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bitcoin lightning network

The Bitcoin Lightning Network is a proposed upgrade to the Bitcoin exponential difficulty issue (which prevents it from being able to process transactions quickly).

The system was proposed in the beginning of 2017, with several companies contributing energy & efforts to developing the underlying technology. The system was originally proposed by Joseph Poon and Thaddeus Dryja in a whitepaper published in January 2017.

The system itself works through the Segregated Witness (SegWit) soft-fork of Bitcoin – designed to provide the system with less restrictive mining abilities (speeding up transaction processing times and generally ensuring the Bitcoin network is much more robust than most others).

The part where the “lightning network” comes in is to help create smart contracts on the Bitcoin network itself – whereby each time someone creates a transaction, the transaction itself is able to be processed immediately – with the resulting mining operation happening in the background.

This allows the Bitcoin system to retain its original standard of operation but with the added benefit of being able to process transactions much faster.

Whilst the system has been hailed as a major step forward in the Bitcoin community, the important consideration to make is that this is simply an incremental improvement on the underlying Bitcoin system, not a revolutionary/overhaul featureset.

Thus, this is not a recommendation or endorsement of any crypto investments…

What is it?

In order to appreciate why the lightning network is needed, you have to dig into how the Bitcoin system works in itself…

bitcoin activityContrary to popular belief, Bitcoin is NOT a currency in itself; it’s a payment network and works very similarly to Visa or Mastercard (transfers one set of fiat currency to another party).

The BIG mistake people have made with Bitcoin lies in the way they’ve perceived the product to actually be a competitor to the USD (it isn’t). This is partly why its token price has shot through the roof, when its value is negligible.

Just like how Visa or Mastercard don’t pretend their cards are currency, Bitcoin should not really have called its decryption tokens “coins”. This misrepresentation is why most people do not have a clue as to the true workings of the system…

payment cycleI’ll explain this process in a second. First, the importance of the Lightning network…

Bitcoin doesn’t have a central clearing house. This means it has to rely on a network of computers (servers) to process its transactions. They do this through a process called mining – whereby various computing systems running BTC’s server software will hash the various transactions created by the Bitcoin wallets. The hashing process is designed to compile new blocks (updates) for the Bitcoin central ledger.

Bitcoin is – at its core – is a “public decentralized financial ledger” – which means that it basically allows you to note down “who owns what”, and change those numbers as required (through transactions).

The point is that whilst this works great, one of the main issues with BTC is the mining network takes up to 10 minutes to process a transaction, with only 7 transactions processed each second. If you compare this to Visa or Mastercard (who regularly process 1,700 transactions per second), you can begin to see one of the major flaws in the BTC infrastructure.

This deficiency has been compounded by two other problems – the exponential difficulty issue, and the way in which the Bitcoin community has no central leadership:

  • Exponential Difficulty

One of the main issues with BTC has been the difficulty problem – the idea that each block in its blockchain database gets more & more difficult to calculate.

As mentioned, we’ll explain this more in a second – for now, it just needs to be stated that Bitcoin has limited the supply of its coins to 21 million. This means that each time a new block is created on its blockchain, the reward for that process is diminished in both quantity and value… making it very difficult for under-powered computered to manage it.

This has locked many miners out of the market, as well as increased transaction costs massively for end-users.

  • No Central Leadership

Hailed as one of the most important aspects to the “decentralized” nature of the Bitcoin system, not having any sort of central management body means that if anything goes wrong, or needs to be upgraded, the system will not be able to cope.

Ultimately, this means something very important – the community is responsible for what happens with the system, with different parties working on different upgrades that can be adopted by the mining network. Segwit was one of these, as is the Lightning Network itself.

If you’re looking at the Bitcoin system from a technical perspective, something becomes clear – as the system has gained adoption, its underlying problems have grown, rather than dissipated.

This has lead many people to either develop new currencies (Litecoin for example), or to propose upgrades to Bitcoin’s. This upgrade process is where the Lightning upgrade comes in.

Powered by Blockchain

In order to fully understand the lightning network upgrade, you need to appreciate the Blockchain technology which powers Bitcoin in the first place…

blockchain technologyBlockchain was created in 2008 to provide a decentralized database to users who wanted to create truly decentralized applications. One such application was proposed by someone (or some people) known as Satoshi Nakamoto who published the now-famous Bitcoin whitepaper in 2009.

Bitcoin wasn’t really seen as such a big deal until people began using it to send money to each other (typically illicitly), after which the viral effect took over, and more & more people started to use it.

The point of Bitcoin is that after the Nixon administration removed the US from the Bretton-Woods System of 1944, the USD and other Western currencies have basically become like Monopoly money (almost worthless). This is how most governments were able to bailout the banks in 2008 (by printing more) and how the majority of banking today works.

Ultimately, what it meant was that rather than having money tied to a central store of value (either Gold or some other commodity), Nixon’s government essentially pulled the rug from under it – allowing fiat currency to essentially be printed.

The problem with this is that it not only leads to rampant inflation (as we’ve experienced in the West), but also causes many people to chase money itself. Whilst this is nothing new, with a value-based system – the money would be tied to assets, and as such people would realize that the value of money lies in the value of an asset. Due to the release of this paradigm – and instead putting the focus on the transaction – the value of money shifted to how many transactions you could produce with it.

Thus, the consumerist culture that grew in the 1980’s and 1990’s is a direct result of what was undertaken by the Nixon government.

Bitcoin is an attempt to solve this problem (although its effectiveness is questionable).

Because Bitcoin is a system operated in a decentralized way – no single party has control over it. The system is what’s known as a “public, decentralized financial ledger” – which means that it’s essentially just a list of who owns how much of the money supply in its network…

public decentralized financial ledgerThink of it like a Visa credit-card with all of the transaction history for that card stored on it. The way that transaction history is unlocked is with something called a “decryption token”. This decryption token is known as a Bitcoin / coin.

The most important thing to know about blockchain is that it works as a decentralized network, which basically takes transactions from the various Bitcoin wallets (client-side applications) and then adds them to the central BTC ledger.

The reason people have valued this so much is because it basically undercuts the banks – whos central ledger systems are bulky and expensive. Bitcoin does exactly the same job (just shifting numbers from one person to the next) without the need for a central system to handle it all.

Why is it needed?

The Lightning Network is a proposed upgrade to this process.

It works by removing the majority of small transactions from the Bitcoin central ledger, instead replacing them with smart contracts…

how lightning network worksThe smart contracts are multi-signature addresses which basically allow two parties to deposit BTC into. These BTC represent a payment channel for each of the parties, whereby if one of the parties makes a payment, the money is deducted from the payment channel, rather than the main ledger itself.

Think of them as “mini” accounts within the Bitcoin blockchain ledger… instead of recording single transactions, these transactions are replaced by the multi-signature address, which is updated as it processes the various updates.

The reason why this is important is because it should not only improve the speed at which these “micro” transactions take place, but also removes a HUGE number of transactions from the Bitcoin network as a whole (speeding up the mining process for the more substantive ones).

What’s especially important is that since this is a proposed update to the underlying Bitcoin network itself, the plethora of coins built on top of it (Litecoin, Dash etc) will actually benefit from the upgrade too. This is what has a lot of people excited about it – but will it help improve Bitcoin’s economic prospectus?

Revolutionary?

Ultimately, the question of whether the Lightning network is going to be worthwhile comes from whether it will have a positive economic impact on the Bitcoin network.

Bitcoin is unique in the technology world because it has not been owned-or-controlled by any central party before. Whilst you could argue its viral nature is very similar to how the web grew, the big deal with the web was how it was controlled by a central committee who continually proposed updates through various standards etc.

With any technology offering, the core value of a company is derived from how much adoption it has achieved. This adoption comes from not only how many people are using the system, but how many are emotionally invested into it too.

The real secret with the technology space comes from the companies who create the next paradigm. Microsoft did it in the 90’s, Google did it in the 00’s, Apple did it in the 2010’s. Amazon kind-of did it as did Facebook… and now Bitcoin has (in its own way) done it.
Bitcoin is the market-maker. No doubt about it.

The reason why this is important is because it doesn’t really matter how much technological development is pushed through its network, the idea of Bitcoin is still prevalent in the hearts/minds of its users. This emotional commitment is what makes it valuable, and is why it’s still #1 – lightning network or not.

The lightning network, as with the raft of other upgrades to the Bitcoin infrastructure over the years, is simply an incremental development on an already-successful system. Whilst it may help nudge adoption higher, it likely won’t have the “revolutionary” impact many people seem to think it will…

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