It’s no secret that Bitcoin, the world’s oldest cryptocurrency, suffers from scalability challenges, being able to only process between 5 and 7 transactions per second (TPS) on its blockchain due to its block size limit of only 1MB.
While many investors would like to see BTC expand beyond its currently dominant use-case as a store of value, turning the world’s first cryptocurrency into a mainstream means for processing payments has proven to be a very difficult challenge over the course of the token’s 13-year history. It even led to an acrimonious split between the two factions of the Bitcoin community, resulting in the 2017 hard fork that gave us Bitcoin Cash and its various subsequent iterations.
Critics contend that Bitcoin was never supposed to be ‘digital gold’, but rather a kind of digital cash, pointing to Bitcoin creator Satoshi Nakamoto’s revolutionary 2008 whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System” as proof.
With both Ethereum and other layer-1 networks reaching bottleneck congestion in recent months due to increasing transactions, this has given rise to a new generation of layer-2 scaling projects including Polygon (MATIC), optimistic rollups like Arbitrum and Optimism, and zero-knowledge (ZK) roll-up protocols like Starknet and ZKSync. These projects aim to offload a significant portion of transactions to a side-chain for processing, in order to alleviate pressure on the Ethereum mainnet.
Is the same possible for Bitcoin, especially now with Jack Dorsey’s plans for Web5 and last year’s Bitcoin Taproot upgrade opening up a plethora of new use cases for BTC?
Enter the Bitcoin Lightning Network, which has resurfaced to prominence after being used in El Salvador last year.
What is the Bitcoin Lightning Network?
The Bitcoin Lightning Network is a layer-2 scaling solution that allows for off-chain transactions, meaning transactions that occur outside of the Bitcoin network itself. The Lightning Network facilitates the opening of payment channels between two parties, and these can be used for instantaneous transactions at low fees – both features that would be impossible on the Bitcoin mainnet.
At the same, critics have also pointed out some drawbacks in the Lightning Network. The problem of too many fees and other inconveniences still pose challenges, while there are also vulnerabilities that could be exploited by malicious actors.
The network offers a lot of promise but with some downsides – just like most projects. Here’s why.
Bitcoin Lightning Network Backstory
Although first proposed in 2015 by researchers Thaddeus Dryja and Joseph Poon in a paper called “The Bitcoin Lightning Network,” the idea for the project actually stems from conversations Bitcoin founder Satoshi Nakamoto had with the developer Mike Hearn, which were later published.
In their paper, Dryja and Poon raised the idea of a protocol located off-chain that would be composed of payment channels, thereby allowing for trustless exchanges. The idea was to offload lots of smaller transactions onto a layer-2 solution so as to avoid congesting the mainnet.
With an average transactions per second (TPS) of around seven, Bitcoin lags far behind other payment alternatives such as Visa, which has reached as high as 47,000 TPS. By implementing the Lightning Network, the developers hoped to help Bitcoin reach and even exceed these heights.
The two men founded Lightning Labs in 2016, launching the beta version of the Lightning Network two years later. The project has received backing and boosting from luminaries in the Bitcoin space, including Twitter founder Jack Dorsey.
Bitcoin Lightning Network Basics
How does it work?
Once two parties establish a payment channel – a form of smart contract – they can send and receive unlimited Bitcoin. These transactions happen instantaneously and at a low cost. For the user opening the channel, some amount of BTC must be locked into the network. They can add to this amount later if they wish. The channels are only updated on the mainnet when they either open or close, massively boosting transaction times. It’s worth noting that it’s also possible to transact with another party with whom you don’t have a direct channel with by utilizing the network to find the shortest route possible to them.
What holds the network together is the nodes. These are formed by combining payment channels, which then help to route the transactions. These lanes of payment formed on layer-2 support one another. When two transacting users conclude their business and close their channel, the data gets sent to the Bitcoin layer-1 network for recording in the next block. This way, all of the smaller transactions that would have slowed down the network get bundled into digestible form.
Pros and Cons of the Bitcoin Lightning Network
First, of course, is the increased speed and improved costs of transacting in Bitcoin via the Lightning Network. Before the solution was implemented, high fees and waits of over an hour were the norm for any kind of on-chain transaction. Smaller transactions were even penalized as miners prioritized the bigger ones so as to increase their rewards. Now, it’s possible to do one’s large transactions on the mainnet while pivoting to the layer-2 for the smaller stuff, realizing the possibility of making everyday transactions with a growing list of vendors – and it’s still early days.
Other positive features to mention are the security protocols underlying the Bitcoin network, and the privacy provided by shielding many transactions under the banner of one larger upload, which is the only part that can be seen.
For newcomers, it can be a little daunting to have to set up two wallets: first the regular Bitcoin wallet and then the additional wallet for the layer-2 network. Fees are to be found at each stage, in particular the first, though some of these issues may improve with time.
In order to remove funds from a payment channel, it’s necessary to completely close it. With partial withdrawals from a channel not possible at this time, users have to start a whole new one to transact with the same person again, which incur costs associated with the openings and closures of channels, called routing fees.
What’s Next for the Bitcoin Lightning Network?
As Bitcoin adoption continues to increase, it follows that at least some people will want to do more than just HODL, and will seek to use it for payments.
Major exchanges such as Kraken, Bitstamp, Bitfinex, and even the financial app Robinhood are beginning to integrate with the Bitcoin Lightning Network. To top it off, there is the nation of El Salvador, where Bitcoin famously became legal tender last year and where the network is used in many everyday transactions. It’s clear that institutions and others are willing to bet big on the development of this project. Only time will tell whether the demand catches up to the infrastructure that is being built to turn Bitcoin into a viable payment method.