Of course, every detail of a technology exists for a reason and is important.
However the Lightning Network is literally built around the idea and concept of payment channels.
In the previous chapters you have already learned that payment channels
* allow two peers who created it to send and receive Bitcoin up to the amount specified by the capacity of the channel as often as they want to.
* split the capacity of the channel into a balance between the two peers which - as long as the channel is open is only known by the owners of the channel and increases privacy.
* do not require peers to do any additional onchain transactions other than the one needed to open and - potentially at a later state - to close the channel.
* can stay open for an arbitrary time. Potentially in the best case forever.
* do not require peers to trust each other as any attempt by a peer to cheat would enable the other peer to receive all the funds in the channel as a panality.
* can be connected to a network and allow peers to send money a long a path of connected channels without the necessity to trust the intermediary nodes as they have no ability to steal the Bitcoin that are being forwarded.
If you are new to the topic we highly encourage you to start there first.
If you however already know a fair share about bitcoin script, OP_CODES and protocol design it might be sufficient to skip the previous chapter and start here with us.
This books follows the construction of payment channels as described in BOLT 02 which is titled `peer protocol` and describes how two peers communicate to open, maintain and close a channel.
We will only discuss opening and closing a channel.
The operation and maintainance of a channel which means either making or forwarding a payment is discussed in our chapter about routing.
Also other constructions of payment channels are known and being discussed by the developers.
Historically speaking these are the Duplex Micropayment channels introduced by Christian Decker during his time as a PhD student at ETH Zuric and the eltoo channels which where also introduced by Christian Decker.
The eltoo channels are certainly a more elgant and cleaner why of achieving payment channels with the afore mentioned properties.
However they require the activation of BIP 118 and a softfork and are - at the time of writing - a potential future protocol change.
Thus this chapter will only focus on the pentalty based channels as described in the Lightning Network Whitepaper and specified in BOLT 02 which are currently supported by the protocol and the implementations.
[NOTE]
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The Lightning Network does not need consensus of features across it's participants.
If the Bitcoin Softfork related to BIP 118 activates and people implement eltoo channels nodes that support eltoo can create payment channels and the onion routing of payments a long a path of channels would work just fine even if some of the channels are the modern eltoo channels or some channels are the legacy channels.
Actually when Lightning network connections are established nodes signal feature bits of global and local features that they support.
Thus havning the ability to create eltoo channels would just be an additional feature bit.
In this sense upgrading the Lightnign Network is much easier than upgrading Bitcoin where consensus among all stakeholders is needed.
Let's quickly summarize what you should already know about payment channels on a technical level and for what you will learn the details in this chapter.
A payment channel is encoded as an unspent 2-of-2 multisignature transaction output.
The capacity of the channel relates to the amount that is bound to the unspent 2-of-2 multisignature transaction output.
It is opened with the help of a funding transaction that sends bitcoin to a 2-of-2 multisignature output together with a communication protocol that helps to initialize and maintain its state.
When someone says they 'own' bitcoin they typically mean that they know the private key of a bitcoin address that has some unspent transaction outputs (UTXOs).
The private key allows the owner to produce a signature for a transaction that spends the bitcoin by sending it to a different address.
Thus 'ownership' of bitcoin can be defined as the ability to spend that bitcoin.
If you have an unpublished but signed transaction from a 2-of-2 multisignature address, where some outputs are sent to an address you own, and additionally you own one of the private keys of the multisignature address, then you effectively own the bitcoin of that output.
Without your help no other transaction from the 2-of-2 multisignature address can be produced.
On the Lightning Network ownership of your funds is almost always encoded with you having a pre-signed transaction spending from a 2-of-2 multisignature address.
These commitment transactions should never hit the blockchain and serve as a safty net for the participants in case the channel partner becomes unresponsive of disappears.
They are also the reason why the Lightning Network is called an offchain scaling solution.
Each channel partner has both signatures for one of the commitment transactions from the sequence of pairs.
The split of the capacity is realized by a `to_local` and a `to_remote` output that is part of every commitment transaction.
The `to_local` output can be spent either at any time with the help of a revocation secrete or after a timelock with the secret key that is controled by the peer holding this commitment transaction.
While the BOLTs introduce payment channels directly with the opening protocol we have decided to talk about the security model first.
The security of payment channels come through a penalty based revocation system which help two parties to split the capacity of the payment channel into a balance sheet without the necessity to trust each other.
In this chapter we start from an insecure approach of creating a payment channel and explain why it is insecure.
We will then explain how time locks are being used to create revokable sequence maturity contracts that create the penality based revokation system which economically incentivizes people maintain the most recent state.
After you understood these concepts we will quickly walk you through the technical details of opening and closing a channel.
Let us assume Alice does not know the details about the Lightning Network and naivly tries to open a payment channel in a way that will likely lead to the loss of her funds.
Alice has heard that payment channel are 2-of-2 multisignature outputs.
As she wants to have a channel with Bob and since she knows a public key from Bob she decides to open a channel by sending money to a 2-of-2 multisignature address that comes from Bob's and her key.
We call the transaction that Alices used a **funding transaction** as it is supposed to fund the payment channel.
As we have discussed the Bitcoins from the resulting UTXO can only be spent if Alice and Bob work together and both provide a signature for a transaction spending those coins.
Luckily Alice has previously read Mastering Bitcoin and she knows all the properties of Bitcoin script and is aware of the risks that are involved with sending Bitcoins to a 2-of-2 multisignature address to which she does not control both keys.
She is also aware of the "Don't trust. Verify" principle that Bitcoiners follow and doesn't want to trust Bob to help her moving or accessing her coins.
What if she could already prepare a refund transaction (which we call commitment transaction in future) that sends all the bitcoin back to an address that she controls?
Just because in general people are expected to broadcast a transaction to the bitcoin network as soon as they have signed it noone forces you to do that.
As Alice would loose access of her Bitcoins once she sends it to a 2-of-2 multisignature output for which she only controls one key, she needs to make sure that she will be able to regain access of her coins in case Bob becomes unresponisive.
Thus before Alice publishes the funding transaction she will create another transaction that sends all the bitcoin from the 2-of-2 multisignature output back to an address which she controls.
Commitment Transactions split the capacity of the channel into a balance which is owned by each partner.
Initially this split means that all the capacity is naturally on the side of the partner who funded the channel.
Of course during the lifetime of the channel the balance could change.
For example Alice might want to send some funds to Bob.
This could happen because she wants to pay Bob or because she wants Bob to forward the funds through a path of channels to another merchant that she wants to pay.
Let us assume as an example that Alice wants to send 30k Satoshi to Bob.
For now we can assume that through some communication protocol Alice and Bob would negotiate a double spent of the funding transaction output of 100k satoshi.
The new commitment transaction for which Alice and Bob would exchange signatures would send 70k satoshi to Alice and 30k Satoshi to Bob.
Of course he could close the channel by publishing the second commitment transaction assigning 30k satoshi to an address that he controls.
But similarly Alice could broadcast the first commitment transaction and transfer the entire capacity of the channel back to an address that she controls.
Regarding the fact that Bob and Alice both have a copy of the transaction and that Bob cannot control the data that Alice has stored on her hardware, it seems pretty hopeless.
Luckily, the scripting language in Bitcoin allows at least for changing commitment transactions in a way that economically disincentivises channel partners from publish an outdated balances after they have negotated a new balance.
Therefore you might be surprised to learn that even though two users are owning and maintaining the channel the current construction requires only one user to open the channel.
This transaction sends 100k satoshi from an address that she - or her lightning node software controls - to a 2-of-2 multisig address for which she and Bob know 1 secret key each.
Thus for the reminder of the chapter in all examples we assume the payment channels that we use as examples already magically exist and the two peers Alice and Bob already have all the necessary data at hand.
Even though Alice and Bob both have a public node key to which they own the private secret opening a payment channel is not as easy as sending bitcoins to the 2 out of 2 multisignature output that belongs to the public keys of Alice and Bob.
While the Lightning Network was certainly invented to scale the amount of payments that can be conducted on the Bitcoin Network it is interesting to note that the network is designed in a way that allows to build channels over various currencies.
However this turns out to be a little bit tricky in reality as the exchange rate between currencies might change which might lead the forwarding node to wait for a better exchange rate to settle or to abort the payment process.
For the opening process the final channel id cannot be determined yet thus Alice needs to select a random channel id with Bob that she can use to identify the messages for this channel during the opening phase.
Once the channel is open Alice will be able to send 99k satoshi along this channel.
Bob on the other side will be able to receive 99k satoshi along that channel.
This means that initially Alice will not be able to recieve Bitcoins on this channel and that Bob initially will not be able to send Bitcoin along that channel.
