchain to increase its speed and scalability. Lightning network is an example of second-layer solutions. Other examples include Plasma and TrueBit. 

In the previous year, Lightning Network has gained tremendous attention because of its advantages. It has become mainstream, and its popularity is increasing rapidly. Thanks to this hype created by media, software developers are now working on various tools that would make this technology more accessible. 

Although Lightning Network has enjoyed widespread attention still there are various ambiguities and questions about it in traders’ minds. For instance, people are unaware of how to use it, how it works, and what its advantages are. But one thing is for sure that if you want to receive the maximum profit from cryptocurrencies, then you should have ample knowledge of the lightning network. In this article, I will try to provide every detail on this topic. 

Key Takeaways

Lightning networks are technological second-layer solutions aimed to solve the issues related to the speed of Bitcoin transactions by providing an option to transact off-ledger. 

Like the blockchain itself, the lightning networks also disintermediate central institutions which route transactions and promote decentralization.

BTC lightning network’s concept was initially introduced in 2015 by Thaddeus Dryja and Joseph Poon. 

Issues Related To Scalability

We all know that Bitcoin has faced many challenges, but the one that has affected it more is its scalability. Slower communication speed and computational overhead spread between sellers and buyers. It means that it suffers only due to its transaction speed because other payment networks are faster. To give you a rough idea of how slow it is, the Visa network can regularly process 24k transactions every second, but on the other hand, Bitcoin’s network can only process 7 in a second. These numbers present a matchless scenario that needed to be altered by any means if Bitcoin had to survive, knowing that the total number of digital coins has already crossed the 5k mark. 

If Bitcoin has to reach a potential level to be used as a medium of everyday transactions, then it will have to process hundreds of thousands of transactions every second, like credit cards and other electronic payment methods. As it uses decentralized technology, it requires consensus from all connected nodes, and it causes lags. 

Those people who are planning to buy Bitcoin as an investment don’t need to worry about scalability problems. It is because these people follow the ‘HODL’ strategy and sell their stocks once a month. So these people wait for the opportunity, and when they can wait for months, they can wait an extra few seconds as well. It means that this scalability problem only affects those people who use Bitcoin as a pure currency to buy services and goods. These people have to wait for every small payment, and these few seconds combine to make a long time delay on a daily basis. In this way, the scalability problem negates the whole purpose of using a digital currency for convenience. 

The reason behind this lag in Bitcoin performance is that its transactions need to be verified from different computers. So it is obvious that it requires more time, but it provides better security. If you compare Bitcoin transactions with Visa’, you would see a huge difference because Visa processes transactions between accounts directly, which is faster and takes only split seconds. But in the case of Bitcoin, multiple individuals and computers are involved in every transaction, even in the small transactions. 

The cryptocurrency market keeps changing all the time, and new inventions and updates keep coming under the spotlight. In various instances, efforts have been made to overcome the scalability issue of Bitcoin. Different proposals and fixes have been introduced, and most of them focus on reducing the number of middlemen who verify the transactions. Lightning network is also one of those fixes that have survived after rigorous testing, and now it is practically used.

How The Lightning Network Works:

Those traders who are already dealing in Bitcoin would know how the Bitcoin transactions are processed with blockchain. The main difference between normal transactions and those which are processed with a lightning network is that in the latter one, transactions don’t need to be recorded all the time. An alternate has been provided, and a secure connection is created between those individuals who frequently exchange Bitcoin, which allows them to easily and swiftly exchange coins without waiting for verification on every single transfer.

When we ask blockchain engineers to define a lightning network, they refer to it as a form of a smart contract. If we see it from a technical point of view, lightning networks use multi-signature scripts to implement the vision. To create a channel, initial funding is required from one of the nodes. This initial transaction or funding is known as a funding transaction. Generally, two master keys are exchanged, out of which one is public while the other is private. This exchange enables them to make transactions but only between these two nodes. If they want to make a transaction to a third party, then they would be required to create another channel. 

In the case of lightning nodes, the signatures are not exchanged to prevent the transactions from being recognized by the main blockchain to save time. As an alternate, both the parties share a single key that is meant to be used to validate transactions between them. These transactions are known as commitment transactions. The two parties can process unlimited commitment transactions between them or any other node and exchange the master key only when the channel is closed, and they want to make transactions processed by the main blockchain. 

To better understand the concept, let’s assume an example. We have two traders, John and Chris, who are planning to exchange their Bitcoin frequently. Now the traditional option for them to do this is through an exchange, but they charge a standard fee on every transaction. In addition, the transactions are slow as well. 

But the modern option, a lightning network, is more advantageous. By using a lightning network, John and Chris can create a mutual wallet that needs to be signed in by using their private key and accessible for both of them. They can deposit their coins in this wallet, and the other one can then transfer them to his account. In this way, the main blockchain doesn’t need to be bothered about every transaction. 

Through this wallet, they can make unlimited transactions to each other, but these transactions would be recorded on the lightning network and not on the main blockchain. The network keeps a detailed record of every transaction made through these wallets. When the transactions between both parties are completed, then the record of difference generated as a result of these transactions is maintained on the main blockchain so that everything remains legally connected. A web of transactions is created and routed between various connected nodes in a decentralized manner. 

In case a situation arises when both parties keep exchanging Bitcoin multiple times, the result is that John owes Chris 5 Bitcoin-only at the closing time. In this situation, the record that will be updated on the main blockchain will reflect only 5 Bitcoin transfers. This precise information saves time for both John and Chris. It also saves bandwidth on the main blockchain that can be utilized for other transactions later.

In this way, the lightning network has solved the scalability issue of Bitcoin to a great extent. You might not understand its advantage theoretically, but you will grasp it better when you will personally use it to make Bitcoin transactions. 

Advantages Of Lightning Network

If you think that the advantages of a lightning network are limited to only greater speed and lower cost, then you are wrong because it improves the overall Bitcoin trading experience. It enables every trader to sell and purchase the master coin more efficiently. Although I had given an example to two individuals, John and Chris, that doesn’t mean that it can only be used by individuals. The lightning connection can be established between financial institutions and other organizations as well. 

By using the transaction process that I have mentioned earlier, institutions are only required to record the transactions, which is, of course, automatically done by the lightning network. After finishing the transactions, the record is settled up by using a single actual transaction at the main blockchain. Shortly, it also might become possible to connect multiple traders and financial institutions through complex lightning networks. This network would be the most efficient way to change the ownership of Bitcoin through private channels and the most cost-efficient method as well. 

Through the lightning network, other performance-related issues would also be resolved, like the use of digital currencies for stock trading and the transfer of tokens among different blockchains. This will surely lead towards a method through which different kinds of cryptocurrencies could be swapped together without the need to use any crypto exchange platform. 

Some critics, on the other hand, are still not optimistic about this latest invention and don’t agree with what the lightning networks promise. They feel that they should remain rational because, like the cryptocurrencies themselves, the idea of lightning networks is also speculative. Only time could remove these concerns of people with the application of this technology realistically. 

Recently, the specifications of the lightning network have been published, and the rules and regulations regarding its use have also been presented before the public. This move can prove a turning point because due to this publication, researchers have declared the lightning network as a safe option to buy and sell Bitcoin. So we can expect that with time, this technology will gain more popularity and respect among traders. 

Transactions that are processed through lightning networks are not only faster and cost-efficient but also more readily confirmed as compared to those which are processed directly through the blockchain. By making the transactions off-chain, the lightning networks work to de-congest the blockchain to reduce the required processing time and fees.  

Fee For Using Lightning Network

If you think that the lightning network is free, then you are wrong. But the fee that is charged is near to none, and it is very cheap as compared to normal transactions of Bitcoin. There is a combination of routing fees for routing information related to the ongoing payments between lightning nodes and BTC’s standard fee to open and close the channels. 

At the time of initial testing of the lightning network two years ago, scientists belonging to two different universities, in collaboration with Institute for Computer Science and Control, worked on a paper. The paper was published later on, and it raised doubts related to the pricing as the researchers expected that the prices would soon be raised because it is not feasible for operators to provide the services at the proposed rates. 

To sum up their research, they concluded that for the majority of large nodes that hold the network together, the participation is irrational economically. According to them, the price must be increased, but if the price is increased, then the technology would lose half of its purpose. The other solution that was proposed is to increase the traffic in terms of magnitude to make the routing of payment economically viable for operators.

Problems Associated With Lightning Network

The most visible issue related to lightning networks is that they led towards replication of the existing hub as well as the spoke model which portrays modern financial systems. In this model, financial institutions act as intermediaries through which all the transactions are processed, but the lightning networks are meant to be decentralized like Bitcoin itself.

Lightning nodes of prominent businesses might become similar to hubs or centralized nodes if they have open connections with others. If a failure occurs at one node or hub, it can easily crush the whole network or at least a large part of it.

The next problem towards which I want to draw your attention is the requirement to increase the fees to maintain the network financially. This is true for the nodes which maintain the network.

Lightening networks also remain under a constant threat of hacking attempts because these networks need to remain online all the time to process transactions in real-time. Cold wallets are not an option because networks don’t allow them at all. 

The Future Of Cryptocurrencies

Cryptocurrencies are becoming popular more than ever and increasingly mainstream. At this time of growth, the lightning network is helping the master coin to grow exponentially. It means that the real aim behind the launch of cryptocurrencies is now more reachable, and it would soon become an alternate mainstream form of payment. Lightning networks have made Bitcoin and cryptocurrencies, in general, a hot topic once again, and people have started to keep a close eye on them. 

With more speed and fewer transaction fees, Bitcoin is nearing itself towards becoming a practical option for common people, and this has only been made possible because of lightning networks. 

Conclusion

Understanding the lightning network is not rocket science if you already understand what a blockchain is. Blockchain technology is already running smoothly and only had a couple of minor issues that are now also resolved thanks to the introduction of lightning networks. Lightning networks are surely the future of blockchain, and further improvement is also on the cards. With some advancements, it will become practical on a larger scale and solve the scalability issues permanently, making Bitcoin and other cryptocurrencies more accessible than ever.

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