Since its launch in 2009, Bitcoin has grown to become the most valuable cryptocurrency by market capitalisation, solidifying its position as the face of the crypto industry. Its blockchain is widely recognised for its high level of decentralisation and security.
Despite these strengths, Bitcoin faces significant challenges with scalability. By design, the network suffers from low throughput, slow transaction settlement times, and high fees.
New blocks are added approximately every ten minutes, with a theoretical maximum of 10 transactions per second (TPS). This is a stark contrast to global payment processors like VISA, which can handle over 20,000 transactions per second.
A chart depicting Bitcoin number of addresses from 2009 to August 2024
Source: Glassnode
Bitcoin’s increasing adoption amplifies these limitations. As more users engage with the network, the volume of transactions grows exponentially, creating a higher demand for space within each block. This leads to rising transaction fees (gas fees), making Bitcoin less practical for everyday payments or microtransactions.
The scalability issue is not unique to Bitcoin; other layer 1 blockchains, such as Ethereum, face similar challenges. In response, layer 2 scalability solutions have emerged.
See; Understanding Blockchain Layers: Layer 0 vs Layer 1 vs Layer 2 vs Layer 3
The Bitcoin Lightning Network is one such layer 2 solution, designed to make Bitcoin transactions faster, cheaper, and more suitable for daily payments and small purchases.
What is the Bitcoin Lightning Network?
The Bitcoin Lightning Network is a Layer 2 solution and payment protocol built on the Bitcoin blockchain to address its scalability limitations. It facilitates near-instantaneous micropayments with Bitcoin, enabling users to send and receive BTC with minimal fees.
Introduced in 2016 by Joseph Poon and Tadge Dryja via their published whitepaper, the Lightning Network take the bulk of the transaction off-chain before finally settling the transaction on the Bitcoin main chain.
Let’s highlight how it works;
How the Bitcoin Lightning Network Work
Here’s a step-by-step explanation of how the Lightning Network functions, along with an example.
Opening a Payment Channel: The Lightning Network operates through payment channels between two parties. To open a payment channel, both parties must commit a certain amount of Bitcoin, which is stored in a multi-signature address. This address requires both parties’ signatures to create new transactions
See: Everything You Need To Know About Multisig Wallets
For example; imagine Mike and Jane want to set up a payment channel. Mike commits 10 BTC, and Jane commits 5 BTC.
An opening transaction holding their combined 15 BTC is broadcast to the Bitcoin blockchain. This initial transaction may take about 10 minutes (due to Bitcoin’s block confirmation times) but only needs to be done once.
Afterwards, the payment channel remains open, allowing Mike and Jane to exchange Bitcoin as often as they wish without further interaction with the main blockchain.
Conducting Off-Chain Transactions: Once the channel is open, Mike and Jane can send Bitcoin to each other instantly with minimal fees.
Importantly, these transactions happen off-chain, meaning they don’t need to be recorded on the Bitcoin blockchain for each transfer. This reduces congestion on the Bitcoin network and allows for faster transaction processing.
For example:
Mike sends Jane 1 BTC. Jane’s new balance is 9 BTC, and Jane’s is 6 BTC.
Mike sends Jane another 2 BTC. Mike’s balance becomes 7 BTC, and Jane’s balance is 8 BTC.
Jane sends Mike 3 BTC. Mike now has 10 BTC, and Bob has 5 BTC.
These transactions happen in real-time with no delays or high fees, unlike typical on-chain Bitcoin transactions.
Closing the Payment Channel: At any point, either Mike or Jane can choose to close the channel. When they do, a closing transaction is created and broadcast to the Bitcoin blockchain.
This transaction reflects the final balance of each party based on the channel’s transaction history. In our example, if Mike and Jane close the channel, the final transaction on the Bitcoin blockchain will show Alice with 11 BTC and Bob with 4 BTC. This transaction is then confirmed on the blockchain, and the funds are released.
Source: Huawei Huang research gate
Scaling with the Larger Network: The power of the Lightning Network extends beyond individual payment channels. It allows payments to be routed across multiple users on the network.
If Mike has a payment channel with Jane, and Jane has a payment channel with Lindal (a coffee shop owner), Alice can send a payment to Linda via Jane, without opening a new channel directly with Carol.
The Lightning Network automatically finds the best route for the payment, ensuring it happens quickly and cheaply. For instance, if Mike wants to buy coffee at Linda’s shop, his payment could be routed through Jane’s channel with Carol.
This process happens almost instantly, with the transaction not needing to touch the main Bitcoin blockchain.
Reducing Blockchain Congestion: The only transactions that touch the Bitcoin blockchain in the Lightning Network are the opening and closing transactions of payment channels. All other transactions occur off-chain, which significantly reduces congestion on the main Bitcoin network.
Benefits of the Lightning Network
Scalability: The Lightning Network dramatically increases Bitcoin’s scalability by moving transactions off-chain. This allows millions of transactions per second, reducing on-chain congestion and making Bitcoin more suitable for high-frequency payments, especially micropayments.
Speed: With payments processed off-chain, transactions on the Lightning Network are nearly instant. Payments can be completed in a few seconds, or even faster if a direct channel exists, making it ideal for everyday use without the delays of the Bitcoin blockchain.
Micropayment Support: The Lightning Network supports payments smaller than a satoshi (0.00000001 BTC), something not feasible on the Bitcoin blockchain. This capability is critical for Web3 applications, like gaming, which require frequent, tiny payments at extremely low costs.
Low Energy Usage: By taking transactions off-chain, the Lightning Network reduces energy consumption compared to on-chain transactions, making it a more environmentally sustainable solution. This improves Bitcoin’s reputation among investors who focus on environmental, social, and governance (ESG) factors.
Lower Transaction Fees: Lightning Network transactions avoid the high fees associated with on-chain Bitcoin transactions. This makes it particularly attractive for micropayments and everyday transactions where low costs are essential.
These advantages make the Lightning Network a crucial layer for improving Bitcoin’s efficiency and practicality in everyday financial activities.
Some Downsides of the Bitcoin Lightning Network
Complexity: Using the Lightning Network is more complex than regular Bitcoin transactions. Setting up channels, finding payment routes, and managing liquidity require technical expertise, making it less user-friendly for those unfamiliar with the system, which limits mass adoption.
Bitcoin Price Volatility: Bitcoin’s price volatility affects the value of transactions and fees on the Lightning Network. Significant price fluctuations can complicate large transactions, making it harder to maintain predictable payment values.
Centralisation Concerns: Another key criticism of the Lightning Network is the risk of centralisation. Large players with significant channels could dominate the network, and as more users rely on these major channels, power could become concentrated among a few entities.
Closing Thoughts
In essence, the Bitcoin Lightning Network enables users to transact off-chain, allowing faster and cheaper transactions while reducing the load on the Bitcoin blockchain.
It works through payment channels that allow two parties to exchange funds instantly and settle their balances on the Bitcoin main chain only when they open and choose to close the channel, making it a powerful solution to Bitcoin’s scalability issues.
[Author’s Note: This article does not represent financial advice, everything written here is strictly for educational and informational purposes. Please do your own research before investing.]
Author: Godwin Okhaifo
Also Read: Understanding Blockchain Layers: Layer 0 vs Layer 1 vs Layer 2 vs Layer 3
