Lightning Network: Bitcoin Scaling Solution

Bitcoin (BTC) is a type of digital currency whose peer-to-peer (P2P) technology allows users to make transactions with greater speed and efficiency. The gradual adoption of Bitcoin and cryptocurrency in general by financial institutions - and payment giants such as PayPal and Square—signaling greater acceptance of financial services, which is pushing the evolution of cryptocurrency to better support its networks.

Essentially, this brings us to the Lightning Network, a layer XNUMX protocol that works alongside Bitcoin to improve speed, versatility, privacy, and lower costs.

Main conclusions:

• Launched in 2018, the Lightning Network is a layer XNUMX protocol that reduces costs and traffic congestion on the Bitcoin network, promoting scalability.
• The Lightning Network features lightning-fast processing speeds without the need for intermediaries, enabling low-cost, fast, decentralized micropayments around the world.
• The Lightning Network's latest update, Taproot Assets, turns Bitcoin into a multi-asset network, allowing developers to issue stablecoins and real-world assets such as fiat currencies and gold on the Bitcoin blockchain.

What is the Lightning Network?

The Lightning Network is a layer XNUMX protocol that runs on top of the Bitcoin blockchain to scale transaction verification. It reduces costs and reduces congestion on the underlying layer of the Bitcoin network. With its instant processing speed, the Lightning Network can facilitate decentralized micropayments on a global scale, eliminating the need for intermediaries.

The Lightning Network was first proposed in 2015 by Thaddeus Dridja and Joseph Poon. In their work entitled The Bitcoin Lightning Network, these researchers described an off-chain protocol designed to operate using payment channels. Using these channels, untrusted parties could make small transactions an unlimited number of times without increasing traffic on the main network. A year later, Drja and Poon, along with other specialists, founded the company Lightning Labs, which continued to develop the concept and eventually introduced Lightning Network in January 2018 following the SegWit soft fork in August 2017.

As the name suggests, the Lightning Network is designed to process transactions virtually free and instantaneously by taking them off-chain. It exists separately from the main Bitcoin network, using its software and nodes to communicate with the network and exchanges to complete transactions.

The Lightning Network was designed to reduce the load on the underlying layer of the blockchain network, reduce blockchain costs, and create private payment channels between parties. Since its inception, the Lightning Network has experienced steady growth and is recognized for its ability to reduce fees and speed up transaction processing times. The Lightning Network has also spread to other blockchain networks, including Litecoin.

Even in the current bear market, these companies Rivers, which specializes in Bitcoin technology and financial services, are witnessing the surprising rise in popularity of the Lightning Network. Since August 2021, its capacity has increased by 1200%. As of September 2023, the number of active users of the Lightning Network is 279 and 000 million people per month.

The Lightning Network recently released a new update, the Taproot Assets protocol, which not only improves the scalability of the network, but also turns Bitcoin into a multi-asset network.

Essentially, Taproot Assets allows you to issue stablecoins and real-world assets such as fiat currencies, gold, and government bonds directly on the Bitcoin blockchain. Since these transactions are carried out off-chain through the Lightning Network, Bitcoin is protected from possible congestion resulting from such activity.

How does the Lightning Network work?

Like the Bitcoin network, the Lightning Network is made up of nodes. However, it uses smart contracts that allow transactions to be carried out without being recorded on the blockchain. Each transaction is privately accessible only to those involved in the transaction, and each node uses Lightning payment channels to make payments. The Lightning payment channel is opened by creating multi-signature addresses between two parties making a transaction. Built-in functions prevent fraud or alteration of the data contained in the channel, and the speed of payments is limited only by the speed of the Internet connection.

Let's say Alex wants to pay Kim in BTC via the Lightning Network. They can first lock their BTC in a unique 2of-2 multi-sigma address, opening a direct Lightning channel, allowing them to initiate a transaction while maintaining a private ledger off the main chain. On the off-chain Lightning channel, the funds in the pool are divided into two sides - Alex's and Kim's funds.

The initial pool balance is 2 BTC (1 BTC each). Alex pays Kim 0,5 BTC on the Lightning Network, leaving him with 0,5 BTC. Kim then receives 0,5 BTC and her current balance is 1,5 BTC. Once a channel is closed, microtransactions are combined into a single transaction, which is then verified, processed and added to the blockchain, with their balances updated accordingly.

However, if Kim or Alex do not have a direct channel, the transaction is routed to Jack using one of the types of smart contracts - hashed time-locked contracts (HTLC). The contract is used to promise Kim that she will receive her BTC, and Jack must prove that he paid Kim the agreed upon amount. In return, Jack will receive a small reward for completing the order.

Bitcoin Limitations

Despite the convenience and ease of use of Bitcoin, its disadvantages have raised some concerns about its adoption as a currency. Thus, BTC is not accepted for payment everywhere, and its value fluctuates depending on demand, which is fraught with deflation. If a file is lost or the hard drive fails, the wallet contained in it disappears, and it is impossible to recover the lost funds. There is also no buyer protection when purchasing goods with BTC.
However, perhaps Bitcoin's biggest limitations relate to its speed, cost and scalability.

Speed

Bitcoin transactions are verified and recorded in blocks. A new Bitcoin block is created every ten minutes, and each block contains a certain number of transactions. Miners prioritize transactions based on transaction fees, which means you may find yourself competing with other users to ensure your transactions are processed quickly. This means that the higher the fee, the faster the transaction will be processed.

During quiet periods, you can count on your transaction being processed on time, but on busier days or times, you may wait a long time—or face high fees as miners chase multiple transactions in the memory pool.

Price

Bitcoin transaction fees are necessary to support the network, but they tend to be high, especially for small transactions. Anyone who wants their transactions to be processed must expect to pay higher fees during network congestion, since only a limited number of transactions can be included in each block. Traditionally, on the Bitcoin network, miners received a subsidy when mining new Bitcoin and a transaction fee when adding transactions to a block.

However, fees for using the Bitcoin Lightning Network are only required for the following:

• Opening a payment channel
• Closing the payment channel

While the channel is open, you can make many transactions, and the only fee you pay is the fee for opening and closing the channel. The Lightning Network uses block space more efficiently, increasing Bitcoin throughput and reducing transaction costs.

Overall scalability
Bitcoin's growth potential is limited, in other words, it has a scalability problem. Bitcoin blocks are about 1 MB in size and are generated approximately once every 10 minutes with a processing speed of about seven transactions per second (GST). Compare to Ethereum, which processes almost twice as many transactions (before the upcoming ETH 2.0 transition to PoS-consensus), and VisaNet can handle up to 24 TPS.

This means that limited throughput limits the number of transactions that can be processed on the chain, thereby limiting database growth. Once the number of transactions exceeds the set limit, nodes will not be able to keep up. Essentially, the network becomes clogged with pending transactions, which can lead to a bidding war.

The scalability problem first became apparent in 2015, at which time various solutions were proposed, including increasing the block size. Bitcoin Cash (BCH) hard forked in August 2017, and in the same year, segregated witness (SegWit) was introduced as a potential solution to Bitcoin's overall scalability problem.

Understanding Layer XNUMX Protocols

The base layer of the Bitcoin network is characterized by the technological structure that supports the network, as well as the monetary application. It is used to validate and complete transactions, but as discussed, it has its limitations, particularly the capacity and cost of Bitcoin. The second layer protocol aims to eliminate these limitations.

The second layer protocol (or Layer 2) is also known as an off-chain solution. It is decentralized like the main blockchain and offers the same security protocols, but its main goal is to solve the scalability problems of conventional blockchain technology.

In a decentralized network, global consensus is required and all participating nodes have a complete copy of transactions to verify. This helps prevent double spending without relying on a central authority or regulator.

The base level is the primary (or level 1) level of security, which creates an immutable record of data. The base layer is the blockchain. The second-layer protocol reduces the amount of data on the blockchain, allowing off-chain transactions.

With a Layer XNUMX protocol, core calculations can be done off-chain while transactions are still tied to the blockchain. This minimizes the amount of data stored at the core level and frees up critical resources without compromising security. In other words, blockchains with layer-XNUMX protocols are more user-friendly and scalable, which means they can compete with larger, more centralized systems.

Bitcoin vs Ethereum: Layer XNUMX Protocols

Both Bitcoin and Ethereum have introduced layer XNUMX protocols to improve speed and scalability. While Bitcoin uses the Lightning Network, Ethereum offers several second-layer scaling solutions such as optimistic folds, zero-knowledge folds, and plasma chains. Ethereum's Layer XNUMX protocols, including Polygon and Arbitrum, aim to solve scalability and cost issues by enabling off-chain computing.

Bitcoin's layer two solution is the Lightning Network, which uses smart contracts to enable near-instant and low-cost transactions, as well as cross-platform “atomic exchanges” where users can trade one coin for another without using an exchange.

SegWit vs second layer solution

Segregated Witness, or SegWit, is the most notable modernization of the Bitcoin protocol to date. It allows you to effectively separate transaction data from witness data, resulting in each transaction on the blockchain consisting of two parts:

• Basic data: This refers to the movement of bitcoins and the data related to this movement.
• Witness Details: Acts as a signature, essentially proving that the owner of the BTC authorized the transaction.

SegWit is a soft fork, or backwards compatible code change, that splits transactions into two segments. This transfers the witness data (or signature) from the original segment to the witness segment.

The SegWit implementation essentially doubles the block size, increasing it from 1 MB to 2 MB, without requiring major changes to existing code. While SegWit does not necessarily solve the scalability issue, it does provide support for layer XNUMX solutions such as the Lightning Network.

How the Lightning Network Helps Fight Bitcoin's Problems

By consolidating multiple microtransactions into one, the Lightning Network reduces network traffic. By moving these microtransactions off the main network, you can free up space for larger, higher-priority transactions and increase processing speed.

The Lightning Network also improves scalability by enabling off-chain transactions and settlements.

How can a user benefit from Bitcoin's Lightning Network?

The main advantages of the Lightning Network are its speed and availability. As discussed above, at the base level of the Bitcoin network, fees and waiting periods can be prohibitive. However, with the Lightning Network it is possible to send and receive small payments in a way that is simply not possible on the Bitcoin network. You can exchange payments multiple times before closing the channel and completing one transaction, all for one fee.

Because the Lightning Network operates as a secondary layer on top of the main network, it still offers users all of Bitcoin's standard security protocols. Users can also switch between networks depending on their needs, turning to the Bitcoin network for large transactions and switching back to the Lightning Network for micro-transactions. Transactions associated with the Lightning Network are private, conducted off-chain and only record the overall results.

Finally, the latest update to Taproot Assets expands the capabilities of Bitcoin technology to a wider range of users, as real-world assets such as fiat currencies and gold can be issued using the Taproot Assets protocol.

Impact of the Lightning Network on Bitcoin Adoption

Lightning Network nodes from January 2018 to October 2023.
Source: Bitcoin Visuals

Increasing the number of nodes and channels in the Bitcoin network allows it to increase the throughput for Bitcoin transactions. As its throughput continues to expand weekly, more people are adopting the technology, making it a critical asset in the Bitcoin ecosystem. The Lightning Network may be the key method that will solve Bitcoin's scalability problem.

Lightning Network performance from January 2018 to October 2023.
Source: theblock.com

If in 2021 the Lightning Network's throughput was more than 1 Bitcoins, then as of October 000, 22, it has increased to more than 2023 BTC. This also demonstrates the higher scalability of the Bitcoin network as a payment system.

The Lightning Network and Bitcoin work together to encourage more people to use both technologies. Those already using Bitcoin will naturally turn to the Lightning Network to make fast, small or low-cost payments. This flexibility and efficiency provided by the Lightning Network will continue to attract more users to use Bitcoin and Lightning. As more people use the Lightning Network and Bitcoin, they will become recognized on mainstream exchanges and accepted as more traditional forms of payment.

Disadvantages of Lightning Network

While the Lightning Network has the potential to solve some of Bitcoin's problems, it also has disadvantages.

First, the Lightning Network may not always be inexpensive to use. This is because before a micropayment can be made between parties, the user must first deposit onto the chain. In addition, the final amount to close the transaction must also be recorded in the Bitcoin chain.

Secondly, as a blockchain, the Lightning Network is subject to various security risks. One of them is due to the fact that attackers create many channels that expire at the same time, which leads to overload of the blockchain and the potential theft of funds from users who are unable to withdraw them due to the overload.

Finally, integrating the Lightning Network into existing payment systems is also a complex process. Merchants may not be interested in switching to the Lightning Network, especially given the volatility of Bitcoin.

The Future of the Lightning Network

Total value locked (TVL) on the Lightning Network from April 2022 to October 2023.
Source: DefiLlama

Currently, there is over $160 million locked in the Lightning Network, with people using the second layer solution to pay for goods, services, applications, and more.

Despite some limitations, it provides users with more options and versatility. As people increasingly use it to make lightning-fast micropayments, developers will continue to create interoperable wallets and support systems to develop and strengthen the network.

Сonclusion

Launched in 2018, the Lightning Network is rapidly changing the face of Bitcoin. Developers have worked tirelessly to create the reliable technology needed to support and promote the network, as well as create a user-friendly platform. Anyone can access and use the Lightning Network using just their smartphone, opening up a wealth of possibilities for seamless payments. The recent integration of the Taproot Assets protocol further expands Lightning's capabilities for both Bitcoin and its users. With the growing number of Lightning Network users, the vision of a faster and more scalable Bitcoin ecosystem is becoming more realistic.