What is Lightning Network and how it scales Bitcoin — a tech guide from Ruslan Tymofieiev

• Recently, Ukrainian startup Stroom Network closed a Seed round and raised $3.5 million to develop and launch the “liquid steaking” of Bitcoin on the Lightning Network.
• This startup was one of the first investments by Boosty Venture Studio, part of the venture builder CLUST.

The founder of venture builder CLUST Ruslan Tymofieiev told us about the Lightning Network protocol and transactions in more detail, and explained why Boosty Venture Studio decided to invest in this technology.

The Lightning Network technology for Bitcoin

Ruslan Tymofieiev is convinced that Bitcoin’s main problems are limited bandwidth, slow transaction speeds, and the rising cost of fees. The Lightning Network is designed to solve these problems.

The problems with speed are related to the specifics of the blockchain. According to the blockchain’s design, only a certain number of transactions can be included in a single block. A transaction is connected to a queue if it does not fall within the current block. This queue can take a few minutes to hours, days, or more to process – depending on how many other transactions are in the line.

Another limitation is cost. The number of transactions requiring verification is also tiny when the system is small. In this case, the network works well, and the cost of transactions is low. However, the transaction cost increases as the web grows because the space in each newly mined block is limited. As a result, only the transactions with the highest fees are processed during periods of high load.

So, there was a need for new technologies that could solve Bitcoin’s scaling problems, and the Lightning Network was born.

What is the Lightning Network

“The Lightning Network is a compromise solution that preserves the decentralization and high level of security of the leading Bitcoin network while improving its performance. It is a layer two network that allows instant and cost-effective micropayments, bypassing the need to include each transaction in the main blockchain.” comments Ruslan Tymofieiev.

The basic idea behind the Lightning Network is to create “channels” between users where transactions can take place off-chain or outside of the blockchain. These channels provide incredible speed and scalability because they can process many transactions before they are included in the blockchain.

How does it work?

How to use Lightning Network? Two users create a channel – a multi-signature transaction on the leading Bitcoin network. This transaction “freezes” a certain amount of Bitcoin in an account available to both participants. After that, maximum payments are limited to the frozen amount. In this way, you are opening up payment channels between people or organizations that want to transact with each other, and in fact, you are simply moving the payment balloons from one side to the other. What’s more, you can do this in real-time. These interactive payments are outstanding for certain types of transactions, such as buying a coffee in a store or making a payment on an e-commerce website, where a one-time expired payment request is created for the sole purpose of that payment, meaning it doesn’t cover all use cases, especially not in asynchronous and on-demand scenarios.

When participants decide to close the channel, they sign and broadcast the current state of their balances to the leading Bitcoin network. These actions allow for a fair distribution of frozen funds among participants.

Advantages and disadvantages of Lightning Network

The development of this technology has greatly simplified the transfer of payments in Bitcoin. Among the obvious advantages Ruslan Tymofieiev highlights:

• Speed → transactions on the Lightning Network are almost instantaneous – from milliseconds to a few seconds, depending on the payment path and liquidity. Processing time in the blockchain can take hours in some cases.
• Minimal fees → transaction costs in Lightning Network are significantly lower than blockchain – from 0.003%
• Scalability → by not having to include every transaction in the blockchain, Lightning Network can handle a large number of transactions (40 million TPS).
• Privacy → transactions in Lightning Network occur outside the main blockchain, increasing user privacy. Everything is visible on the blockchain, so it is pseudo-anonymous. Various companies like Chainalysis have built billion-dollar businesses on blockchain forensics, while in Lightning Network, it is impossible; the privacy is much higher.

Despite all the advantages, the Lightning Network has disadvantages, among which are:

• Liquidity along the payment path → low liquidity and suboptimal distribution, especially regarding large transactions. That is, a payment can go through several channels, and if, for example, there is not enough liquidity between any two tracks, the cost will not go through.
• Unstable or low success rate → as a derivative of the liquidity along the path. I should note here that a 98-99% success rate is already considered low, i.e., we are not talking about the conventional 50%. Why does the success rate depend on liquidity? Because at some point on the payment path, a channel may appear that does not let it through. But this happens in 1% of cases.
• Tendency to centralization in routing hubs → centralization problems arise not only because there are several large hubs created by certain organizations, leading to dominance in the network. Theoretically, these hubs could censor transactions under regulatory pressure, creating additional risks, but their likelihood is small.

But even these disadvantages seem insignificant against the backdrop of the advantages, especially since statistics show that only 1% of transactions through the Lightning Network fail.

The current state of the Lightning Network

1. Regular increase in the number of payments per month

The popularity of Lightning Network is growing. For example, Wallet of Satoshi processed 664,000 Lightning payments in July alone, more than double the 266,000 in July 2022.

Or the statistics of deposits/withdrawals through the Lightning Network: from January through August 2023, payments worth 912 BTC ($23.5 million) were processed.

All this gives grounds for quite optimistic forecasts.

2. Developed ecosystem

Lightning Network technology is widely used in different business segments. Separately, exchanges actively implement Lightning Network; among the most famous are Bitfinex, Binance, Kraken, Okex, etc.

This screenshot shows how the Lightning Network ecosystem looks like:

3. Stablecoins

Also worth mentioning are stablecoins, that is, varieties of digital currency tied to another asset, such as the dollar or gold. According to CoinMasterCap, the market capitalization of stablecoins as of September 2023 is about $125 billion, with a total market capitalization of $1.04 trillion. Dollar-based stablecoins are considered one of the main use cases of cryptos; in fact, an alternative banking system already exists based on them.

The RGB and Taproot Assets protocols will very soon allow the issuance of Lightning-compatible stablecoins. These changes will open up opportunities to migrate a part of USDT settlements from Tron to Lightning Network – we are talking about billions of dollars per day.

Conclusions

To summarize, Lightning Network is an innovative approach to solving the scalability problem in Bitcoin. Its speed, cost efficiency, and ability to work through many transactions make it attractive to those who use this cryptocurrency for financial transactions.

Lightning Network has a global goal to revolutionize payments, and the battle for the stablecoin market is part of that strategy. You can already test how the network works if you have Breeze Wallets, Wallet of Satoshi, etc. If you don’t want to download wallets, you can use the network through Binance and see the benefits.