- Lightning is a protocol that enables cheap and fast native bitcoin transactions.
- At the core of the protocol is the ability for bitcoin users to create a payment channel with another user.
- These payment channels enable users to make many bitcoin transactions between each other with only two on-chain bitcoin transactions: the channel open transaction and the channel close transaction.
- Essentially lightning is a protocol for interoperable batched bitcoin transactions.
- It is expected that on chain bitcoin transaction fees will increase with adoption and the ability to easily batch transactions will save users significant money.
- As these lightning transactions are processed, liquidity flows from one side of a channel to the other side, on chain transactions are signed by both parties but not broadcasted to update this balance.
- Lightning is designed to be trust minimized, either party in a payment channel can close the channel at any time and their bitcoin will be settled on chain without trusting the other party.
There is no 'Lightning Network'
- Many people refer to the aggregate of all lightning channels as 'The Lightning Network' but this is a false premise.
- There are many lightning channels between many different users and funds can flow across interconnected channels as long as there is a route through peers.
- If a lightning transaction requires multiple hops it will flow through multiple interconnected channels, adjusting the balance of all channels along the route, and paying lightning transaction fees that are set by each node on the route.
Example: You have a channel with Bob. Bob has a channel with Charlie. You can pay Charlie through your channel with Bob and Bob's channel with User C.
- As a result, it is not guaranteed that every lightning user can pay every other lightning user, they must have a route of interconnected channels between sender and receiver.
Lightning in Practice
- Lightning has already found product market fit and usage as an interconnected payment protocol between large professional custodians.
- They are able to easily manage channels and liquidity between each other without trust using this interoperable protocol.
- Lightning payments between large custodians are fast and easy. End users do not have to run their own node or manage their channels and liquidity. These payments rarely fail due to professional management of custodial nodes.
- The tradeoff is one inherent to custodians and other trusted third parties. Custodial wallets can steal funds and compromise user privacy.
- Trusted third parties are security holes.
- Users must run their own node and manage their own channels in order to use lightning without trusting a third party. This remains the single largest friction point for sovereign lightning usage: the mental burden of actively running a lightning node and associated liquidity management.
- Bitcoin development prioritizes node accessibility so cost to self host your own node is low but if a node is run at home or office, Tor or a VPN is recommended to mask your IP address: otherwise it is visible to the entire network and represents a privacy risk.
- This privacy risk is heightened due to the potential for certain governments to go after sovereign lightning users and compel them to shutdown their nodes. If their IP Address is exposed they are easier to target.
- Fortunately the tools to run and manage nodes continue to get easier but it is important to understand that this will always be a friction point when compared to custodial services.
The Potential Fracture of Lightning
- Any lightning user can choose which users are allowed to open channels with them.
- One potential is that professional custodians only peer with other professional custodians.
- We already see nodes like those run by CashApp only have channels open with other regulated counterparties. This could be due to performance goals, liability reduction, or regulatory pressure.
- Fortunately some of their peers are connected to non-regulated parties so payments to and from sovereign lightning users are still successfully processed by CashApp but this may not always be the case going forward.
- Many people refer to the aggregate of all lightning channels as 'The Lightning Network' but this is a false premise. There is no singular 'Lightning Network' but rather many payment channels between distinct peers, some connected with each other and some not.
- Lightning as an interoperable payment protocol between professional custodians seems to have found solid product market fit. Expect significant volume, adoption, and usage going forward.
- Lightning as a robust sovereign payment protocol has yet to be battle tested. Heavy reliance on Tor, which has had massive reliability issues, the friction of active liquidity management, interactivity constraints on mobile, and lack of strong privacy guarantees put it at risk.
If you have never used lightning before, use this guide to get started on your phone.
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