The Bitcoin Lightning Network: Overview, Challenges and Potential

18 Apr 2022 by ahmaddaudc

The lightning network is an innovation for Bitcoin that uses the former’s second layer technology to make transactions more efficient.

This publication is brought to you by SVET Rating. Join us on telegram: https://t.me/svetrating

With regards to efficiency, the following criteria is targeted for improvement through the lightning network:

Transaction speed
Transaction cost
Confirmation time
The lightning network works to decongest the Bitcoin blockchain itself and move transactions onto the second layer technology; it uses micropayment channels to scale the blockchain. Micropayments are typically a bracket for payments made at a fraction of a dollar, or less. These payments in particular are even more important within the sphere of the internet, and now web 3.0, where particular importance is given to the “distribution of digital rights, royalties, in-game purchases, online tipping, and even to coordinate devices connected via the internet of things” (Frankenfield, 2021).

Another particular use-case implementation is to facilitate other cryptocurrency transactions, off-chain. It can be used for “atomic swaps that enable one cryptocurrency to be exchanged for another without the involvement of an intermediary, such as cryptocurrency exchanges” (Rasure, 2022). The latter in particular draws the appeal of a DeFi community that has long held the opinion that new generation blockchains are necessarily the only way forward in terms of cryptocurrency transaction adoption.

The first formal elaboration of the lightning network was provided in a paper by Poon & Dryja (2015), with an updated publication available here. The network has since been under development, aiming to solve bitcoin’s slow transaction time and throughput; well elaborated in ‘The Blockchain Scalability Problem & the Race for Via-Like Transaction Speed’ (Kenny, 2019). The main argument made by the proponents of the network’s technology is that in order to foster adoption, Bitcoin not only needs to remain competitive in terms of other blockchains, but also needs to compete outwardly, as a blockchain flagship, and par with payment systems such as traditional debit cards, in order to be taken more seriously by the wider public.

Unfortunately, however, at present, “if it is to achieve its potential of becoming a medium for daily transactions, bitcoin will need to reach tens or hundreds of thousands of transactions per second, similar to credit cards or electronic payments networks” (Rasure, 2022). It cannot do this easily, as due to the decentralised technology, consensus is required by all nodes within the network, and this decreases Bitcoin’s speed.

The second layer technology comprises of multiple channels between parties, described as a “transaction mechanism” (Rasure, 2022) in themselves, which are processed differently to the main blockchain; the main blockchain ledger is only updated when “two parties open and close a channel” (Rasure, 2022). The effect is that the parties can then infinitely transfer funds between each other without informing the main blockchain. This drastically increases speed as not all transactions then require approval, and multiple individual channels work to split transactions between themselves adding an aggregated speed effect. It is the interoperability of these payment channels which comprises the network holistically.

This does not mean that the lightning network is fees-free and in fact in a paper published in 2020, it is argued that “participation is economically irrational for the majority of the large routing nodes who currently hold the network together. Either traffic or transaction fees must increase by orders of magnitude to make payment routing economically viable” (Beres, et al., 2020). Essentially the paper questions the ability of the lightning network operators to process transactions, without fees increase.

The fees required is a debatable ground as of right now, but there are alternative challenges that the network must face; some fundamentally key to the notion of cryptocurrency as it exists in the minds of the general public and user. For example, the lure and appeal to decentralised finance come from an element of lack of intermediaries, and a sense of greater financial and transactional control. However, the architecture proposed may seriously threaten the replication of the “hub-and-spoke model that characterizes today’s financial systems” (Rasure, 2022). As Rasure (2022) describes, “by having more open connections with others, lightning nodes for prominent businesses may become similar hubs or centralized nodes in the network. A failure at one such hub could easily crash a significant portion of (or the entire) network” (Rasure, 2022).

The health of the network can further be questioned as it is required to remain online at all times which increase security concerns. As Sharma (2021) argues, “since the parties involved in the transaction must be online and they use their private keys to sign in, it's possible that the coins could be stolen if the computer storing the private keys was compromised” (Sharma, 2021). Similarly instead if the user goes offline, then there is increased risk of fraud: “Going offline creates its own set of problems on the Lightning Network. According to Dryja, it is possible for one of the two parties from a payment channel to close the channel and pocket funds while the other is away. This is known as Fraudulent Channel Close. There is a time period to contest the closing of a channel, but a prolonged absence by one of the parties could result in the expiry of that period” (Sharma, 2021).

Nevertheless, the network is ever-evolving, and new use-cases are being worked on constantly. For example, in 2020, the network increased its limited channel size from a maximum of 0.1677 BTC. Later, in December 2020, the kraken exchange committed to implementing the lightning network by 2021 with only withdrawals at the start but payment channels to later be incorporated too so lightning transactions could be done directly at the exchange. Lastly, ‘Watchtowers’ have been introduced who are “third parties that run on nodes to prevent fraud” (Sharma, 2021). This is represented in Sharma’s (2021) example below:

“Let's say Sam and Judy put up an initial deposit of 10,000 bitcoins and a transaction of 3,000 has taken place in which Sam purchased goods from Judy. If Judy logs off her system, it is open to possible fraud. Sam could broadcast the initial state, meaning they both get their initial deposits back as if no transactions were done. In other words, Sam would have received 3,000 BTC worth of goods for free.”

Ultimately, the fraud risk was at least previously a major challenge to address, but efforts can be seen by development to omit this risk. The other limitations to concern are cost, especially routing fees, even though typical transactional fees associated have been reduced, and finally the socio-economic impact of a hub-and-spoke model; in order to lure in the Bitcoin faithful, the network must address these concerns as it continues to develop in line with the criteria. So far it seems that it has achieved success in transaction speed and confirmation times but needs to address the criteria involving costs, and additional threats introduced into the Bitcoin system.

References

Beres, F., Seres, I. A. & Benczur, A., 2020. A Cryptoeconomic Traffic Analysis of Bitcoin’s Lightning Network. [Online]
Available at: https://arxiv.org/pdf/1911.09432.pdf
[Accessed 17 April 2022].

Frankenfield, J., 2021. Micropayment. [Online]
Available at: https://www.investopedia.com/terms/m/micropayment.asp
[Accessed 17 April 2022].

Kenny, 2019. The Blockchain Scalability Problem & the Race for Visa-Like Transaction Speed. [Online]
Available at: https://towardsdatascience.com/the-blockchain-scalability-problem-the-race-for-visa-like-transaction-speed-5cce48f9d44
[Accessed 17 April 2022].

Rasure, E., 2022. Lightning Network. [Online]
Available at: https://www.investopedia.com/terms/l/lightning-network.asp
[Accessed 17 April 2022].

Sharma, R., 2021. Bitcoin's Lightning Network: 3 Possible Problems. [Online]
Available at: https://www.investopedia.com/tech/bitcoin-lightning-network-problems/
[Accessed 17 April 2022].