A question we often hear from new users is, “Why would I send bitcoin on the Lightning Network instead of directly on the Bitcoin Blockchain?” A question engineers often ask is, “Why would I build an app to use the Lightning Network, a smaller payment rail, instead of an app that works with the Bitcoin Blockchain/existing wallet programs?”
These are valid questions. At their root, they show concerns about the usability, safety and practicality of the Lightning Network compared to the Bitcoin Blockchain. It also betrays a common misunderstanding that the technologies are in competition, when in reality both networks will function most optimally together.
Together, the Lightning Network and the Bitcoin Blockchain can create a better and more complementary payment system than what anyone is using today — with faster transactions, lower fees, and unparalleled technical security.
Below, we’ve explored two complementary areas between the Bitcoin Blockchain and the Lightning Network — transaction speed and transaction fees.
Currently, the Bitcoin network can process seven transactions per second (TPS) (creating a block of data recording those transactions every 10 minutes). However, as the popularity of bitcoin continues to grow, more transactions will need to be processed every second (so bitcoin can approach the capacity of Visa or Mastercard, which process hundreds of thousands of transactions per second).
One of the ways to enable more transactions, without sacrificing security, is the use of payment channels like the Lightning Network.
Using the Lightning Network, people will be able to send bitcoin transactions to each other on a second layer above the Bitcoin Blockchain. The specific details of their transactions will not be recorded individually on the Bitcoin Blockchain. However, key details and cryptographic confirmations of the transaction amounts will be recorded on the Bitcoin Blockchain. This means these users still benefit from the longevity and security of the Bitcoin Blockchain while being able to send and receive payments much faster.
By having two options to send bitcoin payments (on the Bitcoin Blockchain or on the Lightning Network), we expect to see much less payment “congestion” in the network. By lowering payment congestion, we also expect to see lower and more competitive transaction fees.
Another difference between sending a payment on the Bitcoin Blockchain directly and using the Lightning Network will be the transaction fee cost. Right now, users pay a fee (of varying amounts) to send a transaction to the Bitcoin Blockchain. This is not required, but it incentivizes miners to process their transactions faster. As the Lightning Network gained popularity, bitcoin enthusiasts questioned whether they would see the same or lower fees using the Lightning Network — if the fees stayed the same, why use another payment rail?
In response, Lightning Network creators Joseph Poon and Tadge Dryja hypothesized in 2016 that the increasing levels of competition between Lightning Network nodes (the people/entities who would process transactions) would drive down fees on the network to close to zero.
As the network continues to grow, many of these smaller transactions that take place on the blockchain can be offloaded to the Lightning Network, thereby freeing up space and demand on the blockchain. This means that the Lightning Network might be able to handle thousands, if not millions, of transactions before a single transaction has been broadcasted to the Bitcoin Blockchain.
In comparison, in December 2017 the congestion to send a payment on the Bitcoin Blockchain rose so high that bitcoin transaction fees averaged over $40 compared to an average of $0.30 in January 2017 (CoinMetrics). This was due to a lot of speculative interest, but nevertheless the increased demand led to a steep hike in transaction fees.
Notably, though, with speculative interest in bitcoin calming during the first half of 2018, so too have fee levels. Currently, CoinMetrics pegs on-chain transaction fees at $0.78. Additionally, the number of transactions being sent for inclusion onto the Bitcoin Blockchain has also declined. Figures from Blockchain show that in December, requested transactions were close to 5,000 per second. Fast-forward to early August and that number has fallen to under 2,500.
While transaction processing speed and transaction fees on the Bitcoin Blockchain fluctuate, there is no question that a solution is needed to ensure that the network can accommodate more users long-term.
In the short-term, we think traditional on-chain payments will still be desirable — as the Lightning Network is still young and harder to use given the lack of user-friendly wallets and instructions. However, in the long term, we think the transaction throughput on the Lightning Network exceeds that of Visa or any other traditional centralized payment network.
By offloading payments from the Bitcoin Blockchain, the adoption of the Lightning Network will benefit those who want to exchange value on the second layer. Yet, with more services and merchants adopting the network because of the efficiency brought by Lightning, a new category of use cases will be introduced. We believe this will in turn increase demand for bitcoin as new industries and business models come to light.
Further Reading: Contrasting Opinions
There are some who differ from our evaluation of the relationship between the Bitcoin Blockchain and the Lightning Network (as well as our view of the complementary effects of transaction speed and transaction fees). We have listed them below for your review.
1. In the 2018 research paper, How to Charge Lightning, the author states that one of the key unknowns is what economic effect, if any, the Lightning Network will produce on the bitcoin fee market. “As the block reward in bitcoin declines (halving every four years), the reliance on fees increases and these must suffice to pay for enough mining by honest participants,” the report reads. The 28-page study found that, while the Lightning Network does in fact allow a greater number of transactions to pass through the system, that doesn’t necessarily mean higher fees to miners. The report’s authors conclude that this may lead to lower mining participation within the system.
2. In 2016, Dryja said that making a profit from the Lightning Network would be really hard, as it doesn’t have the similar economic benefit of mining the Bitcoin Blockchain and it is difficult to set up Lightning Network nodes.
3. In this post, Justin Goro, editor of the Social Revolution, states that while use of the Lightning Network will reduce blockchain fees substantially as competition on the blockchain declines, they won’t be reduced to zero. Lightning fees consist of opening and closing channels and fees for routing payments.
4. In July, Andreas Brekken undertook an experiment to determine how profitable the network would be to him when payments were routed through his node. After routing 260 payments for other users he earned $0.31. He also suffered from errors and wallet bugs when sending payments through the Lightning Network in a follow up to his experiment. He does, however, extoll the use of the Lightning Network for microtransactions. “The microtransaction use case, which until now has not been fulfilled by a single cryptocurrency, will open up a sea of use cases and revolutionize the way many services are used,” Goro notes. “Bear in mind also that all the LN nodes locking away coins will increase bitcoin scarcity, driving up price. At this point, Bitcoin will be both an electronic cash for P2P payments and an excellent store of value.” Goro goes on to make a point that there have been fears that the Lightning Network “will undermine the security of the network by lowering the fees miners can earn in performing their proof of work security.”
By Lightning Peach