The Lightning Network is one of the most popular solutions to the ongoing problem of Bitcoin’s scalability.
Bitcoin can currently process, on average, seven transactions per second, while the cost of a Bitcoin transaction is roughly one dollar. Visa, on the other hand, averages roughly 1,700 transactions per second (according to their own figures).
When you make a Bitcoin transaction, it needs to be approved by the network before it can be completed. This is done by miners. Bitcoin needs six confirmations before the transaction is considered to be ‘approved’ and is completed.
The average time to mine a block of transactions on the Bitcoin blockchain is ten minutes, therefore a transaction usually takes around an hour on average to complete. However, this is dependant on network activity and can range anywhere from thirty minutes to a few hours. As the cryptocurrency ecosystem grows, the number of Bitcoin transactions increases and causes network congestion which means miners are busier and approvals are slower.
The Lightning Network was first described in a white paper by Joseph Poon and Thaddeus Dryja in 2015 – the current version of the white paper can be found here. It is a second layer application built on top of the Bitcoin blockchain that allows you to exchange your Bitcoin directly with another person, removing the need for confirmations. It enables Bitcoin transactions to be carried out off-chain. This means it doesn’t record every single transaction on the Bitcoin blockchain. By doing this, the transactions are much faster - almost instantly in some cases - and are extremely small.
The Lightning Network is made possible by creating payment channels between two or more users (or to make use of existing ones) through channel networks. Once a payment has been completed through a payment channel, that payment channel is closed and the final balance of how many Bitcoin each person has in their wallet is recorded on the blockchain.
Fees on the lightning network are also almost non-existent, making it very attractive to people looking to avoid high fees for small volume transactions. The small fees are a result of increasing levels of competition between Lightning Network nodes. As the Bitcoin network continues to grow, many of the small volume transactions that take place on the blockchain can be offloaded to the Lightning Network, freeing up space on the Bitcoin blockchain and helping to avoid network congestion. The means that the Lightning Network could potentially handle thousands, if not millions, of transactions before a single transaction has been broadcast and recorded on the Bitcoin blockchain.