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Regarded as one of the most effective solutions for cryptocurrency scaling, the Lightning Network is a system of smart contracts. Its main goal is to enable fast and cheap payments between two parties on the Bitcoin blockchain.

Planned by Thaddeus Dryja and Joseph Poon in a whitepaper back in 2015, the Lightning Network consists of channels created by users that send payments among themselves in a safe and trustworthy manner.

For instance, if you want to pay for a service using Bitcoin, you simply have to open a Lightning channel and perform the payments from your wallet to the respective platform in a timely fashion. After the channel is closed, the net amount will be settled in the Bitcoin blockchain.

Since the transactions are just between two parties and don’t need to be transmitted to the entire network, they are instantaneous. And, due to the fact that there are no miners that need to be rewarded, transaction fees are almost inexistent.

Lightning Network Explained

Two parties that want to exchange currencies have to set up a multi-signature wallet (which needs more than one signature to confirm a transaction). The wallet address is then recorded on the Bitcoin blockchain. This initiates the payment channel.

The two parties can now perform unlimited transactions without ever needing to access the information that was originally stored on the blockchain. On each transaction, both parties sign an updated balance sheet to always show the number of Bitcoins stored in the wallet, and exactly how much goes to each of them.

When the transaction procedures have ceased, the channel is closed, and the resulting balance is recorded on the blockchain. Should there be a disagreement, both parties can use the most recent balance sheet to get back their initial part of the sum from the wallet.

It’s worth mentioning that performing transactions on Lightning does not require users to set up a direct channel beforehand. You can send funds to another party through channels with users who you are already logged in. The network automatically searches and uses the shortest path.

The advantages of the Lightning Network

The main benefits of the Lightning Network have significantly reduced fees, instant confirmation times (no more waiting ten minutes in order to confirm Bitcoin transactions), and the possibility of improving privacy seeing as these transactions are not kept in a public ledger forever.

Small transactions or payments can easily move through the network with Lightning’s help, similar to how data packets are sent over the Internet. The platform has enough potential to produce new use cases that were not possible up until now like machine-to-machine transactions, content micropayments, and instantaneous asset exchanges.

There is also more room for improvement in the anonymity department, which could be provided by the Lightning Network, even though there is still more to be developed in this particular segment.

In the long run, it seems obvious that the Lightning Network will slowly diminish the need for altcoins with lower transaction fees, but it’s still unknown whether and when the effects of this protocol will be visible.

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