Lightning Network: Enemy or Ally of the Bitcoin?

Lightning network

It is getting every day more evident that the bitcoin presents many limitations as a means of payment. Limitations on the size of the blocks (1MB maximum) and the speed of adding blocks to the blockchain (one every 10 minutes), which generates another limitation that the high costs attached to transactions and make the bitcoin a very poor competitor with regard to other means of payments. This could change with the emergence of the Lightning Network.

What is the Lightning Network?

The Lightning Network is a protocol which goal is to enable the bitcoin to extend its network by accelerating the speed of the transactions. This Protocol now applies to the whole of the blockchains and allows millions of transactions per second with extremely low fees.

The technology used by the lighting network is the so-called “channels of payments”. “Micropayments Channels” is a technology that allows you to gather several small transactions in the same transaction in order to limit the costs and not have to wait for the confirmation of each transaction.

Each party must therefore first create together a channel by issuing a transaction that they must all sign using their private key (i.e a multisig transaction). The transaction will not be broadcasted on the network and will have the vocation to block a certain sum of money.

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The Lightning Network proposes a bidirectional channel, which means that both parties can make payments through the same channel. The two parties may, therefore, block a sum of money in the multisig transaction and perform transactions through this channel.

The Lightning Network also organizes the networking of these different channels in order to make payments by interposed persons. To do this, the software will perform a series of steps that will allow Alice to transfer funds to Carol by the intermediary of Bob.

How does the lightning network actually work?

Let’s imagine that Carol wishes to transfer a bitcoin to Alice, but has no direct channel with her. The payment will, therefore, go through an intermediary, “Bob” who has an open channel with both Carol and Alice.

Lightning Network
Source: BitcoinMagazine

The steps of a transaction conducted through the lightning network are the following:

1- Alice requests Carol to create a value (for example a mixture of digit and letter), and to transfer the hash as well as her bitcoin address.

2- Alice transmits the hash to Bob and tells him that she would send him a bitcoin if he shows the value that he has received from Carol proving that it has transmitted a bitcoin to Carol.

3- Bob receives the value (which checks the hash) from Carol and transmits her a bitcoin in return.

4- Bob passes the value that he has received from Carol to Alice thus proving that it has transferred the bitcoin to Carol. Alice can, therefore, send him to turn a bitcoin safely.

As we see Alice uses the channel that Bob has put in place with Carol to transfer a bitcoin. Obviously, this scenario works with several intermediaries.

But as you may be wondering, what would happen if Alice changed her mind and decided to no longer transfer the bitcoin once she has received the value from Bob and that the latter has forwarded the bitcoin to Carol (step 4 above)?

Hash Time-Locked contract

To solve this issue, the lightning network uses a process called “Hash Time-Locked Contract” which includes both a timer (” Time-Locked”) and a secret (” hash”). If we take the example above of a transfer of bitcoin from Alice to Carol, the establishment of a Hash Time-Locked Contract is done according to the following steps:

Proof of Work

1- Alice sends the bitcoin that she wants to transfer to Carol, toward a third-party address, which requires the signature of both parties to be unlocked (multisig address).

2- Bob can recover funds by sending them to an address he controls at any time by adding his signature and the value that has been transmitted by Alice.

3- Alice can also send the funds to an address that she controls but only after a certain period (” Time-Lock”).

This mechanism is then used at network level. Alice and Bob have also put in place a hash Time-Locked Contract. In our example below, Bob receives the value of Alice before transferring the bitcoin. The two channels are linked so if Alice does not want to transfer the bitcoin, Bob will be able to insert the value that it has received from Carol in the Hash Time-Locked contract in place with Alice and thus be certain to recover it.

The Lightning Network, therefore, represents an important step for the development of the network bitcoin and can be a solution for networks of communication between machines that are presently developing.

The implementation of the lightning network could have the effect opposed to that discount

The Lightning Network seems to have been chosen as the solution to the problems of the bitcoin since it proposes a very promising architecture.

As we just described it allows the creation of channels in which users can perform as many transactions as they wish without having to add them to the blockchain each time but at the same time, benefiting from the security of a decentralized network. In other words, the operations are confirmed instantly and the costs are distributed between all the transactions carried out in the channel when it is closed and the last transaction (which is the result of the netting for what the parties owe each other) is added to the blockchain.

Lightning network
Lightning network

The only problem lies in the fact that the channels are only defined between two persons. In order to reach a person with whom you do not share a channel, you will need to use intermediate nodes or “hubs” (Bob in our example). However, these nodes could be considered by the regulatory agencies as “money transmitters” and as such be subject to requirements such as the minimum capitalization, KYC checks (…) which cannot be filled by anyone.

“FinCEN’s regulations define the term “money transmitter” as a person that provides money transmission services, or any other person engaged in the transfer of funds. The term “money transmission services” means “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”

If this was the case, each node serving as an intermediary should be able to carry out checks on the origin of the funds, which implies the establishment of important system and could therefore not be carried out by financial institutions.

This is where banks and large companies such as the credit card companies could enter the game and begin to manage the bitcoin network, but only the future will confirm this scenario.

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Passionate since 2014 by the technologies linked to the blockchain, I created this blog to share the last innovations, the start-ups and the cryptocurrencies that we believe will significantly improve this developing industry.