The Lightning Network is an off-chain network, offering numerous benefits
to Bitcoin. The Lightning Network will debut in 2018. Yet, it has
been in development since 2016. First, we will explain what the Lightning Network is. Then, we will explain the benefits of the Lightning Network. Last, we will
cover the counter arguemnts and attack risks.
What is an off-chain transaction?
An off-chain transaction is any bitcoin transaction which does not use
the Bitcoin Network, and thus pays no Bitcoin transaction fees to
miners. Buying and selling on exchanges, for example, occurs off
chain. However, withdrawing from on exchange to a bitcoin address
occurs “on-chain.”
All transactions that occur on the Lightning Network will be “off-chain” transactions.
How does the Lightning Network, work?
Lightning has three ingredients:
Payment channels
Hashed-time-locked-contracts (smart contracts)
The Lightning protocol
We enter the Lightning Network by opening a payment channel. This
entry requires an on-chain Bitcoin transaction. Payment channels have
existed since the beginning of Bitcoin.
Payment channels allow two parties to send bitcoin back and forth. The
only limit is the amount of bitcoin in the payment channel.
Think of a payment channel like Paypal. Once you deposit money into
Paypal, you can send that money to anyone else who uses Paypal. But
you can only send up to the amount you deposited in Paypal.
To enter or exit Paypal, you must do a bank transaction. Similarly, to
open or close a payment channel, you must do a Bitcoin transaction.
Hashed time locked contracts (HTLC) are simple smart contracts. They
basically say “payee will immediately get paid (some amount of)
bitcoin, if payee can produce a secret code. If you cannot produce the
secret code within (some number of) blocks, then payor can revoke
payor’s offer and have their bitcoins refunded.”
The Lightning Network uses a series of HTLC’s with the same secret
hash. This process can be repeated as many times as necessary.
Here is a step-by-step of how the HTLC works with four parties: A
(customer) B, C, and D (merchant)
- D Merchant creates a secret string (Key)
- D hashes the Key, using a hash function such as SHA-256
- D shares that Hash with everyone: A, B and C
This Hash is the lock, the Key is the code to unlock the HTLC’s (steps 5-7)
A creates a HTLC with B, with a lock time of 3 days.
B creates a HTLC with C, with a lock time of 2 days.
C creates a HTLC with D, with a lock time of 1 day.
D discloses Key to C, within 1 day, and D gets paid by C.
C discloses Key to B, within 2 days, and C gets paid by B.
B discloses Key to A within 3 days, and B gets paid by A.
If everyone cooperates, all of these transactions occur outside of the
Bitcoin Blockchain. No one needs to publish the transactions, unless
other parties are not cooperating. Ideally, users’ software will keep
track of each step automatically. For example, the software should
keep track of every step above, without the user being aware of every
step.
Everyone gets paid in a mechanical manner. The Lightning Network is
almost atomic in nature, meaning that either everyone gets paid, or
nobody gets paid.
Is Lightning a token or ICO?
No, the Lightning Network uses real bitcoins and smart contracts to allow
participants to aggregate many transactions into one, final,
settlement transaction. Lightning is a “layer two” protocol which
operates on top of the Bitcoin Network.
Example: A and B have lunch together often. A and B take turns paying
for lunch with fiat (dollars). Whoever pays for lunch is refunded by
the other in bitcoins. After a few weeks, each friend has paid
eachother many Bits. Lightning allows both friends to pay eachother,
without paying transaction fees every week. Instead, A and B only pay
transaction fees at their first and last lunch.
An ordinary bitcoin transaction is broadcasted to all bitcoin full
nodes in the world. The Bitcoin Miners take these transactions, and
compile them into blocks. That bitcoin transaction will now live on
the Bitcoin Blockchain, forever.
Lightning transactions, on the other hand, are not broadcasted to
every node. Although Lightning uses real bitcoins, transactions are
withheld from the Bitcoin Network.
Instead, Lightning Nodes keep
transactions secret, except in three circumstances:
- Entering the Lightning Network
- Exiting the Lightning Network
- Settling a dispute on the Bitcoin Blockchain
Is the Lightning Network Anonymous?
The Lightning Network will problably have top-notch privacy features.
It will be much more anonymous than ordinary
Bitcoin transactions.
Some businesses will run cheap Lightning Nodes to collect and sell
data. Lightning users can either use these low-cost lightning nodes,
or, use higher-cost, more privacy oriented payment channels.
The 7 Benefits of the Bitcoin Lightning Network:
1. Lightning Network Users will earn Interest for Lending Bitcoins
The Lightning Network will also pay users for providing liquidity for the Network.
It will be like a bank account which pays interest on deposited
funds.
You can make money by running a Lightning Node!
We will not know how much interest the Lightning Network will pay
until it is up and running. Some people predict that profits will be
high while the Lightning Network is in its infancy. As the technology
is battle-tested and accepted by the community, interest rates may
fall.
Note, the profits of Lightning Node operators equals the transaction
fees for using the Lightning Network.
To use the Lightning Network, you must take out a
series of micro-loans from each “hop” (intermediate peers whom the
payments travels through). The more connections and liquidity in the
Lightning Network, the fewer hops required.
The cost of a Lightning transaction is a function of a few variables:
Amount transacted (demand)
Liquidity in the Network (supply)
Number of hops required (network effects)
On-chain transaction fees (competition)
2. The Lightning Network will be easy to use
To use the Lightning Network, simply download a Lightning wallet. As
of January 2018, most Lightning activity occurs on Testnet (a copy of
the Bitcoin Network which is used to test new developments and code).
As time progresses, more and more wallets will integrate Lightning.
Even wallets that you currently use should eventually implement
Lightning.
“Zap” is the name of a Lightning wallet which is almost ready for Mainnet use.
3. The Lightning Network will create nearly free Bitcoin Transactions
A Lightning Transaction will always be significantly cheaper than a
Bitcoin Transaction. Some Lightning Transactions will even have
negative fees, paying you to use Lightning!
Lightning transaction fees are not paid to Bitcoin Miners. Instead,
Lightning transaction fees are paid to other users in the Lightning Network
who stake money. They will charge a small fee for micro-loans of
bitcoin for a very short time frame (typically a few days).
Lightning fees are set by the users of the network. The software will
automatically find the cheapest route through the Lightning Network.
If no route exists, the software will create a route by opening a new
channel (which does require Bitcoin Transaction fees).
The more bitcoins in the Lightning Network, the lower fees will fall.
Exchanges like Coinbase will likely be Lightning Node operators. Since
many exchanges are likely to enter the Lightning Network, most users
will be accessible through centralized intermediaries.
Sophisticated software will allow users to select custom routes
through the Lightning Network. This will allow users to choose more private routes, perhaps at a slightly higher cost.
In fact, the biggest costs of the Lightning Network are the Bitcoin
transaction fees to enter and exit the Network. As more users and
bitcoins enter the network, less people will need to leave the
Network.
4. The Lightning Network will allow Micro-payments
Currently, the smallest fraction of a bitcoin is called a Satoshi
(0.00000001 BTC). The Lightning Network enables payments and fees of
even smaller than a Satoshi, enabling micro-payments.
Micropayments will allow users to pay for videos per second, to pay
for news per article, and to pay for work per minute.
The Lightning Network will allow people to transact pennies at a time.
People in the poorest countries will be able to afford transactions in
bitcoin.
5. The Lightning Network will allow for millions of transactions per second
There is a tradeoff between decentralization and throughput (the
number of transactions we can process on the blockchain).
Typically, blockchains are very bad at “scaling”. What is scaling? Scaling simply means “handling the growth in the number of users and transactions.” There has been a multi-year
“scaling debate” in Bitcoin, as to the best methods of scaling. But
many people agree, Lightning currently offers one of the best scaling
solutions.
Secondary networks like the Lightning Network allow users to enjoy the security of the decentralized blockchain, without increasing the size of the blockchain unnecessarily.
Like Bitcoin, there is no Lightning company. Although there are about
a dozen full time programmers working on the Lightning Network, the
programmers are simply writing software which allows peer-to-peer
transactions.
Lightning transactions do not require a trusted, centralized party.
Instead, if someone tries to steal from the Lightning Network, then
they are punished by forefiting some bitcoin.
6. The Lightning Network will create Smaller Bitcoin Blocks
Lightning Network will help keep bitcoin blocks small, allowing more
users to run a full node, self-authenticate bitcoin transactions,
enforce Bitcoin’s rules, and keep Bitcoin’s Network decentralized.
7. The Lightning Network will allow for More Bitcoin Full Nodes
First generation Lightning Nodes are full nodes. In other words, more
people will be running full nodes as a result of the Lightning
Network. This is healthy for the Bitcoin Network.
Is the Lightning Network safe?
As with any experimental technology, only time will reveal all
vulnerabilities. At the moment, the Lightning Network is theoretically
safe to use. Here are some potential risks, attack vectors, and things
to look out for.
The Lightning White Paper sets out a solid, theoretical framework.
Sometimes, however, there are bugs in the code.
Download the software from a reputable source
Thus, make sure to only run software which is approved by the
community. Be sure to download only verified copies of the code.
For example, only download from official websites. If you have the
technical ability, check the download’s checksum, or verify that the
software was signed with an authentic PGP signature.
Allow new software a few months to be tested by other people. A
popular wallet, Electrum, was recently discovered to contain a
security vulnerability that threatened users for years without notice.
After news breaks, you need to learn of the vulnerability, because
many hackers will learn about the vulnerability quickly and attempt to
exploit it.
Get involved in the Community
Subscribe to good bitcoin news channels. www.Reddit.com/r/bitcoin,
Twitter, and the World Crypto Network on Youtube are all good sources
of bitcoin news.
Sign up for the mailing list to recieve critical notices from the
software publisher.
Maintain your Internet Connection
Hash time locked contracts are time sensitive. Check you internet
connection daily, to make sure that your software is able to do its
job properly.
If your computer goes offline, you software may not be able to
properly process transactions and catch cheaters.
A sophisticated attacker may periodically ping your IP Address. An
attacker may wait until they find that your computer is offline. The
Lightning Network offers a grace period for users to catch cheaters.
If the grace period is 1,000 blocks, then you should check your
internet connection at least every 1,000 blocks.
If you need to, publish a Breach Remedy transaction (this transaction
punishes cheaters by forefiture of all bitcoins in the payment
channel)
Keep small sums of Cash in your Bitcoin Payment Channels
Do not keep substantial sums of bitcoin in payment channels, unless
you know and trust the other person.
Since the Lightning Network takes all bitcoins in the payment channel
as a fine to deter cheating, you better keep small amounts in payment
channels just in case your software tries to publish an old
transaction.
In other words, keep many small payment channels, because the
Lightning Network might interpet a mistake or bug as an attempt to
steal bitcoins.
If so, you will lose all funds in that payment channel. If you know
the person, they may be kind and return your bitcoin. But if you do
not know the person, it is unlikely that they will return your
bitcoins, assuming they even know who to return them to!
Keep enough Bitcoin to Pay for on Chain Transactions
Always make sure that you have enough bitcoin to pay for on-chain
transaction fees, however high they may be. I’m unsure how Lightning
will allocate on-chain transaction fees. But on-chain fees are
unpredictable. Always keep more than enough to publish time-sensitve
transactions in the next block.
Bitocin developers generally attempt to build systems that can
withstand malicious, rich attackers.
In the Lightning Network, a wealthy attacker may send large payments
through the Lightning Network in an attempt to force channel closures,
and a mass exodus which results in full blocks and massive transaction
fees.
Attackers might also attempt to drain Lightning Nodes of funds, if
they are able to force Lightning Nodes to expend Bitcoin transaction
fees.
These are largely theoretical problems. It will be interesting to see
how the Network bodes!
In Conclusion
The Lightning Network will eventually become a well-connected market
with deep liquidity and great privacy. In the beginning, it will feel
like we are “locking up” bitcoins in the Lightning Network. In the
next few years, it will feel like we are “freeing up” bitcoins in the
Lightning Network.
This new innovation will also accomplish one of its most important goals. It will lower transaction fees and allow for more transaction to be processed. This will effectively allow the Bitcoin Network to grow the way it was intended to.