Lightning Network – A new vision

The issues with current blockchain models when applied to large-scale operations where tens of thousands of transactions need to be processed as fast as possible, since the validation method takes some time depending on how many miners there are.

We’ve already discussed how several methods of sharding can work as possible solutions for this problem, but a different approach includes building a new network from the ground up.

This new network would be specifically designed to allow quick, direct transactions to take place without the need of verification by consensus, while also leaving an open channel for intervention where both parties don’t reach an agreement. It’s called “Lightning Network”, and it has been tested since mid-2018 to this day, raising mixed opinions among crypto enthusiasts. But is it really the solution we need to implement crypto payments into our day-to-day life?

Payment Channels

If we look at the big picture about the functionalities of Bitcoin, one can already see a big issue: if transactions take up to 10 minutes to be validated and introduced in a block, how can we be sure that the other party will fulfill the conditions that were stablished for the transaction after the funds are sent?

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A solution comes in the form of payment channels between nodes. These channels act as direct connections for small transactions that require immediate completion and liquidity to support them, something that a regular transaction does not offer. Both users of the transaction must agree on the terms, as the funds will be stored in a conjoint wallet that will progressively assign funds as conditions are fulfilled. Once the final condition is reached, the refund gives each party the correspondent funds, and the transaction is finished.

These channels are unidirectional and still require some waiting for the original deposit into the conjoint wallet and for the final refund to be validated. What the Lightning Network proposes is built on top of the idea of micropayment channels, while solving time-consuming issues.

The proposed network offers off-chain payments directly and indirectly between two parties, by using public nodes that connect to many others in a bidirectional way. The node-keepers are in charge of keeping their channels open by keeping funds assigned to them, which are later moved by users, and gain revenue by transaction fees. With enough nodes, any two users can be connected directly or indirectly in order to perform nearly instant transactions between them, and the way channels are kept open is beneficial for micropayments that require ensured liquidity.

Deterrents vs Supporters

Of course, this kind of solutions raise skepticism, which can both lead to inaccurate points of view towards the technology or productive discussions towards fixing the issues that may arise from it in the near future.

Some of the most discussed topics about Lightning Network are the creation and maintenance of channels (i.e. liquidity, centralization of channels, closure, etc.) and the current lack of an algorithm that can build the shortest network possible among the existing channels, in order to reduce the fees paid by the users.

In terms of channels, some are concerned about how expensive it can be to create and close them, given that these actions require on-chain transactions. The counterargument is that creating a channel can be an integrated option of existing wallets and systems, while they can remain open as long as the node keeps funds in them. Another concern about channels is how big hubs can control a vast majority, as it is the most efficient model, but economic incentives in the form of revenue created by transaction fees encourages more users to become nodes.

Yet, the main issue is clearly unsolved: the difficulty for an algorithm that can automatically find the shortest channel connection between the two involved parties in every transaction. The obvious solution to this is to create big networks that are able to cover most (if not all) the potential users, which eliminates the possibility of not finding a route between two specific users. An incentive for the consolidation of such networks is the revenue that’s generated through the fees that are charged for using a channel.

Both supporters and skeptics have a certain degree of reason, and the success of Lightning Network will depend on how the discussion encourages the further development of solutions to these problems. But there are also issues in terms of security and economical viability that need to be thoroughly evaluated.

Hostile Conditions

Giving a deeper look to Lightning Network, some more relevant problems come to light, as they are related to security issues and the sustainability of the system in the current economic environment.

The main security risk factors include a potential exposure of private keys (given that the user must be online to receive payments, which requires the use of a hot wallet to be linked to the channel), lost of in-channel funds due to lack of monitoring and attacks directed towards censoring closure transactions in which a hostile miner is one of the parties. Even if this last factor is also extremely dangerous without the full implementation of the Lightning Network, the presence of the other two makes the potential users especially cautious about adopting the new model.

Besides that, there is a necessity of making the network economically viable to maintain channels open. Studies have confirmed that if transactions fees are too low, nodes would not receive enough revenue to be motivated to keep their channels open, and if the fee goes too high, users will not use their channel.

In one of these studies, it would seem like the sweet spot is around 0.0005% to 0.0015% to achieve nearly 1% of annual investment return. The issue comes when the economical landscape around the network proves to be more hostile to this annual return rate than expected, as other alternatives with even lower risks may even offer better rates than that (government bonds, for example).

 

Many of those issues, along with the fact that most crypto enthusiasts are oriented towards taking most risks while aiming for high revenue, might make it increasingly difficult for the Lightning Network to fully develop and reach the state it wants to achieve in concept. However, in its early stages, it has shown an incredible growth in number of nodes, despite raising some eyebrows regarding the distribution of the channels.

We will have to closely follow its development until it exits the beta stage into an official launch, and then wait for customers and merchants to implement it into their day-to-day operations.