Thread by @JohnCantrell97

If you’ve spent any time researching Bitcoin then you’ve probably heard about the Lightning Network but…

Why does it exist?
What is it?
How does it help Bitcoin scale?

I’ve been working with it for years, let me help explain it in simple terms 👇

Bitcoin produces blocks every 10 mins and they can hold a limited number of transactions. This limited space creates a fee market where users can bid for their transactions to be included in a block. This means transactions take at least 10 minutes and must pay fees to miners.

The Lightning Network is a p2p network of payment channels

A payment channel is a contract between two people where they commit funds using a single onchain tx. Once the funds are committed they can make an unlimited amount of instant & free payments over the channel.

You can think of it as a tab where each person tracks how much money they are owed. Each time a payment is made over the channel both parties update their record of how much money each person has. These updates all happen off-chain and only the parties involved know about them

When it’s time to settle up the two parties can take the final balances of the channel and create a channel closing transaction that will be broadcast on chain. This closing transaction sends each party the final amounts they are owed.

This means for the cost of two on-chain transactions (the opening and closing of the channel) two parties can transact an unlimited number of times and the overall cost of each transaction approaches zero with every additional transaction they make over the channel.

Payment channels are a great solution for two parties to transact quickly and cheaply but what if we want to be able to send money to anyone in the world quickly and cheaply? This is where the Lightning Network comes into play, it’s a p2p network of these payment channels.

This means if Alice has a payment channel with Bob and Bob has a channel with Charlie that Alice can send a payment to Charlie with Bob’s help. This idea can be extended such that you can route a payment over an arbitrary number of channels until you can reach the entire world.

Routing a payment over multiple channels uses a specific contract called a Hash Time Locked Contract (HTLC). It introduces the ability for Bob and any other nodes you route through to charge a small fee. These fees are typically orders of magnitude smaller than onchain fees.

This all sounds great but what if someone tries to cheat? I thought the whole point of Bitcoin was that we no longer had to trust anyone and it sure sounds like there must be some trust in our channel partners to use the Lightning Network?

The contracts used in Lightning are built to prevent fraud while requiring no trust. There is a built-in penalty mechanism where if someone tries to cheat and is caught then they lose all of their money. This does mean you need to be monitoring the chain for fraud attempts.

It’s not as complicated as it sounds though. Lightning node software built by @lightning, @blockstream, @acinq_co, and @lightningdevkit will automatically do all of this monitoring for you.

When a fraud attempt is detected the software will automatically construct and broadcast the penalty tx onchain. This transaction sends ALL of the cheaters money to your wallet!

Hope this helps give you a better understanding of how the Lightning Network works and how it provides a new layer for transacting Bitcoin in a much faster and cheaper way. I plan to cover it in more detail over the coming weeks so be sure to follow for more Bitcoin content!