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In the beginning, Bitcoin was meant to be something other than scalable. It’s a decentralized payment system people can access from anywhere while staying anonymous. However, its popularity made transactions much slower and more expensive than expected. The primary blockchain is the first layer of cryptocurrency, and then there are secondary layers, tertiary layers, etc.
A second layer for Bitcoin, the Bitcoin Lightning Network increases blockchain transaction efficiency through micropayment channels as each layer is added.
It is possible to make payments between parties or Bitcoin users through several channels in this layer. A Lightning Network channel transfers money between two parties, and parties can send and receive money through channels. Lightning Network transactions are faster, cheaper, and easier to confirm than Bitcoin blockchain transactions.
Furthermore, Lightning Network transactions can involve exchanges between cryptocurrencies off-chain.
Lightning Network was first proposed by Joseph Poon and Thaddeus Dryja in 2016 and has been under development ever since. The Lightning Network tried to solve a slow transaction time and throughput problem.
What are the issues it tries to address?
A critical challenge that Bitcoin currently faces is the volume of daily transactions that it must deal with. Lightning Network attempts to address these challenges by addressing the following:
- Transaction confirmation speed
As more users transact, mining has become more expensive and time-consuming, as well as more difficult. The confirmation process needs to be improved as transaction numbers increase.
- Reduce your energy usage
It is prohibitively expensive to maintain the Bitcoin blockchain because of the energy required to compute this information.
- Multi-signature scripts and smart contracts
Multi-signature and smart contracts are the backbones of the Lightning Network, which ensures funds reach their recipients.
Lightning Network facilitates multiple transactions by utilizing channels between participants rather than depending on the slower main net for confirmations. Whenever a channel opens, parties can transfer money between themselves as needed.
The channel’s closing sends all transactions to the main net for confirmation.
- Lightning Network concerns
The Lightning Network replicates the hub-and-spoke model of today’s financial system as a decentralized network. At the moment, banks and financial institutions are the primary intermediaries.
As Lightning Network nodes become more open to one another, businesses may become hubs or centralized nodes. The market is volatile, fraud is rampant, fees are high, and hackers are everywhere.
- A closed channel fraud scheme
The Lightning Network could crash if the channel is closed. When Sam and Judy transact, what happens if one has malicious intent? A dishonest party could steal coins from the other party through a fraudulent channel close.
Let’s say Sam and Judy each put up .5 Bitcoins to open a channel, and Sam bought goods from Judy for 1 Bitcoin. If Judy logs off (closes the channel) after transferring the goods, but Sam doesn’t, Sam could broadcast the initial state back (before the 1 BTC was transferred), so they both get their original deposits back. Thus, Sam would’ve gotten 1 BTC worth of goods for free, and his deposit would’ve been refunded.
The Lightning Network requires third parties to run on nodes to prevent fraud. This is called a watchtower. Using a watchtower, you can prevent fraudulent channel closings.
- Fees
Lightning Network transactions are subject to fees. They are a combination of routing fees for routing payment information between Lightning nodes, channel opening and closing fees, and Bitcoin’s usual transaction fees.
Businesses may start charging fees once they adopt the Lightning Network as a payment and settlement layer. Furthermore, many watchtowers charge fees for their services since they are third parties.
When two parties settle a bill between themselves, they need to record the final amount on the blockchain, including the fee for forwarding the transaction. There is either a base fee (a set fee) or a fee rate (a percentage of the transaction).
- Hacks
Moreover, it is believed that hackers can access the Lightning Network’s wallets, payment channels, and APIs.
- Malicious Attacks
Malicious attacks can also congest the network. When there is a malicious hack or attack, the payment channels are clogged, which makes it difficult for the victim to reclaim their money.
Also, you can congest a channel by using a denial-of-service attack.
A congested network can be used to steal funds from parties unable to withdraw their funds due to the network freeze.
