The Lightning Network: A Compromise On Bitcoin

An introduction to the future of APMs

Written by Rebekah Moss 04 Feb 2020 - 10 minutes reading time

Before we begin, here's a glossary of terms that you'll need for this post.

Lightning Network: a protocol built atop of the bitcoin blockchain to enable instantaneous peer to peer payments in BTC.

Bitcoin: A cryptocurrency that is used for both monetary and tokenizing functionalities.

Blockchain A cryptographic ledger that stores data in blocks. The size of each block on the Bitcoin blockchain is idealised at 1mb but bigger blocks have been ‘mined’.

Mining: The process of adding new transactions to the bitcoin blockchain. Miners who contribute computing power to this process earn money and account for the transaction fees on the blockchain.

BTC: An abbreviation for Bitcoin.

Protocol: A set of rules or parameters defining the function of something.

Routed Payments: Assigned payments from payer to payee within set parameters up to an agreed amount.

Scalability: the capacity to change - in this context - to be adopted en masse.

Layer-2: Data that is integrated and encoded with a core layer. In this context, the bitcoin blockchain is both the core and layer-1 and lightning is layer-2; codependent on the core.

Node: An intersectional point in a network.

Tokens: a representation of something - in crypto this can often be art or music.

APM: alternative payment method.

P2P: Peer to Peer

Decentralised: existing outside of government and regulating authorities.

Spartacus Ideal: existing as a statement opposing the ideals of ruling authorities and governing bodies. In this context, cryptocurrency functions in subversion to fiat.

Hard Fork: When the one original bitcoin blockchain split into 2 after two potential paths forward for the scalability issue was theorised. Whilst a hard fork refers to any non-backwards compatible update to the blockchain network, the era of Bitcoin Cash began with the need to increase block capacity on the bitcoin blockchain.

Core Chain/ Main Chain: The original blockchain in which all other protocols and chains are reliant on to function.

On-Chain/ Off-Chain: On-chain refers to a live transaction, whereas off-chain refers to funds held in escrow in the lightning network.

DDOS: Stands for a denial of service of attack that overwhelms the nodes that form the lightning network into failing. This can also happen to bitcoin on-chain nodes and all computers.

Cross-Chain: refers to transactions happening between blockchains of two different cryptocurrencies.

Atomic Swap: refers to making a transaction between two different cryptocurrencies within one payment channel.

Multi-Signature Wallet: A non-custodial wallet that needs multiple private keys to sign/authorize a transaction.

Payment Channel: The off-chain wallet in which unlimited transactions on the lightning network can take place.

Non-Custodial Wallet: a wallet where funds and access are held solely by the user. There is no custodian and if access is lost, funds cannot be recovered.

Escrow: in this context, funds are held in ‘escrow’ and cannot be released until all parties agree on it.

Private Key: typically a user-friendly representation of a private key is presented as a 12-word cryptographic passphrase unique to a user and cannot be recovered by anyone else if lost. It grants access to their bitcoin wallet.

Micropayments: Transactions of low value.

A Compromise on Bitcoin

The lightning network offers bitcoin more than a helping hand as we consider its core mode of operation where; ‘no consensus is needed except for between two parties’ (Zebedee Lightning Developer, Christian Moss).

A phrase that takes on more than one meaning in the payments space - this layer-2 protocol has the ability to solve bitcoin scalability issues - as well as pave the way forward in a compromise for the mainstream that doesn’t necessitate the presence of what many in crypto, see as the imposing thumb of regulating authorities.

The lightning network was created on the bitcoin blockchain; which is not only a form of cryptocurrency but a network to facilitate what is typically large transactions and multi-media tokens.

As a result, since its creation in 2008, the bitcoin blockchain has become an overwhelmed and often oversaturated nightmare that threatens its own viability as an APM, and longevity as a decentralised payment option.

The ethos behind bitcoin is to remain unregulated and decentralised - as encompassed within the anonymity of its founder Satoshi Nakomoto (hence why denominations of bitcoin are dubbed Sats or Satoshis and denominations of sats are known as bits). In preserving his anonymity, bitcoin operates solely on a peer to peer basis, with no central ledger, database or regulating authority, and can be freely used under the ‘Spartacus’ ideal.

However nice an idea, the network has grown sluggish, with a war over solutions even sparking a hard fork that launched bitcoin cash. To put it into perspective, whilst Visa can process 50,000 transactions per second on average, the bitcoin blockchain can only do 7.

Cue the lightning network. The lightning network was officially launched atop of the bitcoin blockchain in 2018, but was initially theorised in a whitepaper back in 2015.

To paraphrase ‘the Coin Telegraph’, the lightning network can be equated to putting the bitcoin blockchain on speed dial; whereas now, it lives in a state of paying more and waiting longer to spend and send money than is worth it. The idea behind the lightning network is to decongest the core chain, which does not have the capacity to process transactions efficiently as it stands.

How does it work?

Built as a protocol -or software – layer atop of the bitcoin blockchain, the lightning network is taking on a behaviour that can easily become centralised as a key part of its functionality. As it will come to light, the key operations of the lightning network usually come with the assumption that the parties involved in a transaction know or have communicated with one another beforehand – negating this dire need for anonymity and decentralisation (despite not being regulated by any governing authority).

Other security concerns appear in its infrastructure as a layer and not a core network; leaving the lightning network susceptible to a DDOS attack or massive financial losses.

Again, these threat levels are not without mitigation or even a solution long-term, but they are worrisome as developers begin use lightning payment channels in real-world applications. However, it’s important to remember that lightning is relatively new compared to its main-chain predecessor.

The Method

When making a transaction on the lightning network between two parties, these parties must open a payment channel via the lightning network. But first, all parties need to create a multi-signature transaction, that acts like a quasi-bitcoin wallet in which multiple people can access the same non-custodial address with respective private keys.

This is created when one user opens a payment channel with an initial transaction that they ‘sign for’ and in doing so, generate a multi-signature address. Another user would then send funds to this same address, and sign the transaction to cite their ownership of it. Only when the other person signs in receipt of it, can the ownership be officially exchanged and the channel closed. Until then funds are held in escrow.

Each party involved in the transaction will deposit BTC.

Toptal

From here on, unlimited transactions can take place at minimal cost, using the deposited amounts by each party, as desired. This is done via redistribution of ‘ownership’ to each of the private keys - aka addresses- held in the wallet. Only when the channel is closed, is a final balance transacted in a one-time broadcast to the core bitcoin blockchain.

If the user who opened the channel was a shopkeeper operating a point of sale, they could ideally take transactions all day without signing for them; keeping the payment channel open until the end of the day when they would then sign for all the transactions, taking ownership and broadcasting them onto the bitcoin network.

To have multiple patrons the shopkeeper is likely to have multiple payment channels, or patrons are likely to connect via 6 degrees of separation; finding the best way to the shop and its keeper via mutual connections - as we’ll find out below:

Upon a mass adoption of lightning, dedicated payment channels won’t be necessary but instead, the lightning network will function better via a network of distributed channels; where said function operates by seeking out the fastest route to make a transaction thereby truly enabling merchants and shopkeepers everywhere.

Distributed Lightning Network - Channels and Nodes - Source:AcingExplorer

Trust needn’t be an issue here. Due to funds being held in escrow, no funds can be released unless all parties in the transaction agree to it. The lightning network also incurs a penalty for fraudulent transactions.

So, all in all, whether it be via one payment channel or a distributed network, only one transaction has been broadcast to the blockchain, despite many having the potential to have taken place.

Pros and Cons

Currently, a technical payment channel capacity cap exists at 0.16BTC for security reasons that have arisen due to the high risk of DDoS (denial of service) attacks due to lightning’s layer-2 infrastructure. Lightning channels function on a node-to-node network and if they were to be intentionally overwhelmed by a flood of data, they would go down with no way to recuperate user funds.

These DoSing attacks also threaten to slow the lightning network down - a direct contradiction of its core premise. As said, one payment channel can potentially link into another with mass adoption; and the risk here is clear.

However, with the lightning network designed to function as a peer to peer network - that doesn’t enforce its rules on an entire network - a workaround has since been developed by the name of ‘Wumbo’ (named in reference to Spongebob).

With consensus and trust a necessity in lightning payments, both parties in a transaction must agree to the expansion of the channel capacity before this protocol can be put in place.

The continuous requirement for the lightning network to remain online is viewed as another risk and point of instability preventing mass adoption of the protocol.

However, whilst the lightning network is online all the time, it is a necessity in holding transactions off-chain. With a compromise on bitcoin’s core operations, the lightning network understands that not every transaction needs to be verified. With a functional design to only accept small payments (that ultimately consolidate into one bigger payment), there is rarely a high-risk payment that falls through the net that would have blockchain miners protesting to confirm it.

Alternatively, payments made directly to the bitcoin blockchain are considered on-chain and must be settled at the time they are made - meaning your funds can be held offline until they are broadcast. However, waiting for your transaction to confirm can take so long that it is usually not worth it or it can ultimately time out.

Fees on the lightning network are also considerably lower than that of the bitcoin network - which threatens to be more than the transaction itself. With an almost instantaneous settlement; the lightning network has the facilities to process up to 1 million transactions per second, as well as facilitate cross-chain atomic swaps (as already achieved with litecoin and bitcoin).

Use Cases

Gaming

Within the close-knit crypto-world, lightning has already found a popular application in the gaming space and is being used as a payment method for game items. Where BTC on the main-chain was being used before and threatened to saturate/spam the blockchain, lightning takes its place as a comfortable home for these micropayments.

Game developers are able to accrue payments from game players for the purchase of in-game items, only to push transactions in bulk whenever they see fit.

Another use for the lightning network in gaming is as a financial incentive. Funded by advertising and sponsorship, players can be incentivised to play games with the reward of BTC micropayments instantaneously via the lightning network.

Developing on this user interaction is via audience participation, which allows multi-user participation in games through a tipping mechanism through payment channels.

Furthermore, combining lightning with WebSockets (a computer communications protocol) allows for the development of routed payments, allowing P2P payments to interact with in-game bots that allow permissionless sends when certain parameters are met - up to an agreed amount.

With no geographical denomination, BTC is arguably a universal currency and easy to implement across the gaming industry. However, crypto still struggles to find a place in app stores due to the lack of its in-app offerings or consumer protection standards. It is now commonplace for most developers to offer crypto-based games as a desktop site, offered via a jump in an app that would not meet app store regulations otherwise.

Retail

In the mainstream, the lightning network is assisting bitcoin in finding its footing as a credible APM. With the recent pursuit of Jack Dorsey of Twitter’s Square Crypto, and the already established Fold App; that facilitates lightning payments and BTC cash back at the point of sale, we have long moved past crypto prepaid cards disguised as debit cards.

The lightning network instead offers instantaneous payments - with variable settlement periods, that aren’t new to merchants in the mainstream. Instead, lightning offers a new avenue of offering Bitcoin as an APM to businesses worldwide. With only 18 months of real development underfoot, the future is bright for the lightning network in resolving scalability issues that long threatened the viability of the bitcoin blockchain.

Sources:

https://blog.sfox.com/lightning-network-bitcoin-97dabedca7f1

https://www.coindesk.com/this-spongebob-themed-tech-proves-that-bitcoins-lightning-is-advancing

https://cointelegraph.com/lightning-network-101/altcoins-with-lightning-network-support

https://www.youtube.com/watch?v=fwjhda8GBIw&fbclid=IwAR2-D0wXMc5FGpXeQTwqPKQ8-t25xKGK3TxTS_gkCTkItQ4dANWmcX3XiRw

https://lightning.network/lightning-network-paper.pdf

https://cointelegraph.com/lightning-network-101/what-is-lightning-network-and-how-it-works

https://www.reddit.com/r/CryptoCurrency/comments/a5ebyr/some_of_the_problems_with_the_lightning_network/

https://www.theblockcrypto.com/genesis/7315/the-growth-of-the-lightning-network-has-been-remarkable-but-theres-a-catch

https://www.coindesk.com/bitcoins-lightning-network-attacked-good

https://medium.com/in-the-fold/introducing-lightning-payments-ffa808c22092

https://hackernoon.com/lightning-network-the-bitcoin-layer-2-network-for-micropayments-un3ja32ht

https://www.coindesk.com/zaps-new-product-lets-merchants-take-dollars-over-lightning-network

https://www.coindesk.com/fold-app-enables-bitcoin-lightning-payments-at-whole-foods-starbucks

https://medium.com/@squarecrypto/what-were-building-lightning-development-kit-1ed58b0cab06

Contact

Send us a message

Join Our Newsletter

Subscribe to our newsletter to stay informed. Our team of experts are at the forefront of the payment processing industry and we regularly post articles about emerging technologies and trends.