What is the Lightning Network in Bitcoin? - Layer 2 Adoption Rises

Bitcoin’s Lightning network refers to a second layer on top of the original blockchain. It’s otherwise known as a layer 2 solution. The purpose of this layer is to lessen the traffic going through the main bitcoin blockchain.

Since its inception, bitcoin has been facing a scalability problem - too many requests and not enough network capacity. Due to the energy-hungry proof of work (PoW) system, transactions get validated at an excruciatingly slow rate. On top of that, miners tend to prioritize higher-paid transactions, leaving smaller ones often piled up at the end of the line.

Putting things in perspective will give you an idea of how painful it was to transact with bitcoin. There were around five million BTC users in 2015. If half of them were active on a daily, you would expect more than two million requests per day. The bitcoin blockchain can process a little more than seven transactions per second. That’s nowhere near the required capacity for a smooth operation.

Luckily, during that same year, two developers, Thaddeus Dryja and Joseph Poon decided they were tired of it all and created the Lightning network.

This second layer protocol exists to expedite transactions and unclog traffic on the main blockchain. There’s a lot more to it, which we will discuss in more detail in this article. We’ll also talk about how the Lightning network usage is on the rise and what that means for the future of bitcoin.

How Does the Lightning Network Operate?

Normally, when you send a bitcoin to someone, the receipt will get broadcast to the network. You’d then wait for miners to validate the payment to add to the blockchain. This is called an on-chain transaction.

The Lightning Network is basically a second-layer system built on top of the blockchain. It will eventually report all transactions to the main chain but otherwise operates independently of it. Think of it as a second waiting line into a concert. Doesn’t matter where you pay for your ticket, everyone will end up at the same place.

Bitcoin users can open private payment channels on the Lightning network between themselves and make as many transactions as they see fit. These are called off-chain transactions.

When a channel is open, users will need to deposit some bitcoin into the network. This is to ensure someone will always get paid. When a user needs to make a payment, they simply need to subtract that amount from their own balance on the network. As soon as the channel is closed, the network will redistribute the bitcoin to each user based on the balance.

For example, Bob is a freelancer that accepts bitcoin payment. Mary is a customer and she opens a private channel on the Lightning network directly with Bob. 

Mary then deposits 1 BTC into the network and Bob deposits 0 (because Bob is the one getting paid.) The balance sheet on the network now reads, Mary 1 BTC/Bob 0 BTC.

Bob finishes a task for Mary and he charges 0.1 BTC. Mary will then subtract 0.1 BTC from her own balance. The balance sheet on the network now reads, Mary 0.9 BTC/ Bob 0 BTC. 

Note that Bob still hasn’t received any money as the channel is still open.

Mary and Bob will then each need to sign the balance sheet to confirm the transaction. A copy of it will be sent to both.

At this point, either Mary or Bob can close the channel and the network will distribute bitcoin to each user according to the balance sheet. If Bob doesn’t want to work with Mary anymore he can use the signed copy of their last transaction to close the channel. Once he does, Mary will receive 0.9 BTC and Bob 0.1 BTC.

Otherwise, they can keep the channel open and Mary will continue to subtract from her balance to pay Bob for his service.

Lightning Network Adoption on the Rise

With the capacity at millions of transactions per second, the power of the Lightning network is undeniable. Individuals and small businesses quickly caught the train to fast and convenient payment.

The number of nodes on the Lightning network is rising rapidly with 2020 having a few over 7,700 to nearly 16,000 in 2021. Overall capacity has increased from 1,000 BTC to 3,000 BTC. This means users can send and receive amounts worth up to 3,000 BTC.

No, that doesn’t mean you can overload the network with 3,001 BTC. Transactions that big will almost always take place on the main blockchain.

People can, however, open multiple channels and then close them at the same time. Doing so will send a huge number of requests to the main chain and cause it to clog. This is one of the inherent problems of the Lightning network. 

Other Problems of the Lightning Network

One of the things the Lightning network was designed to fix is bitcoin transaction fees. They have always been absurdly high, sometimes costing more than the bill itself.

Using a private channel obviates paying fees for every transaction. Users only have to pay once to open and once when closed. While the low cost attracts more users, it doesn’t exactly incentivize nodes to validate those payments. If there aren’t enough nodes, services and companies will soon have to charge clients for paying through the Lightning network. Then, we would be back to where we started. 

The long-term design of the Lightning network is to make bitcoin payments mainstream. Developers have envisioned a future where you can pay for a cup of coffee using bitcoin. The problem with that is being mainstream isn’t always cheap. Not to mention the extreme volatility of bitcoin. Imagine buying your favorite latte for five dollars one day and the next it costs 40 bucks. 

Not all of us would be happy with that.

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