MAJR News 093

Peeling back the layers of Bitcoin. Layer 2: The Lightning Network.

Jun 09, 2021

@henque

MAJR NEWS BRIEF

Today, there are over 73.8 million digital wallets today. There are over 8 billion people in the world. Bitcoin has room to grow.

Bitcoin is the world’s largest and most popular cryptocurrency with a current market cap of roughly $616 billion dollars. While the network has seen amazing growth in adoption and appreciation in price, scalability and transaction throughput remains a target for improvement. Blockchain scalability refers to the amount of transactions that can be processed per second (TPS). Bitcoin was specifically engineered to handle a certain number of transactions can be processed, verified, and put into a block (1MB). This architecture was intended to maintain security and decentralization on Bitcoin’s layer 1 blockchain. Blocks of data are mined every ~10 minutes leaving users waiting between 10-60 minutes for their transactions to be confirmed.

This works fine for bitcoin’s store of value use case, but doesn’t scale as an efficient global payment system. Traditional payment infrastructures, like Visa and Mastercard, process thousands of transactions per second. On the other hand, Bitcoin’s layer 1 can process between 2-14 TPS. This simply is not enough to maintain growth and become a truly decentralized money, a medium of exchange.

Enter the Lightning Network.

The Lightning Network

The technology’s first whitepaper emerged in February 2015, by developers, Joseph Poon and Thaddeus Dryja. A year later, they published the Bitcoin Lightning Network Whitepaper framing a potential application to enhance Bitcoin’s scalability using a layer 2. The project was formally launched in 2018, and has made significant progress over the last few years.

What exactly is the Lightning Network?

The Lightning Network is a layer 2 technology that sits on top of the Bitcoin blockchain as a solution for scalability.

Lightning - a decentralized network using smart contract functionality on the blockchain to enable instant payments across a network of participants.

It was created specifically to help facilitate and manufacture rapid peer to peer transactions thus making the blockchain able to properly develop with its users.

Layer 2 - an off-chain secondary protocol that is built on top of the existing blockchain (layer 1). Off-chain means any event (transactions) occurring on a cryptocurrency network that is outside of the main blockchain.

A layer 2 solution like Lightning allows users to send and receive transactions without having to record every transaction on the main blockchain saving space, time, and cost. The protocol accomplishes by using multiple off-chain payment channels that provide instant transactions between participants. The only transactions that are recorded on the main chain include the one that creates the payment channel and the exit transaction.

The Lightning Network is completely separate and independent from Bitcoin. It is its own software that is in constant communication with the main chain.

How It Works

Here’s a simplified version of how Lightning works.

Two participants create a ledger on a blockchain which each person signs off on and approves.
Both parties create and engage in transactions that are recorded on the Lightning Network but not broadcasted on the main chain.
This channel can be closed out at any time by either party by broadcasting the most recent version of that channel to the blockchain.

Think of the Lightning Network as a bar tab. Generally, individuals don’t pay for every single drink at a time. They start a tab that records every transaction and is then settled at the end of the night. The same goes for the Lightning P2P payment channels.

Wrap Up

As the name suggests, transactions that occur through the protocol are truly lightning fast. Over the past year alone, the number of network nodes has doubled to ~12k which highlights the adoption and demand for the technology.

Number of Lightning Nodes Since 2018

Lightning provides instant payments, increased transaction throughput, and low costs that gives Bitcoin exponentially more value and uses cases real world adoption.

It’s already being supported by top crypto exchanges, such as Kraken.

And, it’s become central to the biggest event in Bitcoin’s 12 year history. Through the use of Jack Maller’s bitcoin payment application, Strike, Lightning will be the underpinning technology for El Salvador’s modern day bitcoin financial infrastructure.

This morning El Salvador was the first country to pass a bill confirming bitcoin as legal tender and will be used interchangeably with the US dollar. The bill was sent to congress and in a matter of two hours was being voted on and was ultimately passed with a super majority. Unreal.

Lightning was critical for El Salvador’s bold move puts Bitcoin on a whole new trajectory as an instantaneous peer to peer payment system. Bitcoin is now ready for global adoption.

Bitcoin keeps getting smarter with time. It’s a technology and future innovations like the Lightning Network will only make the protocol stronger, faster, and more valuable.

Follow the smart money.

Brevin White

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