What is the Lightning Network?​

Initially, Bitcoin was not designed to scale the network. It was created to be a decentralized payment system, where anyone could send or receive bitcoins from anywhere in the world. As we have commented in the introduction of this cryptocurrency training, the growth of the adoption of cryptocurrencies has become its Achilles heel. As it was not designed to be scalable, with the increase in user traffic on the network, transactions began to be slower and more expensive.

Differences between a first layer (L1) and a second layer (L2). Source: Medium

At that time, developers designed layers on top of the blockchains, where the first layer (L1 or layer 1 in English) was the main blockchain. Each layer below was a secondary layer (L2), a tertiary layer (L3), and so on. Each layer complements the previous one and adds functionality. So the Lightning Network is a second layer to Bitcoin that uses micropayment channels to expand the blockchain’s ability to transact more efficiently.

How does the Lightning Network work?

The Lightning network uses channels between users so that multiple transactions can be made without having to wait for the Bitcoin network to confirm the transactions. Between the opening and closing of a channel, both parties can exchange bitcoins with each other as needed until the channel closes. Once the channel is closed, transactions are sent to the mainnet for confirmation.

The Lightning Network consists of multiple payment channels between Bitcoin parties or users. A Lightning Network channel is a transaction mechanism between two parties. Through the channels, users can make or receive payments to each other. Transactions made on the Lightning Network are faster, cheaper, and easier to confirm than transactions made directly on the Bitcoin network.

What problems are you trying to solve?

Bitcoin was not created to handle the number of transactions that now occur daily. Some of the problems that the Lightning Network tries to solve are:

Reduce network energy consumption

The energy required to run the Bitcoin network and all its information is enormous, which makes keeping the Bitcoin blockchain operational really expensive. It is one of the main problems that blockchains that use proof of work (PoW) have recently faced. The environmental policies of the 2030 agenda against climate change predict a difficult future for these blockchains.

Introduce Smart Contracts and multi-signature scripts
Smart Contracts and multi-signature scripts are the main pieces of the Lightning Network. These two are used to ensure that transactions sent through the channels reach their recipients. It is one of the characteristics that differentiates the Bitcoin network from that of Ethereum.

Transaction confirmation speed

Being able to make a transaction on the Bitcoin network has become slow and expensive. This is due to the increase in user traffic carrying out transactions, and the difficulty of mining increases over time. The Lightning Network aims to reduce these additional costs that are generated on the main Bitcoin network and in turn improve the transaction speed of the network.

Comparison of transaction processing per second

What drawbacks does the Lightning Network have?​

Committed decentralization

The main problem that we can observe in the Lightning Network is that it could end up centralizing, something a bit against the origins of Bitcoin. In the traditional financial system, banks and financial institutions are the intermediaries in banking transactions. Therefore, companies that invest in Lightning Network nodes could become centralized nodes in the network by having more closed connections.

Closed channel fraud
One of the risks when using the Lightning Network is channel closure or a disconnection. For example, let’s say Felix and I are conducting a transaction and one of us has malicious intentions. If one of the two goes with bad intentions, he may be able to steal bitcoins from the other using a technique called closed channel fraud. We are going to put an example:

Let’s say that Félix and I each put in an initial deposit of 0.005 BTC to open a channel, and that Félix has sent me a transaction of 0.01 BTC. If I log out (closing the channel) and Felix doesn’t, he could revert the initial state of the transaction (the time before the 0.01 BTC is transferred), meaning we both get our initial deposits (0.005 BTC) back as if no transaction had been made. In short, Félix receives 0.01 BTC for free and recovers his initial deposit.

This makes it necessary for third parties on the nodes to prevent fraud within the Lightning network, called a watchtower. The watchtower monitors transactions and helps prevent fraudulent channel closure.

Commissions

Using the Lightning network involves payment of transaction fees. They are a combination of routing payments to direct transaction information between Lightning Network nodes, opening and closing channels, and regular Bitcoin transaction fees. As businesses begin to adopt the Lightning Network for payments, they may begin to charge fees. Additionally, since watchtowers are third party, many charge commissions for these services.

Malicious attacks​

Another risk to the network is congestion caused by malicious attacks. If payment channels become congested and a hack or malicious attack occurs, users may not be able to recover their bitcoins quickly enough due to the congestion. Attackers can also use a denial of service (DDOS) attack to congest a channel, essentially freezing it. In these types of attacks, the attacker could use congestion to steal funds from parties who cannot withdraw their funds due to the network freezing. In the following tweet we have an example of an exploit suffered on the network during November 6, 2021.

Conclusions from this cryptocurrency training

After finishing this cryptocurrency training on the Lightning Network, we have seen that it is a great solution to deal with the problem of scalability within the Bitcoin network. However, we have also reviewed the current drawbacks that this Bitcoin L2 presents, mainly the problems it presents with closed channel fraud. This is solved by using Watchtowers, but at the same time it is a service that can end up being expensive for the user. Positively, we know that these problems will end up being solved, thanks to the fact that the cryptocurrency ecosystem is always in constant development. And of course, we will continue to work hard writing training articles on cryptocurrencies to continue enriching your knowledge about this wonderful technological revolution.

Source: Bitcoin Mining Council, Bitpay, Medium, economiafinanzas