The Lightning Network – A Micropayments Layer For Bitcoin Transactions

Scalability is one of the main criticisms against Bitcoin (BTC), since the network is not capable of more than 7 TPS (Transactions Per Second). This is due to the “Scalability Trilemma” of blockchains, in which there is a tradeoff of scalability with security and decentralization. You cannot have all three things at once so it requires a balance of resources. If you value more decentralization, you will get more security as well but that will be at the expense of scalability. The blockchain cannot scale if there are too many nodes on the network. When compared to the VISA and Mastercard network, Bitcoin is not on the same level when processing transactions. The VISA network can process over 1,700 TPS or close to 150 million transations per day. In reality though, it doesn’t always reach these values but it gives some idea of the scale VISA is capable of.

While the developer community looks to the fundamentals of Bitcoin as its strength, others view ways to preserve the core architecture while introducing new features to enhance it. One way to improve scaling is through a Layer 2 solution called the Lightning Network (LN). This protocol moves the computational process from the blockchain main network to an off-chain layer. This puts less work on the nodes while using an off-chain layer as the solution to process direct peer-to-peer transactions using payment channels. The blockchain will then be used for settling the transaction and recording it. These can also be implemented as sidechains, which still have a Merkle Root for provability that they are a part of the blockchain. In theory the LN can process up to 1 million TPS and support other cryptocurrency (e.g. Litecoin).

One of the main talking points of the Lighting Network is reducing transaction fees. This means instant payments that only require a fraction as fees. The idea is to enable micropayments using BTC and make it much easier to pay for items like a cup of coffee. Prior to that, paying for coffee with BTC was impossible. Merchants do not accept BTC and the transaction fees were quite expensive. It made more sense to use BTC to move millions of dollars of currency than to transact $5.00 for a cup of coffee. Developers also promote the idea of using the Lightning Network for Atomic Swaps, which allow large amounts of BTC to be exchanged for other currency or cryptocurrency.

The LN has been in development since 2016. One of the requirements needed to support it was the activation of SegWit BIP 141 UASF. SegWit was activated on August 24, 2017 after the Bitcoin community agreed on BIP 91 (signals the support to activate BIP 141). While it has been steadily improving for production use, it is not without critics. The Bitcoin Cash community hard forked from Bitcoin because one of the reasons was that they did not support SegWit and the LN. The Bitcoin Cash supporters believe in larger block sizes and on-chain solutions as opposed to maintaining existing block size and off-chain solutions. Other critics have expressed concerns that the LN could become centralized with payment channels. Several channels could form one large channel and monopolize the network, in theory. Other views state that the channels could become like intermediaries, with the power to deny transactions and thus defeats the purpose of a decentralized system.

There are 3 possible problems with the LN (from Investopedia):

1. Transaction Fees
2. Nodes are susceptible to hacking
3. Does not solve network effect in Bitcoin

Users will choose whichever has smaller transaction fees. If the main network has lower fees, then there is no need for a Layer 2 solution. However, if the main network is slower then it makes an off-chain solution ideal. A faster LN can process transactions faster and more efficiently than the main network. Fees should eventually lower when there are more users.

Since LN nodes have to be online at all times, if a hacker knows the LN node’s IP address and network, they can attempt to attack it. They can attack the node to disrupt its service or even to try to steal BTC. When a node goes off-line, by accident or intentionally, it can also affect transactions. A Fraudulent Channel Close can occur if a channel closes before the transaction completes and pocket the BTC. Network outages can also bring the LN system down if the payment channels are too centralized.

While the LN is aimed to increase adoption of BTC as a form of payment (i.e. medium of exchange), it may not be able to keep up with the network effect. Bitcoin Cash claims to have solved the problem with micropayments since it has a faster network than Bitcoin. In order for LN to be more successful it must be used for making BTC payments. It appears though that more people are willing to hold on to BTC as a store of value rather than for making payments.

Whether LN will become an integral part of Bitcoin, is still up for debate. It presents an excellent idea but it may already be outdated. More Bitcoin maximalists are really just looking at BTC as a digital asset counterpart to gold, so it is a new store of value. As BTC becomes more valuable, people will not likely spend it for micropayment transactions. This is where the altcoins fit the bill for that purpose. Instead BTC will be like digital gold, stored safely by HODlers in their hardware wallets. This creates a dilemma for the LN, but it can still work out for the best. BTC can be divided into smaller denominations or units called Satoshis. The LN can prove its value by providing a safe and easy way to make micropayments using Satoshis. Proving its value will make it a better proposition for developers to incorporate the LN in their applications, and that could onboard users for greater adoption.