Can Bitcoin Finally Become Currency? | Understanding the Lightning Network | Scalability Solved?

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3 years ago

Bitcoin has established itself as both an investment vehicle and as a reverse currency. Both individual and, this time, institutional investors have allocated part of their portfolios into bitcoin, yet, it still hasn't established itself as a currency. This is due to the fact, that bitcoin as a currency has two main problems:

  • Volatile transaction fees, making it too expensive for micro-transactions.

  • A scalability problem, i.e. it can handle a limited amount of transactions, and it takes time to process them. For reference, while Visa can scale to handle up to 24k transactions per second (tps), Bitcoin can only handle 7 tps.

The Lightning Network offers a solution to this problem. Instead of users executing on-blockchain transactions, it allows them to execute off-blockchain transactions via private payment channels. The Lightning Network is only a second layer implementation, not a blockchain substitute. It is built on top of the existing blockchain. The white paper for this technology was published in 2015, however it was only possible in 2017, when the Bitcoin community approved the SegWit protocol, enabling those second layer solutions. In fact, the Lightning Network can be used by any cryptocurrency that allows for the following two features:

  • Multi-signature wallets

  • Time locks

The way this technology works is by setting up a payment channel between you and another party. This party can either be a company or an individual. The problem with on-blockchain payments is that, it didn't make sense to pay for a cup of coffee, for example, using bitcoin, because of the transaction costs and the 3 to 6 confirmation needed to consider the transaction fully confirmed, which could take you 30 to 60 minutes. Instead, by opening up a payment channel with the coffee shop, you essentially get the equivalent of a coffee shop card. You top up the card, and instead of paying money from your bank account, i.e. you wallet, every time you visit the store, you pay using the balance you have on the card, i.e. the payment channel. By doing so, you avoid paying transaction fees every time you transact with the store, and you also avoid the 30' wait time for the transaction to confirm.

If you want to make a payment to somebody you don't have a payment channel with, you can do so through a third party you both have payment channels with. And this can be a single individual or company, or a number of intermediary nods, that will allow the transaction to go through them. The incentive, each of those nods have, is that they get paid a small fee for offering themselves as a bridge between you and the final recipient, which is much lower to the mining fee you would pay for that transaction, and much faster. The assurance you have that the transaction will go through, is the fact that, before your funds are sent, every single nod has to agree to (sign the) transaction beforehand. If anyone backs out, the money is returned to your account.

As with any network, the Lightning Network is susceptible to the 'network effect'. Its applicability relies on the degree to which it is adopted. Moon has offered another solution to spending bitcoin. Instead of setting up lightning payment channels with the merchant, this browser extension allows you to pay online using bitcoin to any visa-accepting merchant. To do so, the company sets up a payment channel between your wallet and a prepaid card, and then send a digital invoice to your wallet, using the lightning technology. Keep in mind that this is not a decentralized transaction, as both Moon and Visa are both centralized institutions.

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