Lightning-Fast payments with the Bitcoin Lightning Network
Bitcoin and other cryptocurrencies are often touted as the future of finance. Yet while they offer many unique features, such as being decentralized and unregulated, the possibility of using digital assets as an everyday form of payment on par with cash or credit has experienced some stumbling blocks. That's because Bitcoin suffers from a scalability challenge. The very technology that makes cryptocurrency possible— in Bitcoin’s case, a proof-of-work powered blockchain—is the same technology that can make it harder to function as a fast and convenient way to pay for purchases in the real world.
To understand how the Lightning Network functions and how it may be an essential solution to business owners looking to save money on credit card fees and accept crypto as form of payment, it's essential to understand blockchain. Blockchains are a complex, decentralized system of digital ledgers of cryptocurrency transactions. Chunks of data are verified and put into blocks of transaction data by people known as "miners." These blocks are linked by nodes in a peer-to-peer network called a blockchain.
Though the system is very secure, it is not suitable for real-time payments, whether online or in-person. For example, while a credit card payment network can handle an average of 6,000 transactions per second, the Bitcoin blockchain network can only handle approximately three to seven transactions per second.1 That's where the Lightning Network comes in. The Lightning Network is capable of processing an impressive 1,000,000 transactions per second.2 But what is it, exactly?
How does the Bitcoin Lightning Network work?
The Lightning Network is a “layer 2" protocol designed to tackle Bitcoin's scalability issues, while maintaining a level of security. The idea is that everyday transactions, like purchases made at a grocery store or pharmacy, would not be stored on Bitcoin's main blockchain but would instead be stored temporarily in the Lightning node database and not in the Bitcoin blockchain. This “off-chain" approach allows instant payments or micropayments with low fees.
To set up a payment channel on the Lightning Network, those involved in the transaction set up a sort of digital depository that they both share—a little like a shared bank account. The Lightning Network has nodes, similar to Bitcoin, known as “Lightening node operators.” A node contains support for the Lightning protocol, and a Lightning channel is simply a connection between two nodes. Each member of the payment channel has their own private key (lines of code that act like a signature) to access the funds. The nodes’ address would be registered on the main blockchain, but actual transactions happen outside of the blockchain.
Lightning node operators on the network have to pay a minimal fee when they open a Lightning Network channel and when they close the channel (the fee goes to cover the cost miners incur when confirming the creation of a payment channel and recording the final balance on the main blockchain). Once the channel is open, participating parties within the channel can make unlimited transactions at no additional cost. When transactions must be routed through intermediary nodes between the two parties, Lightning fees can be charged by each node but these tend to be very low cost.
What it looks like in the real world
Here's an example of how the Lightning Network would work in the real world. Alice frequents Bob’s coffee shop, which now accepts Lightning payments. They are both connected via separate nodes on the Lightning Network, which establishes a payment channel. At time of payment, Bob presents Alice with a QR code that is scanned with her end of the Lightning channel, also known as her “node”. Near instantaneously, Bob receives confirmation that the payment is complete and the bitcoin is deposited in his end of the channel. Bob can use bitcoin accumulated within this channel to pay suppliers and employees, or close the channel to send funds to his bitcoin wallet.
These transactions can take place in just seconds because they’re off the main blockchain. (Normally, transactions must be verified by a miner to be completed, which takes time.) The payment channel is secure and can only be opened when both parties agree. Each time there is a transaction, both keys leave behind a kind of digital signature that confirms the payment and creates a record of the transaction.
So long as there is enough liquidity, and it goes in the right direction, they can continue to make purchases using the channel that they've set up with the coffee shop. This channel on the Lightning Network can support an indefinite amount of microtransactions, making payments quick and easy.
Furthermore, no transactional information needs to be entered into the main blockchain until the channel is closed permanently. When a Lightning channel is closed, Alice’s and Bob’s final balances are added to the blockchain, at which point bitcoin miners verify the closing balances, confirm the final record, and enter it on the main blockchain.
What does the near future of the Bitcoin Lightning Network look like?
As the Lightning network continues to mature, it will likely solidify its place as a useful and cost-effective payment solution that provides more financial freedom for consumers and business owners alike. Importantly, the Lightning Network is already being employed in real-life use cases. To take one example, a Blockchain consulting company in Germany programmed their office vending machine to use the Lightning Network. Vending machines, with their low-volume transactions and need for instant payments, provide a perfect testing ground for the changes that the Lightning Network promises to bring. And in the case of this consulting company, their implementation went off without a hitch.3 Of course, while more large-scale utilization of the Lightning Network still needs to happen –and most certainly will—the technology displays extreme promise, and we can’t wait to see what it will offer to the world in the near future.