The roadblocks stopping Bitcoin from becoming a world-wide, retail currency can be solved through instant, off-blockchain transactions produced through Lightning Network’s coding. By altering the Bitcoin script slightly for transaction protocol, people can send and receive payments through a network of secure channels rather than a centralized hub. If this model is successfully applied, it can expand Bitcoin capabilities by offering mirco-payments for common purchases as it allows more transactions per day.
Let’s begin with what Lightning Network aims to fix.
Current Bitcoin Problems
Although Bitcoin provides the safest and most reliable blockchain for verifying transactions, it has many downfalls that prevent it from growing.
- It cannot provide a cheap way to send mirco-payments due minimum withdraws and high fees that makes small purchases impossible.
- It takes about an hour for payments to be processed through blockchain verification, so small, fast retail transactions cannot occur.
- The amount of possible Bitcoin transactions per day in order to globalize the coin cannot be handled on a massive scale. Currently 1 MB of blocks can verify only 7 transactions per second. That is only 220 million transactions a year.
- There are not enough nodes and miners to spread out the transactions on a massive scale.
- Third parties like Coinbase are needed to send money.
Payment Channels through multiply parties
Lightning Network created a payment channel without third party custodianship. Two or more people can send transactions to one another without broadcasting to the Bitcoin blockchain every time by using multi-sig (multi-signature) and hash-locked contracts (time sensitive).
Payment Channel Models
A simple two-party transaction that includes an initial refund signature sent by the receiver to the sender that guarantees a refund in 30 days. Two parties use the same multi-sig address to store the signatures and currency. The sender then sends the money along with their signature. The receiver has 30 days to confirm and sign in order to end the contract and upload it to the blockchain. The transaction does not hit the network until the contract is closed. During the 30-day open period, transactions of any amount can be sent until the contract is closed.
The transaction can be reversed, and a specific lock time can be set. The receiver can override a transaction and revert to an older transaction in order to pay back the sender. The lock time must be less (closer to the present) each time the channel is reversed.
Problems: Both of these two-way channels function on a basic level, but they do not solve the problem of raising the Bitcoin scale. There would be too many open channels and too many transactions to verify once they hit the blockchain if every transaction only included 2 people.
Three-party payment channels
Send money through an already open channel using a third party (ex. Coinbase).
There is no way to confirm that the receiver got the money and that the third party took the money. There are trustworthy platforms, like Coinbase, but they are many that get hacked , plus a fees usually applies. The goal of Lightning Network is to create a completely trustless network of payment channels with no fees.
Network of Payment Channels
Hash-locked contracts using one-way hash functions will allow large multi-user channels with proof of payment. Transactions are verified by a key generated by the receiver. This key is given to the sender in order to receive the funds. The payment key is sent down the line until it recaches the original sender and the process is reversed with the actual funds being sent back to the receiving end. Anyone who has the key and the original hash function can broadcast the transaction to the blockchain and transfer the cryptocurrency. However, the transaction can be completed off the blockchain if everyone corporates. This key acts as a receipt of contract to prove you are part of the channel’s transaction payment network.
Problem: By not giving the key to the sender, the receiver can hold funds hostage. Then if the channel between another sender and receiver expire, people will lose their money while the receiver steals the funds from the hashlock.
Fix malleability of hash transactions
If there are too many untrustworthy parties, then malleability transactions can occur where funds are held up. This can change the transaction as channels expire, which can destroy their validity and remove the possibility of refunds. With more than 2 parties, resigning is not possible as you may not know who has your original transaction.
Create a time-locked multi-user contract
Users agree to send the key and payment in a certain amount of time or else a refund will be issued. This is implemented by creating a soft-fork in the Bitcoin script using multiply transaction outputs. Contracts are used to settle disputes either outside of the blockchain by removing and restarting the contract or broadcasting the transaction (output and refund) to the blockchain to get a refund. By revealing the transaction on the blockchain, the key to the funds is published, so the sender sends the money and the receiver gets the money automatically. This is a safeguard if one of the parties does not abide by the contract.
Benefits of Lightning Network
- Transaction timeouts creates a voided transaction and a return of funds.
- Creates trustless, instant transactions off the blockchain.
- Can use micro payments without inflated fees.
- Relative timelock means the market price of Bitcoin depends on when the transaction channel begins.
- Bitcoin will scale to be used by everyone worldwide without using much bandwidth.
- Not much storage is needed to archive transactions.
Transforming cryptocurrency viability
If this new technology can safeguard peer-to-peer transactions on the retail scale, then Bitcoin will increase its usability to billions. Transactions would be 100% safe without the use of risky third-party monopolies and without over burdening the blockchain. This could potentially open-up the consumer market to cryptocurrency like we haven’t seen yet. Ultimately, it could be the solution we have been looking for to decentralize the financial industry and make peer-to-peer transactions safe and free.