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What the Lightning Network is, and Why You Should Care


This month, Pick n Pay - which is one of the largest grocery chains in sub-Saharan Africa, announced that it will accept Bitcoin payments in 39 store locations and that the project would be rolled out to all stores. This would mean approximately 2,000 storefront locations and around a 16 percent market share of the South African grocery market.


This is a really big deal. There are two big criticism of Bitcoin - the first is its volatility and the second is its transacting speed which is standing in the way of its adoption as a commercial payment mechanism. The Lighting Network has stepped up to solve that second challenge and allows users to send or receive Bitcoin quickly and cheaply by moving transactions off the main blockchain. It is almost like an HOV (high occupancy lane on a highway where specific vehicles can avoid the congestion of peak traffic. Technically this is known as layer 2 blockchain while the core is layer 1. Pick 'n Pay will be making use of the Lightning Network to enable its customers to pay using Bitcoin.


So how does the Lightning Network work? Let's jump into a simple example. Bob goes to the same coffee shop on the corner of his street every morning and wants to pay in Bitcoin. The problem is that if he uses the Bitcoin core, it could take up to an hour for the transaction to be validated. Bob would also need to pay Bitcoins high network fees even though he is making a tiny transaction. Visa and Mastercard are "perfect" payment solutions because they have the infrastructure to process more than 24,000 TPS (transactions per second). In contrast, Bitcoin on a regular day can validate seven TPS.


With the Lightning Network, Bob can open up a payment channel with the coffee shop. Each coffee purchase is recorded within that channel, and the shop still gets paid. The transaction is cheap and possibly even free, as well as instant. Then, when the Bitcoin that started the channel is spent, Bob can close that channel or refill it. When it is closed, all of its transactions will be recorded to the main Bitcoin network.


Pros Of Lightning Network

The advantages of the Lightning Network are self-evident and, once applied to Bitcoin, could prove game-changing for the cryptocurrency.


1. Speed (Transactions per Second)

In theory, the Lightning Network would drastically increase the total transactional bandwidth available to the Bitcoin ecosystem, with faster transaction speeds being a byproduct. By sidestepping the Bitcoin blockchain altogether via off-chain transactions, individuals can transfer bitcoin between each other with near-instant transaction times.


2. Privacy

While still not nearly as private and anonymous as Monero, the Lightning Network is more private than using the Bitcoin mainnet (especially as a sender of BTC). That's because transactions are only transcribed onto the blockchain after the payment channels close.


While governments eager to constrain cryptocurrency often say criminals use it for anonymity, the Bitcoin blockchain is quite the opposite. As a public ledger, anyone can see any transaction they like and which wallets were involved in said transaction.


Lightning Network is more private than just going directly to the Bitcoin blockchain, as individual off-chain transactions aren't recorded onto the mainnet. They simply get condensed into a larger transaction void of any private details.


3. Transaction Costs

Another benefit to the Lightning Network is lower transaction fees. In the normal Bitcoin blockchain, transactions with higher fees are prioritised by miners, meaning that during periods of congestion, you'll have to pay more in order to get your transactions processed in a reasonable time. With Lightning, you could simply open up a channel between another party and send bitcoin however you wish.


Cons Of Lightning Network

While the Lightning Network is a powerful solution to Bitcoin's main problems, it's not perfect either.


1. Erosion Of Incentives

While the Lightning Network can lower fees, that might not necessarily be good for the blockchain. As a decentralised network, Bitcoin functions not because of a central entity but because numerous people voluntarily chose to participate as miners and validators in exchange for mining rewards.


If the Lightning Network lowers fees, that also discourages people from verifying transactions as their incentive rewards will decrease. Additionally, nodes on the lightning network might not receive enough payments or fees even to encourage people to become nodes in the first place. The counter-argument is that the total volume of transactions should drastically increase, as day-to-day Bitcoin purchases weren't a realistic possibility prior to the Lightning Network. So in principle, larger volumes and liquidity should even out lower fees per transaction, but that has yet to be seen.


2. Transaction Risks And Security

In the lightning network, two parties in a payment channel can take advantage of one another. This usually involves one party closing the channel and pocketing funds without providing said service, or resetting the channel to when it was first opened. This then allows the person who bought goods or services to get away without having paid anything, an issue referred to as a Fraudulent channel close. The good news is that there's a period in which someone can contest a channel's closure. However, this period will expire if one party is gone for a prolonged period.


3. Reliance On Bitcoin

The Lightning Network is largely tied in with the future of Bitcoin. If another cryptocurrency takes its place, the lightning network will lose most of its utility until other tokens are linked up to it.


The Lightning Network also assumes Bitcoin will have a lot more demand from people interested in using it as a means of daily exchange. However, that's far from certain. Bitcoin has established itself as a kind of digital gold, but its price volatility may discourage people from using it frequently. Its volatility also makes it difficult for companies to use Bitcoin as a payment method when pricing their goods or services.


Summary

The Lightning Network has the potential to be the next big revolution for Bitcoin, and its dramatic growth in 2022 is a testament to that.


Users with access to Lightning payments grew from 100,000 in the summer of 2021 to more than 80 million in March 2022. Additionally, Lightning Labs plans to expand Lightning's potential by allowing users to trade other types of tokens. In particular, one protocol would allow users to trade stablecoins on Bitcoin and Lightning instead of just BTC. In this way, the Lightning Network will be able to address not only the transaction speed weakness of crypto, but also the volatility issue given that stablecoins are pegged to a fiat currency - most often the US dollar.



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