Blockchain, Web3

Everything You Need to Know About the Bitcoin Lightning Network


Blockchain wasn’t designed for scalability. It was intended to be a decentralized payment system that would keep participants anonymous and be accessible from anywhere. Blockchain’s popularity became one of its issues as transactions slowed down and proved to be more expensive than intended.

Scalability remained one of the most significant barriers to the widespread adoption of cryptocurrencies. If blockchain were designed for scalability, it could handle millions of transactions per second.

Developers of blockchain then created cryptocurrency layers, where the first layer is the primary blockchain, and every subsequent layer complements the one above it and adds functionality to the system. 

With that context, let’s find out what the Bitcoin Lightning Network is.

Related: Blockchain for Sustainability

What is the Bitcoin Lightning Network?

One of the issues with the Bitcoin blockchain is its languid processing speed of 5 transactions per second. To help fix that, developers conceptualized the Lightning Network, a second-layer solution to be placed on top of the Bitcoin blockchain.

The Lightning Network was proposed by two researchers in 2015- Thaddeus Dryja and Joseph Poon, in a paper called “The Bitcoin Lightning Network”. They based their writing on their discussions with Satoshi Nakamoto, the unknown creator of Bitcoin. Later, the two founded Lightning Labs, along with other contributors, started developing the Lightning Network and launched a Beta version of the Lightning Network in 2018.

The Lightning Network enhances the speed and efficiency of the layer-1 blockchain using off-chain transaction processing. The Lightning Network is akin to lanes branching out from an express highway so that if the highway is clogged by traffic, some of it can be diverted to the lanes, resulting in higher efficiency.

The Bitcoin Lightning Network offloads traffic from the main blockchain network to process some of it on the second layer. Transactions undertaken and executed on the second layer get vetted and confirmed faster and more inexpensively than those on the primary blockchain network. Thus, the Lightning Network also considerably brings down the cost of transactions.

What is the Need for the Lightning Network?

Satoshi Nakamoto’s description of Bitcoin in the 2008 white paper includes the phrase “peer-to-peer electronic cash”, meaning that the founder’s vision for the cryptocurrency was that it would one day become a popular way to pay for goods and services online.

As Bitcoin’s value grew exponentially over the years, the perception shifted as people began seeing Bitcoin as a “digital gold” or an inflation-resistant asset to store wealth over time, away from a centralized authority.

Bitcoin allowed strangers to securely send and receive value, utilizing mining as a way of achieving consensus. However, mining is a resource-intensive process.

The Lightning Network comes in to help Bitcoin function better as the digital currency its founder envisioned it to become. By making transactions more feasible- cheaper, quicker and more energy-efficient, Lightning Network reduces the cost of each transaction to fractions of a cent.

While the main Bitcoin blockchain could handle fewer than ten transactions a second, a Lightning network can handle millions of transactions a second. Additionally, an already sluggish blockchain network could get even slower if it was scaled on the primary blockchain by adding nodes. So, scaling layer-1 was out of the question and scaling layer-2 was almost necessary.

Related: How the Ethereum Merge Impacts DeFi Industry and the Environment

How Does the Lightning Network Work?

Note that the Bitcoin blockchain was designed to function as a Peer-to-Peer (P2P) payments network. So, it was never equipped with the smart contracts system that Ethereum brought in on its Proof-of-Work blockchain.

The Lightning Network adds the smart contracts capability to the layer-2 network, enabling the creation of layer-2 payment channels between transacting parties. Each smart contract contains transaction details, including financial obligations and completion conditions, which, when fulfilled, trigger the smart contract to send data to the blockchain for recording purposes automatically.

Users must lock in Bitcoins to create a payment channel. Once they do so, both parties can transact instantaneously and inexpensively. Then, parties can close the channel when transactions are completed. To keep channels open, however, parties must keep adding more Bitcoin to the network.

Interestingly, parties don’t need to transact in pairs on the Lightning Network. If user A has an open channel with user B and user B has an open channel with user C, user A can transact with user C without establishing a direct channel. These interconnections drastically bring down transaction costs.

However, if user B discontinues their channel with user C, user A will be affected and required to pay and establish a channel with user C to transact with them. Two parties can transact for however long they want on the Lightning Network. Once they close the channel, the transaction is recorded on the primary blockchain.

This ensures that data is consolidated and then processed by nodes on the primary blockchain, reducing the need for resources on every transaction. Off-chain processing is also secure as it rests on the security protocols of the layer-1 blockchain, on which the solution is built.

The Lightning Network provides higher user privacy and maintains the anonymity of transacting parties, only displaying the total transfer of value and not the individual transactions. It’s unlike the primary blockchain, where each transaction appears on the public and transparent ledger.

Related: FTX Collapse and What it Means for Web3

Concerns and Risks with the Lightning Network

The most evident concern with the Lightning Network is that it could replicate the hub-and-spoke model of today’s financial systems, where banks and financial institutions are the primary intermediaries through which transactions occur. Businesses investing in the Lightning Network may become similar hubs, failing the intention for decentralized transactions.

Let’s look at the other top concerns with the Lightning Network today:

  • Closed channel fraud – Let’s say users A and B each deposit an initial 0.5 BTC to open a channel, and a transaction of 1 BTC takes place where user A purchases goods from user B. If user B logs off after transferring goods and user A doesn’t, user A could broadcast the initial state before the 1 BTC was transferred. Both users get their initial deposits back in this case as if no transactions occurred. And user A receives 1 BTC worth of goods for free and gets their deposit back. This compels third parties (or watchtowers) to run on nodes within the Lightning Network to monitor transactions and prevent fraud.
  • Fees – Lightning Network comes bearing transaction fees in a combination of routing charges, fees on opening and closing channels and Bitcoin’s usual transaction fees. Moreover, businesses may start charging fees as they adopt the Lightning Network for payment settlements. Finally, because watchtowers are third parties, they charge for the service delivered. When two parties settle the bill among themselves, they record a closing transaction on the mainnet, which includes a fee (set or a percentage of the transaction) for forwarding the transactions.
  • Hacks – The Lightning Network is decidedly vulnerable to hacks and thefts as payment channels, APIs and wallets can suffer from malicious intrusion.
  • Malicious attacks – A risk to the Lightning Network is malicious and deliberate congestion of payment channels. Such traffic may block genuine participants from getting their money back due to slow transaction processing during congestion. Attackers can use an attack such as denial-of-service to congest a channel and steal funds from participating entities unable to withdraw due to network freeze.

Pros of the Bitcoin Lightning Network

Faster and cheaper transactions through the Lightning Network uniquely enable microtransactions, being the most important advantage of the network. Since it’s connected to the underlying Bitcoin blockchain, the Lightning Network benefits from Bitcoin’s security protocols.

It also allows users to choose the main blockchain for more significant transactions while utilizing off-chain for smaller transactions without compromising security and safety.

The Lightning Network enhances privacy, only allowing onlookers to see the total transfer of value instead of each transaction. It also reduces energy consumption to perform transactions on the Bitcoin network by allowing smaller transactions to be executed off the mainnet.

Finally, Lightning Network introduces smart contracts and multi-signature scripts to ensure that funds are transferred to the intended persons.

Cons of the Bitcoin Lightning Network

Besides the justified concerns about the Lightning Network we discussed in a previous section, the network has a few cons. A user must acquire a wallet compatible with it to use the Lightning Network. When they find such a wallet, they need to fund it from a traditional Bitcoin wallet and pay a fee to transfer Bitcoin to the Lightning Network.

Then, users need to lock up their Bitcoin to create a payment channel. Sending Bitcoin between wallets can be expensive and off-putting for early users. However, it is only getting more convenient as some wallets can manage both on and off-chain payments without paying any fee.

Another disadvantage is the inability to pull out some funds while keeping a channel active. Users need to close a channel in order to make any withdrawals. Closing or opening a payment channel requires users to pay a routing fee.

The Lightning Network suffers from bugs such as stuck payments in the form of outgoing transactions that don’t get verified. While the Bitcoin network refunds a stuck transaction, it could take days before users acquire their funds.

Finally, the Lightning Network might make little to no sense to regulators in the future because of its anonymity factor. If regulators don’t understand the need for keeping micro-transactions hidden and users anonymous, mainstream crypto users might also struggle to rely on the Lightning Network.

Related: 7 Reasons Why Startups Choose KiwiTech

What Does the Bitcoin Lightning Network’s Future Look Like?

In October this year, Bitcoin’s Layer-2 Lightning Network hit the capacity of 5,000 BTC ($100 million), less than four months after it hit the capacity of 4,000 BTC. This indicates that people are paying for goods and services, utilizing apps, or gambling, among other activities, on the Lightning Network.

Lightning Labs recently released a test version of new software to allow creating and working with assets on Bitcoin. The software, Taro, would allow stablecoins to be hosted on the network. And Lightning Network integration would enable their transfer across scaling solutions quickly and inexpensively.

Lightning Network has institutions eyeing it, with MicroStrategy looking for a full-time Bitcoin Lightning Software Engineer to build a SaaS platform and Lightning Network digital payment provider Strike raising  $80 million in a funding round led by Ten31 and joined by Washington University in St. Louis, the University of Wyoming, among others.

Those activities indicate that the future is bright for Bitcoin’s Lightning Network.

For dedicated assistance in developing and implementing blockchain-related projects, reach out to experts at KiwiTech.

Subscribe to our Newsletter
Stay current with our latest insights