What you need to know about the Lightning Network?

When memcoins in the form of BRC-20 tokens flooded the Bitcoin blockchain in early May, the cryptocurrency faced congestion and prohibitively high fees. The world’s largest crypto exchange Binance was forced to disable the ability to withdraw user bitcoins twice a day until an acceptable level of network load returned. Exchange representatives announcedthat its development team is working on integrating translations through a solution called the Lightning Network, which they say “helps a lot in situations like this,” writes RBC Crypto.

The Lightning Network (LN) protocol is a Bitcoin scaling system that is one of the solutions to its limited bandwidth problem. With it, you can make almost instant coin transfers with minimal commissions.

The concept of the protocol was first presented in a white paper called The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments in 2015. Its authors were the developers Joseph Poon and Thaddeus Dryja. Since the advent of the Lightning Network, the developer community has been collectively working on both improving the protocol itself and on applications and tools that support LN transactions.

How it works

If you think of bitcoin as a huge highway, where countless vehicles (transactions) compete for limited space, then the Lightning Network protocol acts as a dedicated lane that allows you to bypass the congested main road. This is achieved by creating special payment channels in which transactions can take place instantly, with a minimum commission and without the need to record each of them in the bitcoin blockchain.

To open such a channel, coin transfer participants create a shared address and replenish it with a certain amount of bitcoins. Then they can transfer funds to each other, and the balance data on their addresses will be updated inside the channel. When they close the channel, the final balance will already be recorded on the bitcoin blockchain as a separate transaction.

Payment channels can be created using wallets or other Lightning Network-enabled software. You can use someone else’s channel as an intermediate link for transfers – in this case, the one who opened it will receive a small commission. Since transactions take place outside the blockchain, it is not possible to isolate a separate identifier for a specific transfer or view data about it in the blockchain explorer.

What prevents the spread

Despite the existing way to solve one of the main problems of bitcoin, the Lightning Network protocol is still far from mass adoption – both for private users and for businesses. The technical complexities involved in creating and managing channels are a significant barrier for average users. LN-enabled crypto wallets are usually non-commercial developments that suffer greatly from interface design and user experience (UX).

In addition, the lack of standards for protocols hinders the interoperability of LN-enabled software developed by different teams. This makes it difficult to connect new users and integrate the protocol into large platforms, whose owners are obviously interested in cheaper and faster coin transfers. Another problem is the limitation of liquidity in the channels. Participants are forced to lock up a certain amount of bitcoin in the channel, which in itself limits the amount of funds available for transfer and reduces the utility of the protocol as a whole.

The relative novelty and limited acceptance of the Lightning Network creates a paradox: few people trust the protocol without its wide adoption, and its adoption, in turn, is constrained by the relatively small number of stakeholders willing to use it.

This is largely due to the fact that the Lightning Network is a non-profit project in itself, the infrastructure development of which is carried out by volunteers. The reverse situation is observed in Ethereum: network scaling projects such as Polygon, Arbitrum, Optimism, zkSync and others have already formed an entire industry and are estimated at billions of dollars.

Projects and investments

However, investors are supporting projects that integrate the Lightning Network into their payment solutions. In August 2022, Lightning Labs raised $80 million to fund the development of the Taro protocol, which allows transactions with stablecoins using the Lightning Network. Among the investors of the project are the former head of Twitter (blocked in Russia) Jack Dorsey and the CEO of the payment company Robinhood Vlad Tenev.

In the same period, an investment round was held by Strike. It has raised $80M, which it is using to partner with major retailers to connect its own wallet and LN-based merchant acquiring. Investors have invested about $10 million in the Amboss and Mash platforms, both of which also create payment solutions based on LN.

Bitcoin scaling is one of the major problems of cryptocurrency. As fees and network load increase, transfer optimization solutions will become more relevant. The Lightning Network protocol is fairly well-known in the community, but there are still many things preventing it from spreading.

Simplifying user interfaces, promoting interoperability, and improving the overall user experience are important steps towards making Lightning Network technology more accessible. Improving liquidity management and security measures is equally important in order to instill confidence in protocol users.