The Lightning Network (LN) is a "second layer" protocol on top of Bitcoin and other blockchains that enables fast, secure, private, trustless and permissionless payments.
Once a payment on the LN has completed, usually within a few seconds, it is final and cannot be reversed: like a Bitcoin transaction, a payment on the LN can only be refunded by the recipient.
While "on-chain" Bitcoin transactions are broadcast and verified by all nodes in the network, transactions routed on the LN are transmitted between pairs of nodes and not visible to everyone, resulting in much greater privacy.
The LN uses onion routing, similar to the protocol used by The Onion Router (TOR) privacy network, so that even the nodes involved in routing a transaction are only directly aware of their predecessor and successor in route.
The Lightning Network was first proposed in February 2015 by Joseph Poon and Thaddeus Dryja as a possible solution to the Bitcoin Scalability Problem.
As Bitcoin grows, and the demand for transactions grows, block sizes will increase until eventually hitting the block size limit, leaving excess transactions to wait in a queue.
Simply increasing block sizes has the undesirable effect of centralizing the network.
Blockchains are gossip protocols, and each node is required to know and validate every single transaction that occurs on the network.
As such, the greater the block sizes, the greater the processing and storage requirements for each individual node.
The greater the requirements, the fewer the nodes that will ultimately be run.
In the Lightning Network whitepaper, Poon and Dryja estimate that in order for Bitcoin to reach the 47,000 transactions per second processed at peak by Visa, it would require 8GB blocks.
This would make running a node completely untenable for anyone but large scale enterprises and industrial grade operations.
The result would be a network in which only a few users can actually validate the state of the ledger, which ultimately breaks the trust model of Bitcoin.
The Lightning Network proposes a new network, a "second layer", where users can transact with each other peer-to-peer, without publishing every transaction to the Bitcoin blockchain.
Users may transact on the Lightning Network as many times with as many users as they want, making use of the Bitcoin blockchain only in order to load Bitcoin onto the network initially and to "settle", that is: remove Bitcoin from the Lightning Network.
The result is that many more Bitcoin transactions can take place "off-chain", with only the initial loading and final settlement transactions needing to be validated and stored by Bitcoin nodes.
Aside from reducing the burden on nodes, these transactions will be cheaper for users as they do not need to pay blockchain fees, and more private for users as they are not published to all participants of the network.
While the Lightning Network was initially conceived for Bitcoin, it is able to be implemented on any blockchain that meets its technical requirements.
* Blockchain: a single distributed ledger agreed upon by a network of participating nodes. The Lightning Network does not use a blockchain to transact, but requires transactions recorded in a blockchain in order for Bitcoin to enter and leave the network.
* Channel: a channel is a financial relationship between two nodes on the Lightning Network. Two users can open a channel with each other using a Bitcoin transaction, and transact with each other by moving Bitcoin from one side of the channel to the other.
* Capacity: channels require Bitcoin to be pre-loaded into them before they can be used. This becomes the maximum amount of Bitcoin that can be transacted using this channel i.e. it's capacity.
** In-Bound Capacity: the maximum amount of Bitcoin that can be received using a channel. Your in-bound capacity is increased when a user opens a channel with you, or you make a payment to another user.
** Out-Bound Capacity: the maximum amount of Bitcoin that can be sent using a channel. Your out-bound capacity is increased when you open a channel with another user, or you receive a payment from another user.
* Invoice: a request for payment from another user that can take the form of a text string or a QR code. Lightning Invoices can be specified with a description and an amount the invoicer is requesting.
* Node: a node is a participant on the Lightning Network. Nodes can open and close channels with each other, route payments from other nodes, and manage their own wallets. Typically a Lightning Network node user will also run a Bitcoin Node to keep track of the status of on-chain payments
* On-Chain/Off-Chain: a payment is considered "on-chain" if it is included in the Bitcoin (or other underlying) blockchain where it is publicly visible to all nodes. Payments that are not visible in the underlying blockchain are "off-chain"
* Route: when making a payment from one user to another, the payment will move along many intermediary nodes before reaching the receiver. This path from the sender to the receiver forms a route on the network.
** Funding Transaction: a transaction that locks Bitcoin into a smart contract to open a channel.
** Settlement Transaction: a transaction that closes a channel, and allocates the locked Bitcoin to the channel owners according to the final balance of the channel.
** Penalty Transaction: if one user tries to "cheat" by claiming a prior state of the channel, the other user can publish a penalty transaction to the Bitcoin blockchain, which allocates all Bitcoin in that channel to them.
* Wallet: an application that manages private keys in order to send and receive Bitcoins. Lightning Wallets have additional features over and above Bitcoin Wallets in that they can open and close channels, and send and receive lightning payments.
Alice is a bitcoin user who wants to make fast, secure, cheap and private payments for small amount retail purchases. She buys coffee with bitcoin, using the Lightning Network
Bob owns a coffee shop, "Bob's Cafe". "On-chain" bitcoin payments don't scale for small amounts like a cup of coffee, so he uses the Lightning Network to accept bitcoin payments almost instantaneously and for very low fees.
Saanvi is a web designer and developer in Bangalore India. She accepts bitcoin for her work, but would prefer to get paid more frequently and so uses the Lightning Network to get paid for each small milestone she completes. With the LN can do more small jobs for more clients without worrying about fees or delays.
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John is a 9 year old boy from New Zealand, who wanted a game console just like his friends. However, his dad told him that in order to buy it, he had to earn the money by himself. Now John is an aspiring artist so he knows that while he is still learning, he can't charge much for his artwork. After learning about Bitcoin, he managed to setup a website to sell his drawings across the internet. By using the LN, John was able to charge as little as $1 for one of his drawings. By being able to set a fair price, which would normally be considered a micro-payment and as such not possible with other payment methods, and by using a global currency such as Bitcoin, John was able to sell his art work to customers all over the world and in the end buy the game console he wanted so much.
Gloria is a teenage gamer from the Philippines. She plays many different computer games, but her favorite ones are those that have an "in-game economy" based on real money. As she plays games, she also earns money by acquiring and selling virtual in-game items. The Lightning Network allows her to transact in small amount for in-game items as well as earn small amounts for completing quests.
Farel is an immigrant, who sends money home to his family in Indonesia by working in the Middle East. Remittance companies and banks charge very high fees, and Farel prefers to send smaller amounts more often. Using the Lightning Network, Farel can send bitcoin as often as he wants, with negligible fees.
Wei is an entrepreneur who sells information services related to the Lightning Network, as well as Bitcoin and other cryptocurrencies. Wei is monetizing his API endpoints by implementing micro-payments over the Lightning Network. Additionally, Wei has implemented a liquidity provider service that rents inbound channel capacity on the LN, charging a small bitcoin fee for each rental period.
In this section we will start by choosing the right software to demonstrate the LN and learn by example. We will examine the choices of two users who represent a common use-case for the LN. Alice, a coffee shop customer will be using a LN wallet on her mobile device to buy coffee from Bob's Cafe. Bob, a merchant, will be using a LN node and wallet to run a point-of-sale system at his cafe so he can accept payment over the LN.
The Lightning Network is accessed via software applications that can speak the Lightning Network protocol. A _Lightning Network Node_ (or simply "node") is a software application that communicates on a peer-to-peer basis with other LN nodes, forming the Lightning _Network_ itself. Nodes also include "wallet" functionality, so they can send and receive payments over the LN and on the Bitcoin network.
Lightning network nodes also need access to the Bitcoin blockchain, or another blockchain such as Litecoin. Users have the highest degree of control by running their own authoritative Bitcoin node and LN node.
However, LN nodes can also use a lightweight Bitcoin client (commonly referred to as Simplified Payment Verification (SPV)) to partially validate the correctness of their blockchain.
The term "Lightning Wallet" is somewhat ambiguous, as it can describe a broad variety of components, combined together with some user interface. The most constituent components of anything called a "Lightning Wallet" may include:
* A keystore that securely holds secrets, such as private keys.
* A Lightning Network node that communicates on the Peer-to-Peer network, as described previously.
* A blockchain node (such as a Bitcoin node), that stores blockchain data and communicates with other blockchain nodes.
* A channel data store with data about channels on the Lightning Network
* A channel manager that can open and close Lightning Network channels
* A path-finding system that can make a path from payment source to payment destination, by connecting channels together.
A Lightning Wallet may contain all of these functions, acting as a "full" wallet, with no reliance on any third party services. Or, one or more of these components may rely (partially or completely) on third party servers that mediate those functions.
A key distinction (pun intended), is whether the keystore function is internal or outsourced. In blockchains, control of keys determines custody of funds, as memorialized by the phrase "your keys, your coins; not your keys, not your coins". Any wallet that outsources management of keys, is called a "custodial" wallet, because a third party (custodian) has control of the user's funds, not the user themselves. A "non-custodial" or "self-custody" wallet by comparison is one where the keystore is part of the wallet and keys are controlled directly by the user.
Blockchains, especially open blockchains like Bitcoin, attempt to minimize or eliminate trust in third parties and empower users. This is often called a "trustless" model, though "trust-minimized" is a better term. In such systems, the user trusts the software rules, not third parties. Therefore, the issue of control over keys is a principal consideration when choosing a Lightning Wallet.
Every other component of a Lightning Wallet brings similar considerations of trust. If all the components are under the control of the user, then the amount of trust in third parties is minimized, bringing maximum power to the user. Of course, this is a direct tradeoff, as with that power comes the responsibility to manage complex software.
Every user must consider their own technical skills before deciding what type of lightning wallet to use. Those with strong technical skills should use a Lightning Wallet that puts all of the components under the direct control of the user. Those with less technical skill but a desire to control their funds, should choose a _non-custodial_ lightning wallet, even if some of the components (other than the keystore) rely on some trusted third parties.
Finally, those seeking simplicity and convenience, even at the expense of control and security, may choose a custodial lightning wallet. This is the least challenging option, but it _undermines the trust model of cryptocurrency_ and should therefore be considered only as a stepping stone towards more control and self-reliance.
Lightning wallets can be installed on a variety of devices, including laptops, servers and mobile devices. To run an LN node and an authoritative Bitcoin node you will need to use a server or desktop computer, as mobile devices and laptops are usually not powerful enough in terms of capacity, processing, battery life and connectivity. On a laptop or mobile device you can run a LN node that relies on a third-party Bitcoin node for access to the blockchain.
Here are some current examples of LN node and wallet applications for different types of devices:
