Before we can get into what the Lightning network is, we need to understand the scalability problem of the Bitcoin blockchain.
The Bitcoin blockchain has a limited capacity to handle large amounts of transaction data within a short period of time. Data from Blockchain Council reveals that the average confirmation time for a BTC payment is approximately 10 minutes, and it can process a maximum of 7 transactions per second. This is because the records which are also known as blocks in the Bitcoin blockchain are limited in size and frequency.
Because of the existence of faster blockchains such as the RippleNet, which according to Blockchain Council can process 1,500 transactions per second with an average ledger settlement (approval time) of 3-5 seconds and the Solana Blockchain which can currently execute over 50,000 transactions per second, Bitcoin investors such as Michael Saylor, see the flagship cryptocurrency as more of a store of value rather than a means of payment.
Saylor, who is the CEO of MicroStrategy, believes that Bitcoin is, “digital real estate and digital gold.” He proves his point by making significant acquisitions of Bitcoin into his company’s balance sheet to the tune of $2.918 billion and an average purchase price of approximately $26,769 per Bitcoin. MicroStrategy has the largest holdings of Bitcoin among all other institutional investors with a total of 108,992 BTC in its treasury.
The slow processing power of the Bitcoin Blockchain has increased competition among other newer blockchains and according to the lightning network documentation, “transactions confirmed on the Bitcoin blockchain take up to one hour before they are irreversible. Micropayments, or payments less than a few cents, are inconsistently confirmed, and fees render such transactions unviable on the network today.”
Thus, the need to scale up the transaction capability of Bitcoin became ever more important and this need gave birth to the Lightning Network.
The Lightning Network
The lightning network was first proposed by Joseph Poon and Thaddeus Dryja in 2015 and has been under development since that time. It is a decentralized layer two technology applied to the Bitcoin Blockchain. It uses high-volume micropayment channels to scale the blockchain’s capability and removes the risk of delegating custody of funds to trusted third parties in order to conduct transactions more efficiently. Transactions conducted on lightning networks are faster, less costly and more readily confirmed than those conducted directly on the Bitcoin blockchain. The lightning network documentation explains that it is one of the first implementations of a multi-party Smart Contract (programmable money) using Bitcoin’s built-in scripting and is leading technological development in multiparty financial computations with Bitcoin.
Benefits of the Lightning Network
One major benefit of the Lightning Network is that payments do not rely on block confirmations which means that they are instant and atomic. Without lightning, Bitcoin aggregates transactions into blocks spaced ten minutes apart. Payments are widely regarded as secure on Bitcoin after confirmation of six blocks, which translates to one hour. With Lightning, the Bitcoin blockchain can be used at retail point-of-sale terminals, user device-to-device transactions or anywhere instant payments are needed.
The Bitcoin blockchain currently enforces a minimum output size many hundreds of times higher and a fixed per-transaction fee which makes micropayments impractical. Lightning enables one to send funds down to 0.00000001 Bitcoin without custodial risk. Lightning allows minimal payments denominated in Bitcoin, using actual Bitcoin transactions. This is why the popular acronym called ‘sats,’ came to be.
Lightning Network transactions are conducted off the blockchain without delegation of trust and ownership, allowing users to conduct nearly unlimited transactions between other devices. The network is designed to decongest the Bitcoin blockchain and reduce associated transaction fees. The lightning network can also be used to conduct other types of off-chain transactions involving exchanges between cryptocurrencies. For example, it is helpful for facilitating atomic swaps that enable one cryptocurrency to be exchanged for another without the involvement of an intermediary, such as cryptocurrency exchanges.
The Lightning Network’s Use Case
Strike is a payment application developed by Zap Solutions Inc., which allows users to send and receive money instantly around the world for free. The application integrates the Bitcoin and lightning network to its platform which makes it all possible. Strike is known for its work on how it made remittances easier for the people of El Salvador, a country where 70% of the population do not have a bank account.
Before strike, according to a CNBC interview with Jaime García, a citizen of El Salvador who currently resides in Canada, he explained the issues he faced sending money to his home country El Salvador. He stated, “It is wild that I had to go to a physical Western Union office, give them actual cash, and then hand them another $25 on top of that, before they would send my money over and then, of course, it takes three days for it to actually arrive in El Salvador.”
He further said, “They have to take a bus to go to a physical location to pick it up, and there are gangs that hang out around those offices. They know what people are going there for, and they basically rob them.”
Matt Hougan, chief investment officer of Bitwise Asset Management, explained that the transaction cost was on the high side. On this, he stated, “Remittances are one area where the status quo in our legacy financial system is terrible, with extraordinarily high fees levelled at populations that can ill afford them.”
With Strike, the people of El Salvador can send remittances in a fast and cheap manner, as they can easily send and receive tiny amounts of Bitcoin only made possible by the lightning network. According to Zap’s Jack Maller, the lightning network is “one of the more impressive advancements in money as a technology in human history.”
Lightning Labs, led by CEO and co-founder Elizabeth Stark, stated that the Lightning network is about Bitcoin being used and not just as a store of value or digital gold. She stated, “The idea that it’s merely a digital rock fails to tap into the very nature of what Bitcoin can do. Bitcoin is programmable money, and Lightning can help scale it to billions of people across the world.”
Elizabeth Stark may be right as El Salvador just adopted Bitcoin as legal tender and the government issued wallet known as Chivo, uses the lightning network to make payments and remittances easier in the Latin American nation. Now remittances are a whole lot easier in the nation, giving traditional payment services like western union a run for their money. The President of El Salvador, Nayib Bukele, estimates that money services providers like Western Union and MoneyGram will lose $400 million a year in commissions for remittances, thanks to the country’s Bitcoin adoption.
Desiree Dickerson, Lightning Labs’ vice president of operations, touts the power of the lightning network stating that it currently has a maximum throughput of 25 million transactions per second and it expects that to increase as the network grows; Desiree also mentions that the Lightning Network settlement is instant, instead of taking 10 to 60 minutes on-chain.
She added, “Lightning is going to transform the way people interact with and use bitcoin. It’s not just, ‘Yay, the number went up, I made a 100x gain on my investment.’ It’s going to be like, ‘Oh shit, you can actually transact and use this?’”