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Lightning network explained.

If you are in Bitcoin I'm sure you have heard about the Lightning network by now. But do you really know what it is? The most typical answer I hear is "It allows cheaper transactions and will allow scalability to the Bitcoin network." Yes, this is 100% true - but most people have no idea how it achieves this.

I am going to do my best to explain how it works. We can get into the more technical details in the comments. But before explaining what the Lightning network is - you must first have a clear understanding on what a payment channel is.

What is a Payment Channel?

A Payment Channel is a technique designed to allow users to make multiple Bitcoin transactions without commiting all of the transactions to the blockchain. In a typical payment channel, only two transactions are added to the blockchain but an unlimited number of off-chain payments can be made between the participants. This means that you can have a large amount of transactions and only have to pay a transaction fee once.

You can think of it as running a tab at your local bar. Instead of paying for each drink individually, you setup a tab with the bartender and agree to pay at the end of the night.

What is the Lightning network?

The Lightning Network is a proposed solution to the bitcoin scalability problem. The Lightning network is a routing protocol for payment channel setup between lightning wallets and highly connected nodes. This means that a user doesn't need to setup an individual payment channel with the payee; they just need to setup a payment channel to a node that has a connection to the payee.

Example:

A user wants to buy coffee with bitcoin. Instead of doing a traditional bitcoin payment directly to the coffee shop the user decides to use their lightning wallet. The users lightning wallet is connected to several highly available nodes on the lightning network. The coffee shop also has a connection to the lightning network via a lightning node. This allows the user to pay for the coffee using the lightning network and not have to pay a high transaction fee since the transaction is off-chain.

At the user's discretion they can end the relationship between the lightning wallet and the node. This is effectively closing out and paying the "tab". Once the connection is closed out all microtransactions are payed. E.g. all the users coffee purchases for the month. When the connection is closed out a single entry output to the blockchain.

The Lightning Network is new.. and it's growing fast!

Here's the stats of the available Lightning nodes right now.

Nodes: 271 ( +500% in one week )
Channels: 757 ( +900% in one week )
Capacity $41,980

Historic Growth

Lightning network Map

Here is a visual map of what the lightning network currently looks like.

And for comparison - here is what the biggest mesh network in history looks like. The Internet.

What does this all mean?

As more wallets become Lightning enabled, more transactions can be moved off-chain.
This will help free up the mempool, allowing all Bitcoin transactions to become cheaper (less tx competition).
This will allow the Bitcoin network to grow exponentially.

Want to learn more about the Lightning network?

If you want to learn more about the Lightning network I highly recommend the Bitcoin talk podcast with guest speaker Andreas Antonopoulos. He gives plenty of practical examples of how the Lightning network will be implemented that are very easy to understand.