What Is The Bitcoin Lightning Network?

As Lighting Network – LN – activity picks up, many must be asking themselves what exactly it is. The Lightning Network is one of the most wonderful developments in the cryptocurrency space since SegWit. It allows users to make fast and fee-less micro payments. LN is basically the Maximalist dream come true by other means. Here is what you need to know about LN without getting too technical.

Lightning Network: Basic Features

bitcoin lightning network explained

The Lightning Network is basically a web of people who agree to open a payment channels between them, both bilaterally and multilaterally by extension. These channels exist on top of the blockchain. Therefore, LN is a second layer – or layer 2 – solution. Here are some of the basic features that allow people to make fast micro payments on the Lightning Network without paying fees:

  • Payment channels are based on multi signature – multisig – wallet systems
  • Parties transfer funds to these multisig wallets and use the Lightning Network protocol to transact between them
  • Payments between parties are not recorded on the blockchain until the parties settle them
  • Therefore, money doesn’t really change hands, but transactions are recorded on a public ledger and can be settled at any point in time
  • Funds cannot be used on the blockchain until they are settled
  • This system requires channels to use the same addresses always until a channel is closed
  • The system also allows people to transfer funds to a third party via a bilateral channel

Lightning Network Explained

The following example will illustrate how all these features come together and how the Lightning Network works:

  • A client opens a channel with his favorite coffee shop
  • That client buys a cup of coffee each day from that shop, making a small payment each time
  • Those payments are recorded between them but not on the blockchain
  • Once the coffee shop decides to settle the payments, it signs on its side of the multisig wallet, registering the transaction on the blockchain
  • All the payments are done to the same address until the settlement comes
  • The coffee shop cannot use the funds to pay for its operating costs until it settles them

Advantages and Disadvantages of the Lightning Network

Using the Lightning Network is advantageous for many reasons. It allows us to pay for coffee with Bitcoin – the Maximalist’s dream. This allows many different businesses to flourish around this layer 2 payment rail. Advantages, however, often come with some drawbacks. Here are the disadvantages of using Lightning Network:

  • Using the same public address can expose an individual – if that address is tied to someone’s identity
  • Until users don’t settle payments, they must take on risk, such as greater exchange risk
  • Since payment channels are established through Bitcoin deposits, payments cannot exceed the amount deposited (to the multisig wallet)

Anti-Cheat System

By now you might be thinking that a party within a payment channel could cheat and register the transactions on the blockchain using a version of the balance sheet that is favorable to them but doesn’t necessarily reflect the truth. Lightning Network has an anti-cheat mechanism to prevent this. Without getting into too much detail, since both parties deposited Bitcoin into the multisig wallet in their payment channel, either party can “spend” the amounts. Therefore, the funds are locked for a number of blocks before any party can settle them. If one party tries to cheat, the other party has time to respond, executing a transaction that spends the inputs or deposits of the transaction, in which party A has signed off on a transfer of funds to party B.

This, of course happens automatically. There is no need to activate it, which prevents malicious actors from trying to cheat the system. That anti-cheat mechanism was made possible by SegWit – Segregated Witness – which was a malleability fix, not a salability fix as most people think.

Enjoy the Lightning Network

Now that you know how the Lightning Network works without getting a degree in computer science, you can take advantage of it by transferring funds to a non-custodial Lightning Network wallet, or by operating your own Lightning Network node. We have all the information you need to set up your own Lightning Node and what you can do on the Lightning Network.