Welcome to Mastering the Lightning Network!
The Lightning Network, abbreviated with LN, is a protocol for using Bitcoin in a smart and non-obvious way. Thus it is a second layer technology on top of Bitcoin. It is changing the way people exchange value online and it’s one of the most exciting advancements to happen in Bitcoin’s history. Today, in 2020, the Lightning Network is in its infancy. In concept it was first proposed in 2015 and the first implementation was launched in 2018. As of 2020, we’re only beginning to see the opportunities the Lightning Network provides including improved privacy, speed, and scale. With core knowledge of the Lightning Network, you can help shape the future of the network while building opportunities for yourself as well. Some basic knowledge about Bitcoin is assumed but can be readily acquired by reading the first two chapters of Mastering Bitcoin which are available for free online.
While the bulk of this book is written for programmers, the first two chapters are written to be approachable by anyone regardless of technical experience. In order to better understand how the technology actually works, and why people use it, we’ll be following a number of users and their stories. But first, we’ll introduce some of the key concepts in the Lightning Network. Let’s get started with why the Lightning Network was proposed in the first place.
As Bitcoin and the demand for transactions grows, the number of transactions in each block will increase until it eventually hits the block size limit. When blocks are full, excess transactions are left to wait in a queue. Many users will increase the fees they’re willing to pay in order to buy space for their transactions in the next block. At the same time, an increasing number of users are left behind. Their transactions, e.g. microtransactions such as common small spendings, are not economically qualified to be on the network. We could increase the block size to create space for these smaller transactions. However, increasing block size simply shifts the problem to node operators, and requires them to expend resources to facilitate these additional transactions.
Because blockchains are gossip protocols, each node is required to know and validate every single transaction that occurs on the network. Furthermore, once validated, each transaction and block must be propagated to the node’s "neighbors", multiplying the bandwidth requirements. As such, the greater the block size, the greater the bandwidth, processing, and storage requirements for each individual node, effectively limiting the amount of scaling that can be done this way. Furthermore, scaling in this fashion has an undesirable side effect of centralizing the network by reducing the number of nodes and node operators. Since node operators are not compensated for running nodes, if nodes are very expensive to run, only a few well funded node operators will continue to run nodes.
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Note
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The side effects of increasing the block size or decreasing the block time with respect to centralization of the network are severe as a few calculations with the numbers show. Let us assume the usage of Bitcoin grows so that the network has to process 40,000 transactions per second. Assuming 250 Bytes on average per transaction this would result in a data stream of 10 Megabyte per second or 80 Mbit/s just to be able to receive all the transactions. This does not include the traffic overhead of forwarding the transaction information to other peers. While 10 MB/s does not seem extreme in the context of high-speed fibre and 5G mobile speeds, it would effectively exclude anyone who cannot meet this requirement from running a node, especially in countries where high-performance internet is not affordable or widely available. Users also have many other demands on their bandwidth and cannot be expected to expend this much only to receive transactions. Furthermore storing this information locally would result in 864,000 Megabytes per day. This is roughly one Terabyte of data or the size of a hard drive. While verifying 40,000 ECDSA signatures per second seems barely feasible (c.f.: https://bitcoin.stackexchange.com/questions/95339/how-many-bitcoin-transactions-can-be-verified-per-second) nodes could hardly catch up initial sync of the blockchain. |
But what if each node wasn’t required to know and validate every single transaction? What if there was a way to have scalable off-chain transactions, without losing the security of the Bitcoin network?
In February 2015, Joseph Poon and Thaddeus Dryja proposed a possible solution to the Bitcoin Scalability Problem, with the publication of "The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments" [1] In the now outdated whitepaper, Poon and Dryja estimate that in order for Bitcoin to reach the 47,000 transactions per second processed at peak by Visa, it would require 8 GB blocks. This would make running a node completely untenable for anyone but large scale enterprises and industrial grade operations. The result would be a network in which only a few users can actually validate the state of the ledger. Bitcoin relies on users validating the ledger for themselves, without explicitly trusting third parties, in order to stay decentralized. Pricing users out of running nodes forces the average user to trust third parties to discover the state of the ledger, ultimately breaking the trust model of Bitcoin.
The Lightning Network proposes a new network, a "second layer", where users can make payments to each other peer-to-peer, without the necessity to publish a transaction to the Bitcoin blockchain for each payment. Users may pay each other on the Lightning Network as many times as they want, without creating additional Bitcoin transactions or incurring on-chain fees. They will only make use of the Bitcoin blockchain in order to load bitcoin onto the Lightning network initially and to "settle", that is: remove bitcoin from the Lightning Network. The result is that many more Bitcoin payments can take place "off-chain", with only the initial loading and final settlement transactions needing to be validated and stored by Bitcoin nodes. Aside from reducing the burden on nodes, payments on the Lightning Network will be cheaper for users as they do not need to pay blockchain fees, and more private for users as they are not published to all participants of the network and furthermore not stored permanently.
While the Lightning Network was initially conceived for Bitcoin, it can be implemented on any blockchain that meets its technical requirements.
As we start exploring the Lightning Network, we will encounter some technical terminology that might, at first, be confusing and a bit difficult to understand. While all of these concepts and terms will be explained in detail as we progress through the book, and are defined in the glossary, we need some basic clarifications to get started. Here are some of the concepts you will encounter in the first two chapters of this book:
- Node
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A computer that participates in a network. A Lightning node is a computer that participates in the Lightning Network. A Bitcoin node is a computer that participates in the Bitcoin Network. Typically a Lightning Network user will run a Lightning node and a Bitcoin node.
- Blockchain
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A distributed transaction ledger, produced by a network of computers. Bitcoin, for example, is a system that produces a blockchain. The Lightning Network is not itself a blockchain, nor does it produce a blockchain. It is a network that relies on an existing external blockchain for its security.
- Transaction
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A data structure that records the transfer of control over some funds (e.g. some bitcoin). The Lightning Network relies moreover on Bitcoin transactions (or those of another blockchain) to track control of funds.
- Payment
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When value is exchanged on the Lightning Network we call this a "payment" as compared to a "transaction" on the Bitcoin Blockchain.
- Payment Channel
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A financial relationship between two nodes on the Lightning Network, typically implemented by multi-signature Bitcoin transactions that share control over bitcoin between the two Lightning nodes.
- Routing vs Sending
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Unlike Bitcoin where transactions are "sent" by broadcasting them to everyone, Lightning is a routed network where payments are "routed" across one or more payment channels following a path from sender to recipient.
- On-Chain vs. Off-Chain
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A payment is "on-chain" if it is recorded as a transaction on the Bitcoin (or other underlying) blockchain. Payments sent via payment channels between Lightning nodes, and which are not visible in the underlying blockchain, are called "off-chain" payments.
More detailed definitions of these and many other terms can be found in the [glossary]. Throughout this book, we will explain what these concepts mean and how these technologies actually work.
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Tip
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Throughout this book, you will see "Bitcoin" with the first letter capitalized, which refers to the Bitcoin System and is a proper noun. You will also see "bitcoin", with a lower-case b, which refers to the currency unit. Each bitcoin is further subdivided into 100 million units each called a "satoshi" (singular) or "satoshis" (plural) |
The Lightning Network is a network that operates as a "second layer" protocol on top of Bitcoin and other blockchains. The Lightning Network enables fast, secure, private, trustless, and permissionless payments. Here are some of the features of the Lightning Network:
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Users of the Lightning Network can route payments to each other for low cost and in real-time.
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Users who exchange value over the Lightning Network do not need to wait for block confirmations for payments.
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Once a payment on the Lightning Network has completed, usually within a few seconds, it is final and cannot be reversed. Like a Bitcoin transaction, a payment on the Lightning Network can only be refunded by the recipient.
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While "on-chain" Bitcoin transactions are broadcast and verified by all nodes in the network, payments routed on the Lightning Network are transmitted between pairs of nodes and are not visible to everyone, resulting in much greater privacy.
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Unlike transactions on the Bitcoin Network, payments routed on the Lightning Network do not need to be stored permanently. Lightning thus uses fewer resources, hence it is cheaper. This property also has benefits for privacy.
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The Lightning Network uses onion routing, similar to the protocol used by The Onion Router (Tor) privacy network, so that even the nodes involved in routing a payment are only directly aware of their predecessor and successor in the payment route.
You will often hear people calling Bitcoin and the Lightning Network "trustless". At first glance this is confusing. After all, isn’t trust a good thing? Banks even use it in their names! Isn’t a "trustless" system a system devoid of trust a bad thing?
The use of the the word "trustless" is intended to convey the ability to operate without needing trust in the other participants in the system. In a decentralized system like Bitcoin you can always choose to transact with someone you trust. However, the system ensures you can’t be cheated even if you can’t trust the other party in a transaction. Trust is a nice-to-have instead of a must-have property of the system.
Contrast that to the traditional banking system where you must place your trust in a third party, since they control your money. If they violate that trust you may be able to find recourse in a regulator or court, but you would be facing an enormous power imbalance.
Trustless does not mean devoid of trust. It means that trust is not a necessary prerequisite to all transactions and that you can transact even with people you don’t trust because the system prevents cheating.
Any system of money must exhibit, to some degree, the three fundamental properties:
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Store of Value (SoV) - money must be useful as a store of value over time.
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Medium of Exchange (MoE) - money can be exchanged for goods and services
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Unit of Account (UoA) - money is used as a metric unit for measuring the value of things.
Bitcoin is an electronic cash system that exhibits these properties to varying degrees. It has proven to be useful as a store of value and is used as a medium of exchange. Within the cryptocurrency economy, it is sometimes used as a unit of account to measure the exchange rate of other crypto-currencies.
Other relevant properties of digital payment systems include the ability of third parties to use them as a method of control and/or a tool of surveillance.
The invention of money (and in particular Bitcoin) was primarily made to facilitate trade and enable the exchange of value between people. However, without the Lightning Network (or another second layer or scaling solution), it would be infeasible for millions of people to concurrently use Bitcoin as a medium of exchange because the network itself would become overloaded, slow, and costly.
To date, Bitcoin is the longest running, most secure cryptocurrency or electronic cash system and many people believe it represents the most stable store of value of all of the current cryptocurrencies. The Lightning Network allows people to send and receive bitcoin, without the overhead associated with on-chain transactions. This might seem confusing at first. You might be wondering how can the Lightning Network actually achieve this? While we could explain the network in computer science terms, it will be much easier to understand if we examine it from the perspective of people using it. In our examples, some of the people have already used Bitcoin and others are completely new to the Bitcoin network. Each of the people and their stories, as listed here, illustrates one or more specific use cases. We’ll be revisiting them throughout this book:
- consumer
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Alice is a Bitcoin user who wants to make fast, secure, cheap, and private payments for small retail purchases. She buys coffee with bitcoin, using the Lightning Network.
- merchant
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Bob owns a coffee shop, "Bob’s Cafe". "On-chain" Bitcoin payments don’t scale for small amounts like a cup of coffee, so he uses the Lightning Network to accept Bitcoin payments almost instantaneously and for low fees.
- web designer
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Saanvi is a web designer and developer in Bangalore, India. She accepts bitcoin for her work, but would prefer to get paid more frequently and so uses the Lightning Network to get paid incrementally for each small milestone she completes. With the Lightning Network, she can do more small jobs for more clients without worrying about fees or delays.
- content creator / curator
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John is a nine-year-old boy from New Zealand, who wanted a games console just like his friends. However, his dad told him that in order to buy it, he had to earn the money himself. Now John is an aspiring artist, so he knows that while he is still improving, he can’t charge much for his artwork. After learning about Bitcoin, he managed to set up a website to sell his drawings across the internet. By using the Lightning Network, John was able to charge as little as $1 for one of his drawings, which would normally be considered a micro-payment and, as such, would typically be impossible on traditional systems. Furthermore, most legacy financial systems wouldn’t even allow a nine-year old like John to open an account! By using a global currency such as bitcoin, John was able to sell his artwork to customers all over the world, store the money he’s earned without a bank account and, in the end, buy the games console he so desperately wanted.
- gamer
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Gloria is a teenage gamer from the Philippines. She plays many different computer games, but her favorite ones are those that have an "in-game economy" based on real money. As she plays games, she also earns money by acquiring and selling virtual in-game items. The Lightning Network allows her to transact in small amounts for in-game items as well as earn small amounts for completing quests.
- migrant
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Farel is an immigrant who works in the Middle East and sends money home to his family in Indonesia. Remittance companies and banks charge high fees, and Farel prefers to send smaller amounts more often. Using the Lightning Network, Farel can send bitcoin as often as he wants, with negligible fees.
- software service business
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Wei is an entrepreneur who sells information services related to the Lightning Network, as well as Bitcoin and other cryptocurrencies. Wei is selling these information services over the Internet by implementing micro-payments over the Lightning Network. Additionally, Wei has implemented a liquidity provider service that rents inbound channel capacity on the Lightning Network, charging a small bitcoin fee for each rental period.
In this chapter, we looked at the history of the Lightning Network and the motivations behind second layer scaling solutions for Bitcoin and other blockchain based networks. We learned basic terminology including node, payment channel, on-chain transactions, and off-chain payments. Finally, we met Alice, Bob, Saanvi, John, Gloria, Farel, and Wei who we’ll be following throughout the rest of the book. In the next chapter, we’ll meet Alice and walk through her thought process as she selects a Lightning wallet and prepares to make her first Lightning payment to buy a cup of coffee from Bob’s Cafe.