ANZ Finance blog | The Bitcoin Lightning Network

The Bitcoin Lightning Network

Published 21 October 2022

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

The Bitcoin Lightning Network -- McGraw Hill Ideas In Finance

"The Bitcoin blockchain has a scalability problem."

The Bitcoin blockchain has a scalability problem. Bitcoin transactions are not finalised until they are added to the blockchain. In the meantime, transactions are pooled. Users can attach a fee to their transaction to encourage “miners” to add their transaction to the next blockchain (i.e., bump them up the waiting list). A new block is added every 10 minutes. A block is 1 megabyte in size, containing around 2,000 transactions. Not bad, but it would be nice to be able to scale it up. Since the block size will not change, what can be done to scale up the Bitcoin network?

One solution is the Lightning Network. You can think of the Bitcoin network as a base layer. On top of this can be built additional layers. The Lightning Network is a so-called Layer 2 protocol. The general idea is to create a separate section on the blockchain for a particular transaction set. Participants in that set can transact with each other without the need to update the whole Bitcoin blockchain for each transaction. Once the participants are finished distributing funds amongst themselves, the blockchain is updated and the separate section is closed. Theoretically, the time between opening and closing can be lengthy. During this time, bitcoin or sats* can flow among participants without the need for the transactions to added to the Bitcoin blockchain. This is especially useful for smaller valued transactions. And the transactions will process very quickly (like lightning). Participants don’t have to wait 10 minutes for the next block to be added to the blockchain, or longer if their transaction is not added to the next block.

"Bitcoin network can handle about 2,000 transactions every 10 minutes, which is only 3 or 4 per second. Visa’s network can handle more than 65,000 transactions per second. There’s a long way to go, but you get the idea."

Like all things Bitcoin related, the Lightning protocol is open source and is being worked on by various groups. Anyone with the skills is usually welcome to contribute. The primary creator of the protocol is Lightning Labs. The CEO and co-founder of Lightning Labs is Elizabeth Stark. The company’s aspiration is to become the Visa or Mastercard network of bitcoin. We mentioned above that the Bitcoin network can handle about 2,000 transactions every 10 minutes, which is only 3 or 4 per second. Visa’s network can handle more than 65,000 transactions per second. There’s a long way to go, but you get the idea.

Many companies are already using the Lightning Network. For example, in the U.S., Block Inc. (which was founded in 2009 by Twitter co-founder Jack Dorsey along with Jim McKelvey) offers an app called Cash App (formerly Square Cash), which uses the Lightning Network to allow customers to send and receive payments denominated in bitcoin.

Bitcoin and the Bitcoin Lightning Network are not just about payments. We can glimpse the future when we look at the types of things being worked on by companies like Microstrategy, which counts Visa among its many corporate clients.

In September 2022, MicroStrategy announced that it is recruiting team members for a Bitcoin Lightning Network project. The project will involve the development of a “software-as-a-service” (SaaS) platform based on the Lightning Network. The job listing says: As a Bitcoin Lightning Software Engineer at MicroStrategy, you will build a Lightning Network-based SaaS platform, providing enterprises with innovative solutions to cybersecurity challenges and enabling new eCommerce use-cases. The interesting thing here is the reference to cybersecurity. It should be possible, using the Lightning Network, to set up paywalls on websites where users deposit a small number of sats to enter and receive them back when they exit. It would be seamless, and the user wouldn’t notice. This is impossible using credit cards because of the transaction fees but, if it can be developed, “lightning paywalls” could be an important tool in the battle against bots and denial-of-service attacks. Simply, it could make such cyberattacks too expensive to orchestrate.

"Moving beyond “payments” is something that stretches the imagination. However, even the core ideas that revolve around payments are significant..."

For a person living and working in an advanced economy, these ideas might be interesting, but their importance is difficult to grasp. In fact, we are only just beginning to see what can be done with the Bitcoin network among others. Moving beyond “payments” is something that stretches the imagination. However, even the core ideas that revolve around payments are significant if you live in a dangerous country where it’s not safe to carry your money with you (or even keep it in your house) or if you live in a warzone and need to flee and you can’t get to a bank to withdraw your savings or if you live in one of the many countries where inflation erodes your purchasing power on a weekly basis. In these countries, these ideas solve real-life problems. In fact, part of the stated motivation of these entrepreneurs is to help such people, globally, not just in advanced economies. How it all works out, we shall see.

*Sats is short for satoshis. A satoshi is the smallest bitcoin denomination, equal to one 100-millionth of a bitcoin. At the time of writing, one Australian dollar is equal to about 3,000 satoshi.

Discussion Question

Which companies already use the Bitcoin Lightning Network? What alternatives to the Lightning Network are under development that also aim to resolve the “scalability problem”?