Crypto 103 - Bitcoin's Lightning Network⚡

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Bitcoin literally up for grabs. Interested? Scroll to the end of this article to find out more.

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Prerequisite knowledge

1. Understanding of blockchains and how they work (see opinion article below): Crypto 101 - Blockchains 🧊⛓
2. What the blockchain trilemma is & how blockchains (layer 1s and layer 2s) interlink to push cryptocurrencies towards world domination (adoption): Crypto - 102 Blockchain Trilmma📐

Note: This is not to drive readership to my past opinion articles; Having some knowledge of crypto can help you better understand why lightning networks are important in the world today.

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Lightning Network

An explainer on how it works & why it makes Bitcoin (BTC) a better candidate for a payments network that is:

• Decentralized
• Scalable
• Secure

Let's go ⚡

What is the Lightning Network?

The Lightning Network (LN) is a L2 protocol / solution that enables high-volume, low-latency (fast) bitcoin micropayments without the need for trusted intermediaries. MANY BTC micro-transactions can happen FAST & in a decentralized manner.

How does LN achieve this? Payment channels.

The easiest way to understand it is via an example. Alice & Bob each have 1 BTC.

Due to a commercial agreement, Alice needs to send Bob 0.01 BTC every day. In today's prices, that's about $400 to $450 USD (prices move fast these days). This is a typical BTC transaction, but with only a transaction speed (TPS) of 7 per second, it's hard for the whole world to conduct such transactions without bringing the network to a standstill due to network congestions. See below for what happens when there are more transactions than the throughput BTC has to support it.

Sorry if it's unclear; the highest fees paid (as shown in the chart) was $62.79 USD. For users who don't own alot of BTC yet wish to transact via Bitcoin as a medium of exchange (more later on why they would want to), $62 USD is a high amount, especially if you need to send $500 USD (12% transaction fees!).

How can the LN help alleviate this issue?

As mentioned at the start, LN resolves the need for trusted intermediaries. How do you send funds without a trusted party? That's like sending money to your friend but without PayLah or PayNow. The only way you'd send it is via a physical transfer.

With programming imbued into all blockchains, trustless payments can easily happen via multisignature (multi-sig) transactions.

What are they?

Transaction denotes a transfer of something (in this case BTC) from 1 party to another. When sending via PayLah, only 1 signature is needed: in this case your PayLah account (usually using FaceID for iPhone) from which to send money. In a multisignature transaction, multiple parties need to agree to send the same money. In the banking, wire transfers (especially in large sums) often require multiple signatories to "sign-off" on it before it can be sent.

In crypto, its the same thing. Without getting into the technical jargon, know that for each crypto address (in this case bitcoin), it has a public and private key. The private key is akin to your own signature; only you have it. Take good care of your wallets! I list down 5 lessons to avoid getting scammed like I did.

Resources:

https://www.massmux.com/introduction-to-digital-signature-in-bitcoin/

https://searchcio.techtarget.com/definition/multisig-multisignature

To transfer money via the LN, a channel (between 2 parties) has to be opened. However, there's no reason to open a channel with no BTC to transfer. The BTC is in the bitcoin network. To "send" it to LN (so payments can happen), both parties can commit & sign a multi-sig transaction on the amount of BTC allocated to each party. This transaction is then broadcasted to the bitcoin blockchain.

Alice can commit 0.5 BTC, whilst Bob can commit 0.1 BTC. Once this is broadcasted, both Alice and Bob can freely send BTC micropayments to one another.

===== Details of transactions =====

Start balances

Alice: 0.5 BTC

Bob : 0.1 BTC

Total: 0.6 BTC

Alice sends 0.01 BTC to Bob

Alice sends 0.02 BTC to Bob

Bob sends 0.05 BTC to Alice

Alice sends 0.1 BTC to Bob

Final balances

Alice: 0.42 BTC

Bob : 0.18 BTC

Total: 0.6 BTC

===== Details of transactions =====

Alice and Bob decides to end their channel. To do that, they again have to agree on the final state of the channel. How much BTC does Alice and Bob have? Both parties then agree and sign-off (via multi-sig transactions) to agree on the final state of the channel.

Note that these are all REAL transactions happening off-chain (i.e. not on the bitcoin network). When the need for BTC micropayments has ceased, the final state (of the LN wallets) will be broadcasted to the network, and the funds returned to their original BTC wallets.

The details of transactions above are similar to how banks operate (AKA netting). Customers use various methods to transfer money between one another across banks. Usually, to facilitate each and every transaction (such as PayNow of $5 to to your friend's OCBC account via his phone) is quite burdensome on any network and increases unnecessary costs.

It's kind of like how you settle your bill with your friends after the night out. This would be infinitely better than settling each starter, main, dessert separately.

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Channel State

Alice or Bob can elect to broadcast the most recent txn (spend) & final state onto the Bitcoin blockchain at any time to redeem their balance of funds. This will then close the payment channel on the LN.

Anytime you update the channel with a transaction, the channel's state (i.e. final balance) will be enforceable. This is because the prior state will be revocated, or in other words, void. As such, only the most recent state of that channel can and should be broadcasted.

If Alice or Bob incorrectly broadcasts an old transaction state (such as when Alice still has 0.5 BTC after sending 0.08 BTC. The counterparty can take all funds in the channel as a** [penalty transaction**](https://river.com/learn/terms/p/penalty-transaction/). As long as one party is able to produce a new transaction state within a time window (recall that new transactions will update channel state, voiding old ones, and that transactions are multi-sig and require two parties).

This ensures direct economic incentive to only broadcast the latest state, reducing the potential for fraud.

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Now that we have a better understanding of channels within the LN, we can visualize the LN in its entirety here.

It's not stated on the picture, but if you were to take a look, you'd see: ~16k nodes, 67k channels, 2.3K btc cumulative, 3.5m satoshis ($1.5k USD) on avg/channel, and climbing!

Not exaclty Visa (~70,000 Transactions Per Second with likely millions of transactions happening worldwide in minutes), but pretty validating to see these metrics.

Since there are ~67k channels open, it may be feasible for users to send BTC to any other LN user, without having to persist a channel. For LN, payments can be sent over many channels w/o trusting the intermediate nodes.

Let's examine this further.

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This is analogous to IP networks where packets of data are routed over many physical networks. Serving the website of, say Uber US website requires them to send data of the website from their origin server all the way to your mobile or laptop screen. Data are transmitted in packets to ensure information reliability; Whole websites should not have to be sent as very large files, which can clog up the network.

In LN, users pay a small routing fee to pass the payments between nodes to other users. The fees are really small.

Consider an example (Alice Charlie Bob) where Alice needs to pay Bob a sum of 0.01 BTC. Recall, 1 BTC = 100,000,000 satoshis. Alice would simply need to pay the base fee and fee rate. Base fee is usually 1 satoshi, and fee rate is 0.1% of transaction value.

How cheap is 1 satoshi? USD $0.0004229916. That's cheap. Essentially, for a small fee, you would be able to send bitcoin to any other user, even without opening a channel within the two. Talk about permissionless.

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Summary

LN can be a little dry to new investors. Even with 4 years of crypto usage, I've not personally used LN (have no need to send micropayments). But as a potential investor in Bitcoin, you need to understand its value proposition and how it amplifies Bitcoin's use case as a store of value. With LN, Bitcoin has the potential of becoming a permissionless medium of exchange as well.

Hopefully the TL;DR summary below helps solidify your understanding in the Lightning Network ⚡

Lightning network allows its users to transfer bitcoin as micropayments to any other user via channels, which works like how you would settle payments with friends at the end of a night out, rather than after starters, dinner, drinks, dessert individually (AKA netting). All actions in the LN usually requires signatures (private keys) of 2 wallets (i.e. multisignature), ensuring agreement of both parties are reached before transactions are made. Each transaction will update the channel state (e.g. final bill), which will void the previous one. Users can "end the night early" by broadcasting the final state (e.g. bill) to the Bitcoin network (e.g. to their friends), and collecting/paying from their Bitcoin wallet. Users can also make payments other users by routing through other channels (e.g. passing it on) without establishing a direct channel, for a very small fee.

As a further appreciation of the Lightning Network, you may wish to take a look at the articles below describing its importance in the world today.

El Salvador using Lightning Network to facilitate Bitcoin as their Legal Tender.

Twitter implementing functinality for users to tip other users in Bitcoin (on iOS currently).

Editors note: Expect usage metrics for the LN to rocket upwards once the tip function gains traction on Twitter.

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Closing thoughts

Thank you for reading thus far. I am simply trying to educate the mass market about the non-price aspects of crypto. As with stocks, once you understand the value proposition, you'll eventually realise whether this particular investment is overvalued or undervalued. I think my tone implies quite clearly which side I am on.

Cheers and keep stacking sats,

Joey

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