Bitcoin Lightning Network Explained


April 16, 2021 | AtoZ Markets – Bitcoin is a cryptocurrency that is highly popular around the world for several reasons. A cryptocurrency is a form of digital currency that you can use to buy products and services by using an online ledger that boasts excellent cryptography for securing transactions.The benefits of using Bitcoin for profit or purchasing is easy for end users. A lot is going on behind the scenes, which makes this currency work. Such currencies are influenced by speculators, which increases chances of making huge profits. Here we provide you a brief glimpse into the basics of how Bitcoin works.

What is Bitcoin Lightning Network?

Putting it in simple words, the Bitcoin lightning network is a system built on top of the Bitcoin. The system is designed to let users receive and send their BTC payments fast and easily. The transaction fees that are incurred on users is less than what they would have paid outside the lightning network. The upside of the lightning network is that it makes Bitcoin more useful for day-to-day transactions. It can be said that this network makes Bitcoin more adaptable for users.

Bitcoin has suffered from minor scaling problems. The lightning network is designed to make it work more efficiently. The network is essentially a system of smart contracts built on top of the Bitcoin blockchain. Two parties can use the system for exchanging direct transactions that are cheap and fast.

Why is it Important?

The lightning network can potentially revolutionize the way miners use Bitcoin forever. The high volume of transactions can bog down the Bitcoin system, which leads to problems with scalability. Each time the system attempts to execute more transactions, it bogs down. This results in failure of data processing.  The lightning takes off a chunk of transaction data from the Bitcoin blockchain, leaving fewer transactions for processing.

The system was designed to speed up transactions by forming a secondary layer above the main Bitcoin blockchain. The network can also come in handy for swapping one cryptocurrency for another without involving an intermediary. By removing intermediaries and financial institutions such as banks that are responsible for routing transactions, the network accelerates transaction throughput. The network uses digital wallets for easy transfer of Bitcoins among users. This leads to development of payment channels between two users. These off-chain transactions are easy to process and allow micropayments between miners.

How Does the Lightning Network Work?

It is vital to understand how the lightning network works. The system opens transaction channels between two parties. Users are liable to pay a fee for this part of the transaction equal to Bitcoin’s transaction charges. Every channel that opens needs to be closed once the transactions are settled. The opening of transaction or deposit will take place using Bitcoin’s chain.

Parties can process numerous transactions between each other but once the transaction bill is settled, recording a closing transaction is required. This will serve as evidence of a settled amount on the blockchain.

Users pay a transaction fee when the channels open and close, and a separate routing fee for transferring payments between channels. The advantage of using a lightning network is its low fee. The lightning network requires nodes to be available online to send and receive payments. Parties use personal keys to log in to the main system. The system is encrypted which secures transactional activity. The system also lets miners put their Bitcoins in a Cold Storage; an online wallet used for storing Bitcoins. User’s digital wallet is not connected to the internet thereby protecting it from unauthorized access, and vulnerabilities like viruses and malware.

The cold storage resolves the issue of transaction vulnerabilities by using an offline environment. Each processed transaction goes through an offline wallet that is on a temporary storage such as USB, hard disk. Here, the transaction receives a digital signature before the system transmits back to the online network. The private key makes no contact with an online server during this process. This protects the transaction from hackers and other online vulnerabilities. Using cold storage keeps your private key protected and to be used again.

Limitations

The lighting network is an ongoing development as it incorporates changes from time to time. It is an interactive protocol where parties communicate when doing transactions. In theory, the network can process millions of transactions simultaneously, which is often more than seven transactions per second of Bitcoin. Alternatively, Bitcoin Blockchain allows parties to send and exchange payments without communicating. Often, parties remain unaware of the payments heading their way.

Another limiting factor comes into play when multiple payments are routed. For lighting to work properly, routing of payments is essential. Capital allocation through routing paths and nodes allows smaller payments to process whereas bigger payments take time. To address this issue, a soft limit on big lightning channels and transactions is in place. Due to this limitation, users prefer lightning networks for smaller transactions and Bitcoin Blockchain for bigger payments.

Lightning Network can be unreliable at times as it is essentially an unproven technology. The scalability of this system is also in question. Some criticize its ability to process vast quantities of transactions and call this approach the reinvention of the wheel. According to them, the shortcomings in Bitcoin Blockchain by increasing the block size instead of bringing a new system would have been the easy way out.

Conclusion

The lightning network’s experimental nature will see it incorporating many improvements once its beta phase is over. Lightning network is not operational despite spending years in development. The technology shows promise and will see more improvements in future. The technology can offer fee-free ordering paths and cross-chain transactions.

It would take time to overcome challenges, but once these are over, a lightning network could become the preferred method of sending and receiving transactions for millions. Fixing bugs in the platform is just a matter of time as the network progresses towards becoming a valuable tool for Bitcoin miners.

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