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What is Bitcoin’s Lightning Network and How Does It Work?

I write for a crypto blog and do cryptocurrency research all day so that you don't have to.

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Bitcoin is the most popular cryptocurrency. At its most basic, it is just a digital currency that can be sent and received.

However, Bitcoin’s popularity is also its curse.

The more people who send and receive Bitcoin, the slower, and more expensive, the transaction becomes.

Many people want Bitcoin to be the future of how we pay for things, but with the way Bitcoin currently is, just paying for a coffee could take minutes or hours. That’s because Bitcoin can only handle 7 transactions per second. If more than 7 people are using Bitcoin at any given time then the next person has to wait.

On top of that, Bitcoin’s miners prefer to mine the transaction with the highest fee first because then they will receive a larger reward. That means if you want to make a transaction on Bitcoin fast you have to pay more, so your transaction will be validated before those who paid less. Except no one is going to pay for coffee using Bitcoin if there is a $50 transaction fee associated with it.

Enter the Lightning Network.

What is the Lightning Network?

The Lightning Network is a way to make Bitcoin transactions away from Bitcoin’s blockchain.

The Lightning Network was built for those small transactions that can bottleneck the Bitcoin network. In fact, there is a cap of 0.168 BTC per transaction over the Lightning Network.

What the Lightning Network does is packages up hundreds, or thousands, of small Bitcoin transactions, and reports just the total amount back to the Bitcoin blockchain. That means that there can be hundreds of Bitcoin transactions, but Bitcoin only has to process one large one.

The Lightning Network is designed to help speed up and scale the slow Bitcoin blockchain by allowing users to make thousands of transactions per second all while still being able to rely on Bitcoin’s security and decentralization.

Because the Bitcoin blockchain only has to deal with one translation, the fees on the Lightning Network are almost non-existent. Literally, the transaction fees are fractions of a penny. That means there will be no extra cost for those looking to make small transactions, like buying a coffee.

Not only are fees non-existent, but transaction time is almost nothing too. Sending a small amount of Bitcoin on the Lightning Network will take a second or two rather than many minutes.

With the Bitcoin Lightning Network things like walking into a shop and using Bitcoin to buy coffee don’t sound too far off.

How Does the Lightning Network Work?

The Lightning Network is a second layer built on top of the Bitcoin blockchain. Bitcoin is the first layer. Blockchain layers are just a way for us to categorize and understand the architecture of the blockchain.

Bitcoin is a layer 1 blockchain. Layer 1 blockchains are responsible for users being able to send and receive transactions over its network.

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The Lightning Network is a layer 2. A layer 2 is meant to help scale the layer 1 blockchain by speeding up the transactions by processing hundreds of small transactions and sending them as one.

Blockchain layers are important when doing research on cryptocurrency, blockchain, and its application. For the sake of this post, we only need to know the basics of layer 1 and layer 2, but you can reference this simple guide to blockchain layers if you want to learn more in-depth details about what each layer does. Knowing more about layer 1 and layer 2 can help you understand Bitcoin and the Lightning Network even better.

In order to speed up Bitcoin transactions, the Lightning Network allows users to open up payment channels directly with each other.

Once two users have opened up a payment channel they can send and receive as many transactions as they want with each other. When they want to pull their funds out, they can close the channel. Once the channel is closed, the Lightning Network reports the final amount and that is recorded on Bitcoin’s blockchain.

For example, you and I open up a channel, each with 10 BTC. We then make several transactions, and I end up with 5 BTC and you end up with 15 BTC. We are done making transactions so we close the channel. Now the Lightning Network tells the Bitcoin blockchain that I now have 5 BTC and you now have 15 BTC, instead of us each having 10 BTC.

The cool thing about the Lightning Network is that you don’t have to have a payment channel open with every single person you want to make a transaction with. If User 1 wants to send 1 BTC to User 3, they can do so without opening a channel, as long as they both have a channel open with User 2.

If a coffee shop has channels open with thousands of users, then you too have access to those thousands of users without opening a payment channel with them. Eventually everyone will somehow be connected to everyone through the Lightning Network.

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Will the Lightning Network Be Used in the Future?

Only time will tell! But based on its growing popularity, the Lightning Network seems like it will be a big part of every day transactions using Bitcoin.

Right now, there are many businesses, even countries, that are accepting Bitcoin over the Lightning Network.

You may have already heard that El Salvador made Bitcoin legal tender throughout the country. The government created an app called the Chivo wallet that is compatible with Bitcoin’s Lightning Network. Now citizens of El Salvador can easily buy and sell goods using Bitcoin quickly and cheaply.

Twitter is another main proponent of the Lightning Network. Twitter allows its users to tip each other using Bitcoin. Now, one Bitcoin is worth around $20,000, so tips are in extremely small amounts like 0.0005 BTC, which is perfect for Bitcoin's Lightning Network. If a user opens a payment channel with Twitter, then they can quickly send Bitcoin tips to other users who have a payment channel open with Twitter, without going through the trouble of opening a payment channel with each other.

Another large company taking advantage of Bitcoin’s Lightning Network is Cash App. If you haven’t heard of Cash App, it’s an app that allows users to send and receive money with their friends. Cash App allows Bitcoin as a payment method. Again, these transactions are mostly small - $20 for dinner here, $10 for gas there. Using the Lightning Network, users can send and receive Bitcoin quickly on Cash App.

Summary

Today you learned what the Bitcoin Lightning Network is, why it was needed, and how it works. To recap:

The Lightning Network is a way to make quick, cheap Bitcoin transactions away from the Bitcoin blockchain.

Bitcoin can only process 7 transactions per second. As more people use Bitcoin, transactions get slower and more costly. The Lightning Network speeds up the Bitcoin blockchain by processing many small transactions and sending them to the blockchain as one large transaction.

The Lightning Network works by allowing users to open up payment channels using Bitcoin. Users can then send and receive as many transactions as they want with each other. When they are done and ready to receive their funds, they will close the channel. The Lightning Network then records the final transaction result on Bitcoin’s blockchain.

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