The Lightning Network is a decentralized system that will run alongside the Bitcoin blockchain in an attempt to make transactions faster, decrease fees, and allow Bitcoin to handle a much higher transaction volume. This system will be vital for keeping Bitcoin competitive in the future, as new cryptocurrencies with many of these features are constantly being created. For example, Ripple, Stellar, and Nano, all offer massively-scalable, near-instant transactions for practically no cost.
What’s wrong with Bitcoin right now?
As cryptocurrencies have become more popular, the Bitcoin network has seen a huge surge in volume. All of the extra users have caused the fees and transaction times to skyrocket. From the start of the Bitcoin in 2009, up until the end of 2016, transactions usually cost less than 20 cents and were finalized in about 10-30 minutes. These numbers rose throughout 2017; in December the transaction fees averaged above $20, with a peak of $55 per transaction – that’s 275 times what the fee was one year earlier. Similarly, transaction times have rose to an average of 60 minutes, with frequent spikes to 4+ hours when the network is congested.
This increase in fees and settlement times is due to how the Bitcoin network currently operates. The Bitcoin blockchain is built from collections of transactions called “blocks”. A new block is mined approximately every 10 minutes and added to the blockchain, causing the transactions on that block to be saved permanently. Each block is limited to a size of 1MB, while a transaction is about 500 bytes, meaning that only about 2000 transactions can be processed every 10 minutes.
Due to this, demand far outweighs the processing speed. To make sure miners choose to include your transaction in the next block, you can offer to pay them; this is where transaction fees come from. With more competition, these fees have kept increasing, causing the crazy figures seen in December.
If Bitcoin is going to continue growing, it needs to be able to handle huge amounts of fast and cheap transactions – that’s where the Lightning Network comes in.
How will the Lightning Network solve these problems?
As Bitcoin is limited by the amount of transactions that can be processed per block, the Lightning Network plans to make transactions cheaper and faster by taking them off of the blockchain. In reality, the blockchain doesn’t need to know about every individual transaction made, it just needs to know about the net change to each account balance. By utilizing this idea, the Lightning Network is able to group a huge amount of Bitcoin payments into a few blockchain transactions.
The Lightning Network is actually just a huge network of off-blockchain payment channels. When a users chooses to join the Lightning Network, they will form at least one channel (a link) with another user. When they want to send Bitcoin, the funds will move through these payment channels until they reach the recipient. For the users, making a payment using the Lightning Network is no different to an on-chain transaction.
By utilizing this huge network of payment channels, the Lightning Network is able to transfer funds practically instantly and with minimal costs. As unlimited connections can be formed in the network, it is also infinitely scalable. This means that Bitcoin will eventually be able to handle huge amounts of transactions per second, making it a viable alternative to credit card transactions in retail environments. If the Lightning Network continues to grow, Bitcoin should remain as a dominant and practical cryptocurrency well into the future.