Because the Bitcoin blockchain remains bogged down by relatively high fees and slow transactions, various solutions have been proposed and created. One of the most prominent is the Lightning Network, a peer-to-peer system that allows Bitcoin payments to be performed quickly and inexpensively.
The Lightning Network was originally conceived in a 2015 whitepaper authored by Joseph Poon and Thaddeus Dryja. Later, Lightning received additional development from MIT, Blockstream, Lightning Labs, and ACINQ.
An early test of Lightning was performed in December 2017, and a working betanet was released in March 2018. An early commercial application was demonstrated in September when a bar in Berlin used Lightning to create a point-of-sale terminal.
The Lightning Network does not have a native cryptocurrency. As a result, it did not have an ICO and it does not have a market cap. Lightning does, however, generate value for users: peers who serve as nodes and operate payment channels can charge fees to those who make payments on the network.
The Lightning Network's primary innovation is its ability to perform off-chain transactions, which do not take place on Bitcoin's main network. When a normal Bitcoin transaction is made, miners on the Bitcoin network must validate that transaction. As mining difficulty increases, transactions require more work from miners and become more expensive for users.
Lightning circumvents this problem by performing payments without actually interacting with the Bitcoin blockchain. Lightning relies on peer-to-peer payment channels, which are explained below.
On the Lightning Network, two nodes can keep a payment channel open between them. One or both node operators must commit cryptocurrency to the channel. These committed amounts determine the channel's transaction capacity.
Subsequent transactions affect the channel's balance. If one node decides to close a channel, each node receives or pays the difference from the balance. This final transaction takes place on the actual Bitcoin network; intermediate transactions do not.
When enough of these channels are created, a full-fledged network begins to form. This allows payments to "hop" from one channel to another until the payment reaches its intended recipient. As a result, users can make payments to destinations that are not directly linked together.
Multisig cryptography and time locks allow payments to be passed securely from one node to another, ensuring that only the designated recipient, and not the relaying nodes, can access the funds.
The Lightning Network is mainly useful for performing very small transactions or micropayments, which are hit the hardest by Bitcoin's current fees. As such, Lightning has potential applications for merchants who sell inexpensive items or incremental services.
Although the Lightning Network is principally used to transfer Bitcoin, it can be used with other cryptocurrencies: Litecoin is also compatible with Lightning. Multi-crypto support allows for "atomic swaps," which exchange one cryptocurrency for another without the use of an actual exchange.
The potential benefits of the Lightning Network may take some time to actualize. Because the Lightning Network relies on peers, people must adopt it before it becomes truly useful. Unfortunately, Lightning's node software is fairly difficult to set up, and at the moment, the rewards for operating a node are fairly negligible. However, adoption is growing.
If Lightning were to become successful, other problems may arise: an active Lightning Network would enable nodes with many open channels to originate and become payment hubs. This would add a significant amount of centralization to the network and could enable regulation and external interference.