Previously, we discussed the Bitcoin Layer 2 ecosystem. Most Layer 2 solutions primarily rely on transferring liquidity from other networks to the Ethereum ecosystem to participate in various DeFi activities. However, these so-called “withdrawal bridges” typically use a multi-signature mechanism, which introduces a certain trust factor when handling assets. Users cannot ensure that they can withdraw their assets unconditionally at any time. This makes many Bitcoin holders lack the motivation and feel uneasy about transferring BTC assets into the potentially risky Ethereum environment, as the security of assets is the premise that guarantees all returns.
In this context, the Lightning Network stands out as an important Bitcoin Layer 2 solution. The Lightning Network aims to enhance Bitcoin’s scalability and transaction speed. Unlike “bridges” that rely on multi-signature mechanisms, the Lightning Network creates off-chain payment channels, allowing users to conduct fast and low-cost transactions without transferring liquidity to other networks. For many Bitcoin holders, the Lightning Network provides a secure and efficient way to conduct everyday micropayments without the risk of transferring BTC assets to other blockchain networks. The emergence of the Lightning Network has injected new vitality into the Bitcoin ecosystem and provided more possibilities for DeFi and other application scenarios.
What is the Lightning Network
Concept
The Lightning Network can be viewed as a prototype of the currently popular Rollup technology. Its core idea is to move the transaction execution layer off-chain to improve execution efficiency; the final state is then written back to the blockchain during final settlement. By allowing users to conduct transactions off-chain without requiring block confirmation on the blockchain, the Lightning Network significantly enhances the transaction speed and efficiency of the Bitcoin network. This mechanism helps reduce transaction fees and improves the overall scalability of the network.
As a Layer 2 protocol, the Lightning Network enables users to create payment channels on the Bitcoin network. It operates on top of the Bitcoin blockchain by using multi-signature wallets to create off-chain payment channels. Since Bitcoin lacks a smart contract system like Ethereum’s, the Lightning Network leverages Bitcoin’s limited scripting capabilities to construct a series of 1-on-1 “state channels” and connects these state channels into a payment network, achieving a unique form of fast payment similar to “Rollup.” The design goal of the Lightning Network is to address the scalability issues of the Bitcoin network while maintaining decentralization and security.
Development Path
The concept of the Lightning Network was first proposed by Joseph Poon and Thaddeus Dryja in 2015. They described this innovative solution in a white paper to address the scalability issues of the Bitcoin network. In 2015, Joseph Poon and Thaddeus Dryja released the Lightning Network white paper, outlining the vision of improving Bitcoin transaction efficiency through off-chain payment channels. Between 2016 and 2017, early implementations of the Lightning Network protocol began to appear, with multiple development teams and companies such as Lightning Labs, ACINQ, and Blockstream getting involved in development. In 2018, the mainnet version of the Lightning Network was officially launched, and early users started to test and use this technology.
From 2019 to 2020, the Lightning Network gradually matured, with the number of nodes and channels increasing rapidly, and the network capacity continuously growing. More and more wallets and services began to support Lightning Network payments. After 2021, the Lightning Network entered a rapid development phase, with an increasing number of merchants and applications integrating Lightning payments, and the ecosystem continuously expanding.
It can be said that the Lightning Network is to Bitcoin what Visa is to currency. In 2022, there were also several significant funding rounds in the Lightning Network space, with top institutions such as a16z and Paradigm participating in related project investments. For instance, in April 2022, Bitcoin-focused company Lightning Labs completed a $70 million Series B funding round led by Valor Equity Partners. In May of the same year, Bitcoin Lightning Network company Lightspark, founded by Meta’s former cryptocurrency head David Marcus, completed a funding round led by a16z and Paradigm. In September 2022, the crypto payment application Strike, built on the Bitcoin Lightning Network, announced the completion of an $80 million Series B funding round.
Advantages and Problems Solved
The Lightning Network, with its unique off-chain transaction mechanism, offers a series of significant advantages and addresses some key issues within the Bitcoin network.
- More Convenient for Microtransactions: The Lightning Network allows users to make payments using the smallest unit of Bitcoin, the “satoshi,” catering to everyday small-scale expenditures. In traditional Bitcoin transactions, microtransactions are often impractical due to high transaction fees, but the Lightning Network greatly reduces the cost of these transactions, making microtransactions more convenient.
- Lower Transaction Costs: In the traditional Bitcoin network, the transaction fee is approximately $2, and during the market peak in 2021, it exceeded $60. However, through the Lightning Network, the fee for a $100 transaction is only around 1 cent. This is extremely cost-effective for daily microtransactions, significantly lowering the transaction costs for users.
Bitcoin transaction fees, data source: https://bitinfocharts.com/comparison/bitcoin-transactionfees.html
Faster Transaction Processing: The current Bitcoin network can handle a maximum of 7 transactions per second. Network congestion often leads to transaction confirmation delays, affecting the user payment experience. The Lightning Network, in theory, can handle millions of transactions per second, greatly enhancing processing speed. This ensures users can complete payments instantly, optimizing the overall payment experience.
How It Works
The Lightning Network enables fast and low-cost Bitcoin transfers through off-chain payment channels. Here is a brief overview of its operation:
- Creating a Payment Channel: Two parties (e.g., Alice and Bob) create a multisignature address on the Bitcoin blockchain and deposit a certain amount of Bitcoin. This step requires an on-chain transaction and the payment of corresponding transaction fees.
- Conducting Off-Chain Transactions: Once the channel is established, both parties can perform multiple off-chain transactions within the channel. These transactions are not immediately recorded on the blockchain but update each other’s balance. After each transaction, both parties sign a new transaction state.
- Settling the Channel: Either party can close the channel at any time by broadcasting the latest signed transaction state to the blockchain to settle the final balance. The blockchain will only record one transaction, reflecting the final result of all off-chain transactions within the channel.
- Routing Payments: If there is no direct channel, payments can be relayed through intermediate nodes. The nodes in the network automatically find the optimal path for the payment.
Suppose Alice wants to pay 1 BTC to Bob:
- Channel Creation: Alice and Bob create a payment channel on the blockchain, each depositing 1 BTC.
- Off-Chain Transaction: Alice pays 1 BTC to Bob within the channel, updating the balance to Alice 0 BTC and Bob 2 BTC.
- Channel Settlement: Alice and Bob decide to close the channel and broadcast the latest balance state to the blockchain.
Technical Features
The core concepts of the Lightning Network are primarily twofold: RSMC (Recoverable Sequence Maturity Contract) and HTLC (Hashed Timelock Contract). The former addresses the confirmation of off-chain transactions, while the latter addresses payment channels.
RSMC (Recoverable Sequence Maturity Contract)
RSMC, or “Recoverable Sequence Maturity Contract,” is akin to a funds pool mechanism that ensures a large number of intermediate transactions can be completed off-chain, involving the blockchain only at the final withdrawal. The main principles are as follows:
- Creating a Payment Channel: Two parties (e.g., Alice and Bob) create a “micropayment channel” on-chain, pre-funding a certain amount. Initially, the funds are allocated according to the pre-funded amount.
- Off-Chain Transaction Confirmation: After each off-chain transaction, both parties jointly confirm and sign the transaction result, invalidating the old version of the allocation scheme. When either party needs to withdraw, they can submit the latest transaction result signed by both parties to the blockchain for confirmation.
- Anti-Cheating Mechanism: Any version of the allocation scheme requires both parties’ signatures to be valid. If one party submits an old transaction result when withdrawing, the other party can provide proof within a certain time frame, showing that the old scheme is invalid, and the funds of the old scheme will be forfeited to the challenging party.
- Encouraging Off-Chain Transactions: Even if both parties agree to withdraw, the funds of the party who first initiates the withdrawal will arrive later than the other party, encouraging more off-chain transactions.
HTLC (Hashed Timelock Contract)
Micropayment channels are implemented through Hashed Timelock Contracts (HTLCs). Simply put, the transferring party freezes a sum of money and provides a hash value. If another party can provide a string that matches this hash value within a certain time, the money is transferred. The HTLC mechanism can also be extended to scenarios involving multiple intermediaries, creating virtual payment channels between any two parties. For example, if Party A wants to transfer money to Party C, Party C provides a hash value to Party A. Party A signs a contract with Party B stating that if Party B can provide a matching hash value within the stipulated time, Party A will pay Party B. Party B then signs a contract with Party C, and Party C provides the hash value to Party B. Party B receives the funds from Party A. Ultimately, Party A effectively transfers money to Party C through Party B.
Current State of the Lightning Network
The technology behind the Lightning Network is gradually maturing, with payment and social media giants promoting its adoption. As of May 18, 2024, the Lightning Network has approximately 13,000 nodes, over 50,000 payment channels, and about 4,856 BTC in channel capacity.
Data Source: https://1ml.com/statistics
The primary metric for measuring the growth of the Lightning Network is “public node capacity,” essentially how much BTC is locked in public channels. We can see that the public channel capacity, when settled in USD, is gradually increasing. As adoption rises, the ecosystem infrastructure around the Lightning Network continues to develop.
Bitcoin Lightning Network Capacity, data source: https://bitcoinvisuals.com/ln-capacity
Ecosystem Projects
Like any emerging technology, the Lightning Network, as the primary transaction scaling solution for Bitcoin, has seen continuous development. More projects are entering the ecosystem and building solutions on top of it. However, the entire ecosystem is still in its early stages.
Reference: Arcane Research
UXUY
On December 5, 2023, UXUY, a next-generation multi-chain trading platform incubated by Binance Labs, officially announced support for the Lightning Network and Lightning Address, becoming the world’s first DEX to support the Lightning Network. This milestone marks the achievement of the first phase of UXUY’s Bitcoin Layer2 plan, “Struck by Lightning.” Before integrating Bitcoin and the Lightning Network, UXUY had already connected to over ten public chains and Layer2 solutions, including Ethereum, BNB Chain, Polygon, Tron, Optimism, and Arbitrum. UXUY is leveraging the convenience of the Lightning Network to reconnect the entire crypto market.
In March 2024, UXUY launched the UXUY Marketplace, a decentralized marketplace that is friendly to stablecoins, offering advantages such as decentralization and low gas fees. Anyone can use sats from the Lightning Network and stablecoins to trade tokens and inscriptions, among other Bitcoin assets.
Strike
Strike is a payment platform based on the Bitcoin Lightning Network that offers instant Bitcoin payment services. Users can use Bitcoin via Strike for various transactions, such as online shopping, micropayments, tipping content creators, and buying and selling Bitcoin. The platform’s predecessor is the Bitcoin ecosystem wallet Zap. In September 2022, Strike completed an $80 million Series B funding round led by Ten31. Additionally, Strike has partnered with companies like Shopify and NCR to establish systems that allow merchants to accept cryptocurrency payments and quickly convert them into fiat currencies like USD.
Since El Salvador adopted Bitcoin alongside the USD as legal tender, Strike has become one of the most popular applications on the Lightning Network. Although this is currently the primary use case, from the perspective of the Bitcoin network and ecosystem, Strike’s limitation lies in its inability to bring more assets (such as USDT issued on the Omni layer based on Bitcoin) into the Lightning Network. Therefore, it has not unlocked more potential development opportunities for the Bitcoin ecosystem.
Taro
Taro is a new protocol based on Bitcoin’s Taproot technology, designed to define standards for issuing and using tokens on the Bitcoin blockchain. It is primarily used for issuing assets on the Bitcoin blockchain, such as fungible tokens and NFTs. The protocol is developed by Lightning Labs, a company focused on Bitcoin Lightning Network technology, providing software support like Lightning Network node management tools and wallets. Lightning Labs has also developed a test version of the software, LND, which allows users to send Bitcoin and Litecoin directly without requiring blockchain confirmations.
Taro relies on Bitcoin’s latest Taproot upgrade, embedding arbitrary asset metadata by constructing new tree structures, thereby leveraging the security and stability of the Bitcoin network, along with the speed, scalability, and low fees of the Lightning Network. This allows Taro to be used in conjunction with multi-hop transactions on the Lightning Network, offering instantaneous, high-capacity, and low-fee transaction solutions. In April 2022, Lightning Labs secured $70 million in funding.
Lightspark
Lightspark is a Lightning Network payment solution provider founded by former PayPal president David Marcus. The company primarily offers solutions for enterprise users to use Lightning payments, such as providing relevant APIs and SDK toolkits to support enterprise integration of the Lightning Network. In May 2022, Lightspark completed a funding round led by a16z and Paradigm. On April 30, 2024, cryptocurrency exchange Coinbase partnered with Lightning Network infrastructure company Lightspark to launch support for the Lightning Network starting today. This partnership provides Coinbase users with a faster and cheaper way to send, receive, or pay with Bitcoin directly from their accounts.
Summary
We believe that in the future bull market, especially with the arrival of a Bitcoin ecosystem bull market, the increase in fees on the Bitcoin Mainnet may lead to a surge in Lightning Network activity. Users may begin to adopt this cheaper transaction method. Additionally, the continuous optimization of asset issuance methods on Bitcoin, such as Runes and BRC-20, and the release of Taproot Assets on the Lightning Network, will further promote the future of the Bitcoin Lightning Network.