To understand the Bitcoin Lightning Network – commonly referred to as LN (Lightning Network) – you first need to understand what Bitcoin itself is. Everyone knows that Bitcoin is a so-called “cryptocurrency,” which essentially means decentralized digital money that’s cryptographically secured.
This “decentralized” quality of Bitcoin is actually one of its finest qualities and why it has so much appeal. The only management system for Bitcoin is the Blockchain, that is, the Bitcoin “ledger.” This ledger records all of the Bitcoin transactions and contains certain crucial information, namely the sender, the recipient, and how much Bitcoin is being transferred.
Each block on the blockchain is a package of information about transactions. Every time a block is created – which happens every 10 minutes – it is immutable, meaning it cannot be changed or tampered with. The Blockchain itself is the core foundation of Bitcoin and what makes the network decentralized and secure.
Now you may be asking yourself, “I thought this was about the blockchain, so why am I just reading Bitcoin for dummies?” Well, the lightning network ties directly into the main Bitcoin blockchain – commonly referred to as the base layer – and the transactions on it.
Let’s begin by addressing the issue of Bitcoins scalability. In short, the main blockchain isn’t designed:
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To process an enormous number of transactions
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In seconds (at the speed of light)
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at a very low cost (almost free)
As a result of this issue, the concept of the lightning network was introduced by Joseph Poon and Thaddeus Dryja in their (long) whitepaper entitled “The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments,” originally published in February 2015.
In it, they outline an excellent resolution for scaling Bitcoin. Rather than having all the Bitcoin transactions immediately recorded on the blockchain, why not have transactions occur off-chain, and then, after everything is settled, go back to the blockchain and record the transactions?
The best analogy for the Lightning Network is a bar tab. When you’re with your buddies at the bar, it can be really irritating to pay for your drinks every time you order one, but with a tab, you can just pay for everything at the end. This is quite similar to how the Lightning network makes recording Bitcoin transactions far more convenient and efficient.
It allows transactions to take place off the chain, and then, once everything is settled, it goes back to the blockchain to record the transactions. This makes the whole peer-to-peer transaction even more realistic and possible.
The LN is built on top of the blockchain and allows individuals to open payment channels. Once a channel is established, the participants can freely trade with one another under signed transactions. This information is stored locally by the transaction parties.
They can continue paying each other back and forth until they are ready to close the channel. This is like settling your tab. The final amount of the transaction is then recorded on the blockchain.
As you can see in the above table the lightning network is a far more efficient and convenient way to transact Bitcoin and resolves the issue of the blockchain’s scalability.
Additionally, it allows for almost instant transactions, anywhere in the world, at the cost of pennies. A Capability that hasn’t even been possible with Fiat currencies. It’s been put into effect and I’m sure we’ll be seeing it implemented more and more commonly in the future.