Bitcoin is great for large transactions, but if you are using it to buy a cup of coffee — not so much. Until recently, inefficiencies limited Bitcoin’s potential as a financial solution for everyday purchases.
The Problem With Bitcoin
In order to maintain the security and transparency on the Bitcoin blockchain, the blocks of data that make up the blockchain are quite small. Bitcoin’s blocks are only able to hold one megabyte of data. Some of the newer blockchains, like Solana, use block sizes of 10 megabytes. This lack of size slows transaction speeds and as a result, there can be “traffic jams” on the blockchain.
These traffic jams increase the fees that are necessary to add transactions to a block of data. When traffic is high, it is possible to have fees greater than the value of the transaction itself. It is estimated that the Bitcoin blockchain can handle roughly seven transactions per second (TPS.) In comparison, Visa’s network can process up to 65,000 TPS for fractions of a penny.
Fortunately, developers in the crypto community have been aware of this limitation for quite some time. The most compelling solution would be creating a way for transactions to be processed outside of the blockchain on some sort of second layer or “sidechain.” Once complete; those transactions would then be added to the main Bitcoin blockchain in one lump sum at a minimal cost for users.
In 2018, a company named Lightning Labs confronted this challenge by launching the Lightning Network. They were the first to successfully integrate Bitcoin with what is known as a Layer 2 protocol. This innovation allows payments to be tracked on a second layer and then added to the Bitcoin blockchain at a later date. The most critical feature of this second layer is that it has no capacity limits. With less congestion on the network, payments can be sent for less than half a cent and are near-instantaneous.
The Lightning Network
Similar to how users of Venmo or other digital payment apps give little attention to what goes on behind the scenes and trust the technology to settle payments, it is not necessary for users of the Lightning Network to be aware of what’s under the hood. Digital wallets are the equivalent of apps like Venmo and connect to the Lightning Network to facilitate transactions. The Lightning Network utilizes payment channels that are created between parties to facilitate transactions. One user sends a payment and when the other accepts, a channel is created.
Since the channels exist outside the main Bitcoin blockchain, users can send and receive payments without having to pay a large fee or wait for verification on the Bitcoin blockchain. These channels remain open between users until one decides to withdraw Bitcoin. When the transaction is complete, then the payments are recorded as one transaction on the Bitcoin blockchain.
The Lightning Network is an interconnected system that looks more like an electric grid with thousands of channels connecting thousands of users. Due to this interconnectedness, the network is able to find the path of least resistance to transfer payments between users, regardless of whether they have an existing channel.
A Real-World Example of Lightning in Action
Let’s say you are visiting a friend in Spain. One evening, you and your friend go grab a bite at your friend’s favorite restaurant. This restaurant accepts Bitcoin. When paying your bill, you search for the restaurant in your digital wallet, you send the payment, and everyone is happy. What happens behind the scenes is where the true value of the Lightning Network comes into play. Since your friend has been a loyal Bitcoin paying customer of the restaurant, there is an existing channel between the two of them. Instead of creating a new channel, the Lightning Network will transfer your payment through the existing pathway between your friend and the restaurant because your friend is a regular there. None of the parties involved are aware of this as it happens.
Think of it as being similar to having a mutual friend of someone on Facebook. This way, if a user does not have an open channel with someone on the Lightning Network, there is still a path through mutual users.
As more people use the Lightning Network, more channels are created, which then causes the network to become faster and more expansive. The reach of the network will continue to expand as major competitors begin to realize its value. In 2021, Twitter announced that users can now send each other Bitcoin through user profiles. The country of El Salvador recognized Bitcoin as an official currency and released a digital wallet that uses the Lightning Network. Mobile payment giant CashApp revealed that their users will be able to send Bitcoin through their app as well.
The main way to use the Lightning Network and send Bitcoin back and forth is through a digital wallet. Some of the more well-known wallets include Strike, BlueWallet, Satoshi’s Wallet, and Breez. Simply connect a payment method, like a debit card, purchase some Bitcoin, and you can now send Bitcoin to anyone in the world with an internet connection — lightning fast and dirt cheap.