Origin of Bitcoin
If we look at the origin of Bitcoin, back to Satoshi’s whitepaper, we can see that it was designed to be a trustless peer-to-peer electronic cash system. Using the blockchain as its underlying infrastructure, the original goal was to carry out electronic payments without the need of a trusted third party. Over the last 9 years, different use-cases for Bitcoin have emerged. To name a few:
- Digital gold: the argument that Bitcoin is sound money and may eventually become an even better form of gold. Given the volatility of Bitcoin and the fact that it may increase in value at any point, it is more suitable to be held rather than spent on transactions. Individuals in this category often also believe that it may eventually transition from a store of value to medium of exchange.
- Peer-to-peer payments: similar to a decentralized PayPal or Venmo, in which fast and cheap transactions can take place over the internet.
- Anonymous online transactions / dark-net currency: bitcoin as a mechanism to facilitate black market online transactions. Those close to the pulse know, of course, that bitcoin is currently a poor substitute for fiat currency in black market transactions given its transparent nature.
The Development of Lightning Network
The Lightning Network is a protocol being developed as a layer 2 solution; it sits on top of the Bitcoin blockchain, but can be implemented by any blockchain. Its main goal is to scale and speed up blockchains, enabling instant transfer of payments as well as reduced transaction fees.
Lightning Network adopts an off-chain approach using payment channels and smart contracts. A multi-signature wallet is setup, which is where the bitcoin is held. The funds sent to the multi-party wallet address are confirmed on the Bitcoin blockchain, which anchors the payment channel. Once set up, any two parties can conduct and sign transactions on smart contracts to keep track of the amount of bitcoin each user holds. As multiple transactions occur, individual updates are not uploaded to the blockchain; instead, each user keeps a copy. It is only when a payment channel is closed that the balance of the transactions is ultimately settled on the blockchain.
Additionally, users can transact with anyone who is connected to their network of payment channels via nodes and multiple hops. This also means that in order for payments to take place, one must be connected to the network (and offline payments aren’t possible). For example, Alice has been transacting with Bob, and now chooses to transact with Dave. Instead of opening up an entirely new payment channel between Alice and Dave, she can indirectly connect with him through Bob as long as Bob has sufficient funds. In this scenario, Bob functions as the node on the network, similar to a bitcoin miner, as he processes the transaction on the network. He does not have any control over the transactions or funds: Bob will only receive Alice’s payment if he has already sent the outgoing payment to Dave.
For example, if Alice wants to send Dave $5 – Bob will first send Dave $5. After this payment has been received, Alice will then pay Bob.
What makes Lightning Network unique?
Instant Payments & Micropayments
Because the Lightning network does not require block confirmations, regular payments can potentially be instant and free . Additionally, it enables payments down to 0.00000001 bitcoin without facing custodial risk. Currently, the Bitcoin blockchain requires a minimum payment size of about 100 times larger. This not only opens up the ability to carry out ordinary transactions and payments, but also the application into a variety of industries and countries. For example, given the volatility of the Venezuelan Bolivar, the Lightning Network could facilitate bitcoin transactions and payments in Venezuela.
As payments are instant and off-chain on the Lightning Network, they able to support virtually unlimited transactions between other users. While Visa supports an average of about 4,000 TPS (with a peak capacity of about 56,000 TPS), The Bitcoin Blockchain is only able to achieve 7 TPS. The Lightning Network would enable this number to increase exponentially. The Lightning Network is being designed to be a universal payment network accessible to everyone.
Although Lightning is built on the Bitcoin Blockchain which requires significant resources to verify, a new protocol for simplified Blockchain verification called Neutrino is being developed which can support trust-minimized Lightning and Blockchain payments on platforms as lightweight as a mobile phone. Lightning Labs is coordinating with other Bitcoin contributors to standardize their Neutrino protocol concept across the Bitcoin network.
As not all of the payments are recorded on the blockchain, user privacy is improved.
Ultimately, given the different use cases surrounding Bitcoin, it could facilitate peer-to-peer payments today or enable transactions in the future as the price volatility stabilizes. As the development of Lightning Network progresses, it will enable several interesting applications to surface. It will not only drive the development of financial applications, but it will also spark user adoption, allowing users to transact via mobile phones with minimal trust requirements.