Explaining the Bitcoin Lightning Network and its Real-World Benefits for Everyday Spending

Jan 10, 2019 | Crypto News

Combating issues to create the best possible version of the cryptocurrency industry is a priority for many pioneers. Today, however, there are still several obstacles preventing most people from using Bitcoin to make everyday purchases.

While Bitcoin is an effective medium for making high-value payments, its effectiveness is limited when it comes to frequent and/or small transactions.

Largely, this is due to issues regarding the scalability of the Bitcoin network. Currently, the network slows down and transaction costs increase as adoption grows. This is because Bitcoin transactions are stored on a highly-secure and resource intensive blockchain.  

One of the most prominent solutions that aims to allow Bitcoin to be an effective everyday spending mechanism is a protocol known as the ‘Lightning Network.’

The Lightning Network is designed to be effective for small transactions

Without the Lightning Network, every single Bitcoin transaction that occurs is recorded in ‘blocks’ and sequentially added to the blockchain. Before transactions are added, they have to be confirmed by ‘miners’ that allocate their device’s resources in order to verify pending transactions.

As a result, Bitcoin transactions are highly secure and transparent. The consequence of this proof-of-work (PoW) validation algorithm, however, is that a lot of information has to be stored directly on the blockchain and even small purchases can be accompanied by significant transaction fees.

To combat these negative aspects of the network, numerous pioneers are developing real-world solutions. In fact, the Lightning Network protocol is being worked on by several separate project teams, though it was first proposed by two developers, Joseph Poon and Thaddeus Dryja.

Put simply, the idea behind the Lightning Network is that not all transactions have to be stored individually on the blockchain. While it’s important to store high-value transactions for the sake of security and transparency, proponents believe that smaller transactions can be effectively lumped together to reduce the consumption of network resources.

The result is a system that handles some transactions ‘off chain’ (meaning not on the Bitcoin blockchain) to increase speed. First, a ‘payment channel’ is created by two or more parties and this opening transaction is recorded on the blockchain.

Then, the transactions conducted between these parties are handled outside of the blockchain. When the involved parties are done with their set of transactions, a closing transaction is recorded on the blockchain which contains all pertinent information in order to update everyone’s new Bitcoin holdings.

The role of the ‘multisignature’ cryptocurrency wallet

The Bitcoin Lightning Network leverages what’s known as a multisignature (multisig) wallet in order to create payment channels. Like most other types of cryptocurrency wallets, multisig wallets are a way of securely storing digital assets like Bitcoin through a software application.

While traditional cryptocurrency wallets grant access to whoever holds the private key (a string that verifies wallet ownership), multisig wallets require multiple private keys before funds are accessed.

When a payment channel is opened as part of the Lightning Network protocol, all involved parties have their associated funds stored on a multisig wallet for a temporary amount of time. Once the transaction is concluded, unspent digital assets are returned to their respective owners and the transaction concludes in the same way as any other purchase.

Effectively, this means that a set of transactions on the Lightning Network can be conducted through only an ‘opening’ and ‘closing’ entry on the Bitcoin blockchain. While multisig wallets are able to safely store funds, sending transactions through the Lightning Network is currently only recommended for small and frequent transactions as the protocol is still in a relatively early stage of development.

The Lightning Network is improving transaction speeds and lowering fees

The Lightning Network is just one of several ideas to improve the functionality of cryptocurrencies in the context of everyday spending. Its prominence in future-gazing cryptocurrency discussions is owed to several core factors.

Firstly, the Lightning Network is currently live on the Bitcoin blockchain, meaning users can send transactions through the network. This places it ahead of other more theoretical solutions, as it is already demonstrable in the world today.

Secondly, the network has gained popularity over time, and more users are operating Lightning Network nodes. As a result, this adoption could allow the protocol to serve as the much-needed solution for Bitcoin to compete with other payment methods in an everyday capacity.

Once solutions are employed to address Bitcoin’s issues with scalability, proponents believe that adoption will rise and Bitcoin will become a standard method of transacting with vendors and friends throughout the world.