Lightning Network
Lightning network is a payment protocol that operates on top of the bitcoin network. It is a network of decentralized nodes that allows sending a large number of transactions extremely fast and for a negligible fee. The lightning network facilitates micropayments, making the existence of a completely new type of applications possible.
The key idea of a lightning network is that small and every day transactions don't have to be stored on the main blockchain; it is also called an off-chain approach.
Despite the fact that the lightning network was growing since the moment of its conception, challenges persist. The price fluctuations of Bitcoin halted this cryptocurrency from becoming a universal payment method for both business and consumer transactions.
One of the conditions that can help participants prevent problems and arguments regarding transactions is having several copies of data spread on the network. It can also help in preventing fraud.
For instance, if the network gets hacked and the details of the transaction are changed, copies on the distributed ledger may be reviewed and the pseudo-transaction may be stopped.
Scalability issue of bitcoin
Nevertheless, the process of validating the transactions by every single note can get the system halted, especially when the transaction volume is high. In this case, the bitcoin network has problems with processing several transactions at the same time. The network needs to build a scale to process more data simultaneously. This in turn, would allow transactions to be processed successfully.
Since miners take longer to validate transactions, transaction fees increase. Also, sometimes participants pay a higher fee in order for the transactions to be processed faster. Lightning networks help to build scalability, decrease processing times, and lower transaction fees.
The lightning network
To put it short, the lightning network makes it possible for participants to transfer cryptocurrency without paying fees. To make this possible, off-chain transactions are created, so that participants are able to transfer cryptocurrency between each other.
The main goal of the lightning network is to create channels in which payments between participants can be made quickly and efficiently. The processing time and the number of transactions can improve, when it is possible to make the transactions off-chain. Lightning-compatible wallet is used in order to complete transactions.
3 main problems with lightning networks
1. Lightning network does not solve bitcoin’s transaction fee problem completely. Lightning network is thought to be a solution to bitcoin’s rising transaction fee problem. Its advocates say that one of the reasons for Bitcoin's congested network is transaction fees. However, this congestion is only one of the several factors that affect transaction costs. Moreover, cryptocurrency is considered to be one of the important elements that affect the ultimate cost of the lightning network.
2. Remaining online at all times makes nodes vulnerable. In order to send and receive payments, nodes need to constantly be online. The participants involved in the transaction need to be online as well, and they use the private keys to sign in. There is a possibility, however, that these private keys can be compromised, and the coins can be stolen.
Cold storage of cons, that is used on a lightning network is considered by many to be one of the safest methods for storing virtual currency. Conversely, going offline creates additional problems on the lightning network. According to one of the developers of the lightning network technique, it is possible for one of the participants to steal capital while the other participant is not online. This is also known as a Fraudulent Channel Close.
3. Price fluctuations of cryptocurrency. Lightning network’s emergence is supposed to indicate its possibility to become the transaction tool that can be used every day. Parties can create payment channels with both businesses and people. For instance, one can create payment channels with their favorite online store and make transactions using cryptocurrency.
Despite the fact that Bitcoin starts to draw a lot of attention to itself, it still has a long way to go to gain mainstream attention. On one hand, increased attention to this cryptocurrency results in investment. On the other hand, it attracts a lot of traders which leads to Bitcoin’s price fluctuations.
The tendency of the Bitcoin’s price to frequently change makes using this cryptocurrency for the companies harder when pricing and selling their goods and when purchasing inventory from suppliers.
For instance, imagine that a company needs to pay an invoice to their supplier through cryptocurrency. Generally, clients have about a month to pay. If during this month the price of the cryptocurrency increases the business has to come up with the additional 10 percent worth of government-issued currency, convert it to cryptocurrency, and pay the supplier for their goods.
An exchange risk exists because instead of being paid in cryptocurrency by their clients, the business gets paid in fiat currency. The same can happen with consumer transactions, since most employees' salaries aren’t paid in cryptocurrency. Hence, the transactions are being converted to Bitcoin.
Consequently, the effect of lightning networks on reducing transaction fees may be limited because cryptocurrency is still not a universal payment method.
Routing fees
There is a separate fee – the routing fee that is used to transfer payments between different channels. The lightning network fees are rather low, so, theoretically speaking, it can attract more participants.
However, despite the fact that the fee for the routing payments of the nodes is low, there may not be enough motivation for nodes to make the payment process quicker. Moreover, sometimes fees can change due to businesses adopting lightning networks as a form of payment.
Malicious attacks
Malicious attacks are yet another reason for network congestion. If payment channels become congested due to malicious attacks, there is a possibility that participants will get their money back much later than they anticipated because of the congestion.
Sometimes created channels can expire. If a vindictive party creates several channels and makes all of them expire simultaneously, this would broadcast to the blockchain and negatively affect the block. Hackers may also try to congest the network to steal money from participants.
The future of bitcoin's lightning network
Of course, some of the challenges with Bitcon’s lightning network still remain. However, some significant developments are going to be made in the future that will be able to improve the network. For example, new use cases and some additional features have already been incorporated by the technology’s core team.
Larger payments via lightning network
Despite the fact that at first the size of the channel was limited to 1677 BTC, in 2020, the constraints were finally removed, and clients were able to have bigger channels. Previously mentioned channels increase the utility for both business and participants.
Watchtower
Watchover is a third party that runs on nodes in order to prevent fraudulent schemes within the network. For example, if Pam and John are participants and one of them has malevolent intent, they can steal the other participant’s money/goods. The watchover monitors transactions and helps participants prevent fraudulent channel close.
If Pam and John put up an initial deposit of 20,000 bitcoins, and then a transaction of 11,000 bitcoins from John to Pam has taken place. In case Pam logs off her system, a fraud is highly likely going to take place. John could easily broadcast the initial state and make it seem as if there was no transaction between them. So, simply put, John could steal 11, 000 bitcoins from Pam without paying for the goods she offered.
Example of a lightning network
Let’s take a look at an example. Let’s say that Rose prefers buying her shampoo from only one distributor once a month. Creating a transaction on a block chain for a bottle of shampoo is too much. She might pay more fees than the actual price of a shampoo bottle. But using a lightning network allows her to set up a channel with the shampoo distributor. To do so, both the shampoo distributor and Rose need to deposit a certain amount of Bitcon in a multi-signature address. Let’s assume that Rose deposits 0,02 BTC and the distributor deposits nothing, since they do not offer refunds. This multi-signature address can be used when both parties agree. When Rose opens a payment channel, she needs to create a balance sheet that will have the information on how the address should be distributed. So, initially it is going to say that Rose will get 0,02 BTC and the distributor will get nothing (the same as the amount they previously deposited). Opening the payment channel happens on the main blockchain; this way both parties can be aware of whether or not the transaction is happening. When the distributor sees that Rose has deposited a certain amount of money, they can be sure that they will certainly get paid for their goods once the channel closes. After the channel is open, Rose can order the product she needs. If a bottle of shampoo costs 0.003 BTC, Rose would need to change the balance sheet by subtracting the price of the shampoo from her balance and adding it to the distributor’s balance. After this, Rose and the distributor need to sign the updated balance sheet with their private keys. This way Rose can purchase the shampoo as long as she has a balance on the payment channel.
The bottom line
The concept of lightning networks constantly developing and improving. It is highly likely that it will make a huge difference to the blockchain of Bitcoin. But the lightning network might not be the one and only solution for all the challenges that Bitcoin faces. Moreover, with all the changes and improvements, come new problems within Bitcoin’s ecosystem. Eventually, new developments might be able to solve these problems.
It is important to be aware of the fact that investing in both initial coin offerings and cryptocurrencies is highly risky. Market Cheese makes no representations or warranties as to the accuracy or timeliness of the information contained in this article.
