What is the Lightning Network and how does it work?

[Transcript of Video]

Today we are going to talk about the Lightning Network.

Now first, let’s remind ourselves that the blockchain of bitcoin is a global peer-to-peer payment network that enables any person on the planet to make a payment to any other person on the planet in a safe, fast and secure way with low fees and without any intermediaries.

Now it turns out that the blockchain of bitcoin actually has a scalability problem meaning that it cannot process many payment transactions in a very short time period and that the scalability problem leads to higher transaction fees and delays in confirmation of the transactions for the end users.

Now one of the potential solutions to the scalability problems is the Lightning Network. Now, the Lightning Network is actually a payment layer protocol that operates on top of the bitcoin blockchain. And the Lightning Network is actually composed of bi-directional payment channels that are created by nodes through smart contracts.

Now actually in practice, the way it works is that a user commits a certain number of bitcoins to the Lightning Network and then he opens a payment channel towards the Lightning Network. That user can then make as many transactions or payments in the Lightning Network as he wants without actually broadcasting those transactions or payments to the blockchain.

And in the end the user can close the bi-directional payment channel and then transmit the final transaction to the blockchain or bitcoin. Now, the Lightning Network is an interesting solution to the scalability problem of the blockchain of bitcoin and was actually created to enable processing many transactions which are done very often.

But we have to wonder is the Lightning Network truly the solution to the scalability problem of the blockchain of bitcoin and can it enable global payment system for millions of users around the world? First, it is important to understand that the Lightning Network actually requires large liquidity hubs that can support many payment channels. And secondly, the support of these payment channels requires a lot of capital.

Now its not hard to predict then that as the Lightning Network grows, the liquidity hubs will not have enough capital. Meaning that they will have to close down many payment channels to support the network. Additionally, opening and closing of payment channels can actually be quite costly and quite slow. And finally, maybe the most important actually is that large liquidity hubs lead to centralization and that increases the risk of the Lightning Network since the failure of certain or more liquidity hubs can lead to the collapse of the lightning network.

So, it seems that the lightning network might actually not solve the scalability problem of the blockchain of bitcoin, but there are other solutions like for instance, wrapped bitcoins. Wrapped bitcoins are super simple. They are tokens on another blockchain that represent bitcoins. So, for instance, wrapped bitcoins on Ethereum is actually a token on the Ethereum network that represents bitcoin. Hence, we can use the speed and low fees of the Ethereum network to solve the problem of scalability of the blockchain of bitcoin.

So that was all for today.

I hope you enjoyed learning about the Lightning Network.

And until next time!