How the Bitcoin Lightning Network Could Solve the Blockchain Scalability Problem

With the increasing momentum in blockchain adoption and the growing number of pilots with distributed ledger technology, the problem with its scalability becomes more important than ever before. While some professionals are raising concerns, Joseph Poon and Thaddeus Dryja, the developers behind the Bitcoin Lightning Network, may have a solution to the blockchain scalability problem.

Launched in 2013, the Lightning Network is a ‘decentralized system for instant, high-volume micropayments that remove the risk of delegating custody of funds to trusted third parties.’

Blockchain scalability problem and implications

Let's talk about the scalability problem for a moment, explained in the Lightning Network paper. The fact that each node in the bitcoin network must know about every single transaction that occurs globally may create a significant drag on the ability of the network to encompass all global financial transactions. It would certainly be preferable to perform all transactions with a higher efficiency, but in a way, that wouldn’t require sacrificing the decentralization and security that the network provides.

At the moment, bitcoin supports less than 7 TPC with a 1-megabyte block limit. Achieving the scale of transactions that large financial institutions perform hourly and daily would require hundreds if not more terabytes per block.

If we were looking at a scenario where bitcoin replaces all electronic payments, the result would either be a total collapse of the network or in the ‘best case’ extreme centralization of bitcoin nodes and miners, which itself contradicts the very idea of a distributed ledger.

With extreme centralization comes the issue of security and other problems related to privileged parties that will validate transactions. The Lightning Network suggests that having privileged, trusted parties creates a social trap whereby the central party will not act in the interest of an individual (principal-agent problem), e.g. rentierism by charging higher fees to mitigate the incentive to act dishonestly. The privileged parties in extreme cases will have a full custody of customers’ funds then.

The Lightning Network can solve the problem with the network of micropayment channels

For the bitcoin blockchain network to reach substantially of higher capacity that it has today, transactions need to happen off the bitcoin blockchain itself. The best case would imply bitcoin network supporting a near-unlimited number of transactions per second with extremely low fees for micropayments. Larger payments can be ensured with many micropayments sent sequentially between two parties in that case.

A network of micropayment channels is offered by the Lightning Network developers as a possible solution to unloading the blockchain network and increasing its capacity while possibly eliminating the risks associated with it.

How does the network of micropayment channels work?

The main idea is that if only two participants care about an everyday recurring transaction, it’s not necessary for all other nodes in the network to know about that transaction. By eliminating the necessity of the whole network of each and every node to be informed and validate the transaction, two interested parties keep the whole network from bloating and overload. Moreover, there is no need in a centralized counterparty either, because only two parties actually exchanging funds are involved in the ‘operation.’ The solution can be achieved by using time locks as a component to global consensus.

Simply put, the Lightning Network offers to move transaction between two people from a group chat to direct messages where two parties settle the transaction right away and set the time when the private chat will be recorded in the group chat. Those parties further don’t even need to stay in that chat (the channel where the transaction happens).

As explained in the paper of the Lightning Network, Funds are placed into a two-party, multi-signature "channel" bitcoin address. This channel is represented as an entry in the bitcoin public ledger. In order to spend funds from the channel, both parties must agree on the new balance. The current balance is stored as the most recent transaction signed by both parties, spending from the channel address. To make a payment, both parties sign a new exit transaction spending from the channel address. All old exit transactions are invalidated by doing so.

Almost an infinite number of chats between any two parties can be created then to perform an infinite number of transactions without the centralized authority and the counterparty risk. Micropayment channels would allow the bitcoin blockchain to scale to serve much larger amounts of instant transactions without overloading the network.

Those channels are not bloating the blockchain network because they are not an overlay on the network, transactions are actual bitcoin transaction happening off-chain. The solution doesn’t require two parties to trust each other, instant transaction is happening in a given channel between parties, only electing to defer the broadcast to the blockchain in such a way that both parties can guarantee their current balance on the blockchain.

By embedding the payment conditional upon knowledge of a secure cryptographic hash, payments can be made across a network of channels without the need for any party to have unilateral custodial ownership of funds. The Lightning Network enables what was previously not possible with trusted financial systems vulnerable to monopolies—without the need for custodial trust and ownership, participation on the network can be dynamic and open for all.

Although the Lightning Network developers believe that the solution could possibly solve the blockchain scalability problem, they do recognize there are certain risks. However, the network of micropayment channels has a great potential of bringing the blockchain adoption to a whole new level as it opens up borders for an infinite number of instant transactions with no risk of centralization. The LTP Team will be keeping an eye on the Lightning Network to see the solution applied and evolved.