What is the Lightning Network?

The Lightning Network is a payment system built on top of bitcoin. It lets people send bitcoin almost instantly and for very low fees by keeping most payments off the main blockchain. Only the opening and closing balances are recorded there.

Why was it created?

Bitcoin's blockchain adds a block about every 10 minutes, and each block has limited space. The network can handle only a handful of transactions per second, and fees rise when demand is high.

The Lightning Network was proposed in a 2015 paper by Joseph Poon and Thaddeus Dryja as a way around the bottleneck, and it began carrying real payments in 2018. It is the best-known example of a layer 2, a system that runs on top of a blockchain and relies on it for final settlement.

How does a payment channel work?

1. Open. Two parties lock some bitcoin into a shared address with a normal blockchain transaction. This creates a payment channel between them.
2. Pay. They pay each other, as many times as they like, by exchanging signed updates of who owns how much of the locked funds. The updates stay between the two of them, so they are near instant.
3. Close. When either party wants out, the final balance is recorded on the blockchain and each receives their share.

Users do not need a direct channel with everyone they pay. A payment can hop across a chain of connected channels to reach its recipient, and cryptographic contracts stop the intermediaries along the route from keeping the money.

If one party tries to cheat by publishing an old balance, the other has a set period to prove it and can claim all the funds in the channel as a penalty.

What are the trade-offs?

• Liquidity limits. A channel can move only as much bitcoin as was locked into it. Large payments can fail to find a route.
• Staying online. Receiving a payment generally requires the recipient's software to be connected, and users must watch for cheating attempts or pay a service to do it.
• Hot wallets. Funds in channels are controlled by keys on internet-connected devices, which are more exposed to theft than cold storage.
• Custodial shortcuts. Managing channels is technical, so many people use apps in which a company runs the channels and holds the coins. That brings back the trusted middleman bitcoin was designed to remove, as explained in custodial vs non-custodial wallets.

Who uses it?

Lightning is supported by a range of wallets, payment processors and some large exchanges. It is used for small purchases, tips, cross-border transfers and payments priced in satoshis, the smallest unit of bitcoin.

Critics note that adoption has been slower than early supporters predicted, and that routing tends to concentrate around a small number of large, well-funded operators. Supporters respond that the network is still being developed.