Many people believe Bitcoin and blockchain adoption represent the future of our financial system. But there’s a major problem standing in the way of that goal: scalability.
The Scalability Problem
To give you an example, the payment provider VISA processes on average about 4,000 transactions per second and can reach a peak of up to 65,000 transactions in a single second. Bitcoin, on the other hand, can only handle up to 7 transactions per second, with a block size of 1MB. Just to make sure you get the scale of the difference — we’re not talking about 7 thousand transactions per second, but just 7!
Clearly, the main blockchain isn’t very scalable.
What Is the Main Blockchain?
When we talk about the main blockchain, we mean the mainnet or layer 1. This is the layer where all confirmed transactions are recorded directly on the blockchain, and where the consensus rules (like block size and the limited number of transactions) apply.
The Solution: the Bitcoin Lightning Network. But what is the Bitcoin Lightning Network?
The Bitcoin community came up with a solution called the Lightning Network to solve the scalability problem. The core idea is that small, everyday transactions don’t need to be stored on the main blockchain. This avoids the 7-transactions-per-second limit and is known as the off-chain approach (outside the network).
How Does the Lightning Network Work?
Let’s take an example: Mihai buys himself a coffee every morning on the way to work. Creating a blockchain transaction just for a coffee would be overkill. He could end up paying more in fees than the coffee itself costs. With the Lightning network, however, Mihai can open a payment channel with the coffee shop.
To do this, both the coffee shop and Mihai deposit a certain amount of Bitcoin into a multi-signature address (requiring multiple signatures). Let’s say Mihai deposits 0.05 BTC, while the coffee shop deposits nothing, since it doesn’t offer refunds. This multi-signature address works like a safe that can only be opened when both parties agree.
When we open the payment channel, we also create a balance sheet that states how the money in the address should be split. For now, it says “Mihai gets 0.05 BTC, and the coffee shop gets 0 BTC”, exactly what each deposited. Opening the payment channel happens on the main blockchain to ensure transparency.
Transactions on the Lightning Network
Now that this channel is open, Mihai can order his morning coffee. Let’s say a coffee costs 0.001 BTC. To pay for it, Mihai updates the balance sheet. He deducts the cost of the coffee from his balance and adds it to the coffee shop’s balance. The sheet now says “Mihai gets 0.049 BTC, and the coffee shop gets 0.001 BTC”.
Mihai and the coffee shop sign the new balance sheet with their private keys, each keeps a copy, but they don’t do anything else with it. Mihai can keep ordering coffee as long as he still has a balance left in the payment channel. They can carry out hundreds of thousands of transactions between them, with no real limit, because it all happens outside the main blockchain.
Blockchain network layers
Closing the Payment Channel
The payment channel can be closed at any time by either Mihai or the coffee shop. All they need to do is take the latest balance sheet, signed by both parties, and broadcast it to the Bitcoin network — that is, submit the transactions carried out on this channel to the main layer, the mainnet. Miners will validate the signatures on the sheet and, if everything checks out, release the funds according to the balance sheet. This creates a single transaction on the Bitcoin blockchain.
Advantages of the Lightning Network
This means the Lightning network can significantly reduce the load on the main blockchain. It only requires two on-chain transactions: one to open the payment channel and another to close it. It’s also very secure. The system ensures that only the most recently signed balance sheet can be used to unlock the funds.
And because both parties hold a signed copy of the balance sheets, they can release the funds at any time, even if the other party stops cooperating. For example, Mihai can’t hold the coffee shop’s money hostage, and vice versa.
The Lightning Network and Payments Through Intermediaries
You don’t need to open a payment channel directly with everyone you want to send Bitcoin to. You can use the network to route your money through intermediaries. For example, Flavia, a friend of Mihai’s, already has an active payment channel with him on the Lightning network. If Flavia wants to buy a coffee, she doesn’t need to open a channel directly with the coffee shop. She can send the money to Mihai, who will forward it on to the coffee shop.
On the Lightning network, your payment tries to find a route from person A to person B, using as few intermediaries and as low fees as possible. That further reduces the load on the main blockchain. However, it does require intermediaries to have enough funds in their payment channels. For example, if Mihai doesn’t have enough funds to forward the payment to the coffee shop, the system will look for another route through other intermediaries. If that’s not available either, a direct channel will be created between Flavia and the coffee shop.
Availability and Adoption of the Lightning Network
The Bitcoin Lightning Network is already deployed and in use. Wallets like Muun Wallet have integrated this technology, letting users make fast, cheap transactions using the Lightning network. Countless transactions have already been carried out successfully through this solution.
If you’d like to set up a Muun Wallet Bitcoin wallet to use the Lightning Network, you can read our dedicated article on the topic.
For more information on how it works, check out Lightning Network
If you’d like to learn more about bitcoin, you can read more on Investopedia or on Wikipedia