What is the Lightning Network and why should I care?

5 June, 2019

If you follow all the latest cryptocurrency news, you likely have heard of the Lightning Network. Do you know what that network is? More importantly, do you know why you should care? The Lightning Network is important enough that it could completely transform how people use cryptocurrency.

The Lightning Network is an additional layer built on top of Bitcoin's main network layer for the purposes of conducting transactions between two parties. In theory, worldwide deployment of the network should speed up Bitcoin transactions considerably. The goal is to eventually make it possible for Bitcoin to compete with traditional electronic payment systems from companies like Visa and MasterCard.

This post will describe exactly what the Lightning Network does and why it is so important to the cryptocurrency community. Note that the network is still in its infancy. Despite all of the buzz, developers still have a long way to go to get it ready for prime time. That could still be years down the road.

Understanding the problem

A good place to start is discussing the problem that led to the idea of the Lightning Network. That problem is speed. When Bitcoin was first launched, its network was capable of processing upwards of seven or eight transactions every second. That was fast enough given the relatively low volumes of Bitcoin trading. Fast forward 10 years and seven transactions per second just will not do.

To their credit, network maintainers have managed to increase speed a little, but not nearly fast enough to satisfy current volumes. Assuming Bitcoin is stuck at seven transactions per second during peak trading times, it doesn't compare well to the 61 transactions per second that Bitcoin Cash is capable of. Neither crypto networks even come close to Visa's 24,000 transactions per second.

Why it matters

If you are the kind of person who only uses bitcoins to occasionally take a shot at the MegaMoolah.com progressive jackpot, you probably don't much care that Bitcoin can only process 7 or 8 transactions per second. Your biggest concern is making a deposit so you can play your favorite video slot. But imagine being a giant retailer desperately wanting to start accepting bitcoin payments in order to increase market share.

You feel like you cannot because the Bitcoin network just isn't fast enough. So rather than getting involved in something that could potentially become a boondoggle, you maintain the status quo. You accept Visa, MasterCard, and scores of other traditional payment systems all while saying no to Bitcoin.

The truth is that no cryptocurrency on the market has the transactional capacity to match what Visa, MasterCard, and other global payment systems are capable of. That is why crypto still hasn't taken off as a payment system 10 years after Bitcoin's first launch.

Until crypto platforms have that capacity, they will never become dominant payment systems. It is a real problem that requires an innovative solution. Enter the Lightning Network.

How the network works

As previously discussed, the Lightning Network is essentially an additional network layer. It exists on top of the main Bitcoin layer where transactions are processed and blocks are built. This additional layer was birthed out of the realization that it wasn't really necessary to record every single Bitcoin transaction - especially those transactions that took place between two consenting parties willing to trust each other.

Imagine you have two family members living on separate continents. Bill might live in the UK while his sister Jane lives in Australia. The two regularly send bitcoins back-and-forth in order to facilitate running a family business from both locations.

With the Lightning Network, Bill and Jane can establish a private channel through which they can exchange bitcoins to their hearts' desire. They create a shared wallet along with individual private keys that allow access to coins in both directions. The network keeps a balance sheet - just for these two people - as coins move back-and-forth.

Should Bill or Jane ever decide to close the private channel, a final balance sheet will be issued to reflect how many coins each one owns. All of that data is then sent to Bitcoin's primary network layer and entered as a single transaction. What may have been 100 transactions in the private channel exist as only one transaction in Bitcoin's blockchain.

Private channels eliminate minor transactions

The beauty of the Lightning Network and its private channels is that it eliminates minor transactions from the main Bitcoin ledger. Imagine 100 customers of a local coffee shop all using bitcoins to purchase their morning joe on the way to work. The Lightning Network theoretically allows the coffee shop to establish private channels with each customer. They can then sell coffee to those customers every day from a month.

Closing the private channels at the end of every month condenses 3,000 minor transactions down to just 100. That saves a lot of processing time and power on the main Bitcoin network. This is the ultimate goal of the Lightning Network: removing as many minor transactions as possible from the primary network so miners have less work to do. That should lead to faster transaction times across the board.

Eliminating transaction fees

A secondary benefit of the Lightning Network is that it could theoretically eliminate transaction fees. Using our example of Bill and Jane, there would be no need for transaction fees between them. They are siblings and business partners merely transferring coins back and forth as needed.

Even the example of the coffee shop applies here. As long as the coffee shop owner was willing, there would be no need to charge any fees from customers who wanted to pay for their coffee with bitcoins. When private channels are closed at the end of 30 days, the condensed records are processed by the main Bitcoin network without any additional fees required.

In cases where transaction fees were assessed, experts say that they would be lower. They do not say why, but that's the prevailing theory. Time will tell if it is actually true.

As a side note, one of the reasons Bitcoin transaction fees seem to continue growing ever larger is related to the amount of work miners have to do to process blocks. The more work required the more resources miners expend. Transaction fees increase because miners have to be compensated to make network maintenance worth their while.

Security concerns

The fly in the Lightning Network ointment is security. Like anything else network related, security is of utmost importance if developers hope to protect individual identities and prevent coin theft. Right now however, the network lacks most of the security features that make Bitcoin as secure as it is.

The secondary layer is not protected with the same kind of encryption. It is not protected with the same kind of proof-of-work algorithm required to verify transactions on the main network. In essence, making the Lightning Network do what it does requires leaving out all of Bitcoin's primary safety features.

There are other ways to secure the network and developers are working on them. What they come up with will be pivotal in determining the network's success. With adequate security and enough speed, there is no reason that the network cannot turn Bitcoin on its head. But without proper security, no amount of speed will be enough to do the trick.

Copycat networks

It will be really interesting to see what happens if the Lightning Network delivers as promised. Will other crypto platforms come up with something similar? And if not, will they come up with their own way of streamlining transactions so as to increase speeds enough to compete with traditional payment networks?

There are so many questions and very few answers. But that is half the fun of following the cryptocurrency sector. Entire websites are devoted to tackling subjects like this. Some address tough topics with nothing more than speculation, others have hard facts to back up their positions. The reality is that we never know what we are going to get until it finally arrives.

Common sense suggests there will be some copycat networks that do essentially the same thing as the Lightning Network. But just like Ethereum is completely separate from Bitcoin in its core principles, chances are that some crypto developers will come up with a completely different way to solve the speed problem. Their solutions will not look anything like the Lightning Network.

The Bitcoin Achilles' Heel

Analyzing both the need and benefits of the Lightning Network reveals something interesting: Bitcoin's biggest strength is also its Achilles heel. That strength is decentralization.

Bitcoin was built on the notion that no government or central bank should have control over it. It was designed to be a decentralized monetary system that is controlled by anyone and everyone who owns coins. To make that possible, Bitcoin had to be created with its current blockchain ledger system and encryption.

It is both the blockchain and encryption that require so much work just to maintain the network. And every time a new block is added to the chain, more work is required. Unless something changes, Bitcoin transactions will just get slower and slower. Hopefully the Lightning Network turns out to be a viable solution.