Can the Lightning Network solve Bitcoin's scalability problems?

. 4 min read

If you have tried to send bitcoin transactions during busy periods, you’ll understand one of the major barriers to adoption of the first cryptocurrency as a unit of transaction: it’s just too slow. The very elements which secure the network - miners verifying transactions cryptographically and writing them to the blockchain - have fundamental scalability issues, and can create backlogs of hours, even occasionally days, to confirm transfers. Along with this goes high fees, to reflect the demand when the network is overloaded.

Could the lightning network, still in its early days, be the change which makes the difference? First proposed by Thaddeus Dryja and Joseph Poon in a 2015 whitepaper, the idea is based on a network that sits on top of the bitcoin blockchain, and opens and closes specific connections to it. The network is comprised of user-generated channels that send payments back and forth in a secure and trustless manner.

So the purpose of the lightning network is to remove some of the transactions from the primary network altogether, by opening up designated off-chain channels for a batch of smaller transactions over an agreed period. Only once the channel is closed is the netted-off deal written to the main blockchain.

You could think of it like opening a tab at a bar, or perhaps a better analogy would be leaving your pre-authorised credit card with the bartender. You don’t know exactly how much you and your friends are going to drink tonight, but you’re happy to cover a bill up to a certain amount, so you agree that in advance - that’s the opening of a lightning channel on the bitcoin blockchain. Instead of handing over your plastic, the you create a multisig wallet with your trading partner, which contains a fixed amount of bitcoin, as your ‘credit limit’.

Through the evening, the bartender tots up the rounds and keeps a note, but doesn’t open the till. Instead he adds it all up at the end of the night - minus any discounts, refunds for that dodgy cocktail, and taking into account the 20 your friend dropped in. In the event of any dispute you compare and agree with your own record of the total (if this really were mirroring a lightning contract, the bartender would get you to sign the cost of each round as he pours it, and you’d keep a copy). The final bill is what gets charged to your card in a single payment - and thus our lightning channel gets closed, when this single net transaction gets written to the blockchain.

Our bar tab analogy implies that it’s only payments between two parties this can manage, but because it’s a network of nodes, you don’t have to set up a direct channel to transact on lightning - you can send payments to someone via channels with people that you are connected with.

The network automatically finds the shortest route, and establishes the required smart contracts across it, however many links are involved. In theory, everyone should be connected to everyone else through the network via only few nodes. Users are incentivised running these connecting nodes through micro-fees that are paid out every time a transaction uses one of their connections. With the total number of active nodes on the lightning network exceeding 2,000 in April 2018, with 5,801 open channels, this suggests a sufficiently decentralized network is already starting to exist, along with a clear proof-of-need for this secondary service.

Whilst the idea of this secondary layer had been under discussion for some years, implementation was made possible by the adoption of SegWit on the bitcoin and litecoin networks. This fixed aspects of transaction malleability, without which transactions on the lightning network would have been too risky to be practical. Of course without the realtime security of the main blockchain behind it, the lightning network does not carry the same intrinsic protection - which is why each channel is underwritten with an amount of pre-funding. But even if larger transfers will always be done using the decentralized security of the original layer, there are so many cases where the balance of risk vs speed supports the use of off-chain deals.

For example for micropayments, solving a major challenge the sovereign currency infrastructure has never managed to address. There are online services which pay users for microtasks such as viewing ads or answering surveys, a few cents here and there - but they all have payout thresholds which reflect the costs of administering the payment itself, making tiny remittances unfeasible. Imagine being able to truly flow value in real time - so as each second of video is consumed, a payment is received. As Andreas Antonopoulos said, “Bitcoin is not a currency. Bitcoin is the internet of money”. Once we separate the idea of transmitting value from the concept of units of exchange, that’s when things have the potential to get truly disrupted.

The lightning network, whose total network capacity crossed $150 during April 2018, is starting to make the difference, with near instant transactions, greatly reduced fees, and privacy benefits as well through keeping numbers of transactions right off the main blockchain. Indeed the launch was so hotly-anticipated that during the beta rollout in January, people were trying to use it before it was fully ready.

It looks like bitcoin is ready for lightning, but remember this is only the first major secondary network application to be applied, and many other solutions are being proposed in terms of alternative off-chain solutions.

Let’s keep an eye on the number of nodes as adoption spreads, and also how this affects the price and marketcap of a number of altcoins whose main use-case seems to be a mitigation of this long-term barrier to bitcoin use. Will speedy coins continue to flourish, or will investment flow to the ‘granddaddy’ crypto which has been in existence for nearly a decade?

Exciting times ahead for sure.