This will give you a basic understanding of the lightning network, how it works, and where exactly it fits in the Bitcoin ecosystem
The lightning network is very new and some interesting use cases have come to the surface. It is definitely not for everyone and you need some technical expertise to get under the hood. Simply using it however is now quite simple.
This is short multiple choice quiz to cement the concepts we covered.
So let us say we have two people, John and Mary. They are perhaps relatives, colleagues, friends, neighbour. Now let us imagine they have to regularly send very small amounts of money. They will now set up a channel on the Lightning Network
Firstly, they need to create a multi-signature wallet, which is a wallet that they can both access with their respective private keys. Then, they both deposit a certain amount of Bitcoin (ie. 0.5BTC each) – into that wallet.
Going forward, they can now do unlimited transactions between the two of them. At the core, the funds do not actually move. You simply redistribute values to different columns in the same wallet balance sheet. For instance, if John wants to send 0.1 BTC to Mary, he will need to transfer the right of ownership of the amount to her. The two of them use their private keys to sign for an update to the shared balance sheet.
You only distribute the funds when you close a channel. The algorithm uses the most recently signed balance sheet to determine who gets what. If Mary and John were to decide to close the channel after that one transaction, John will get 0.6 BTC and Mary will receive 0.4 BTC.
When you close a channel, you broadcast the information about the start and finish balance to the Bitcoin blockchain. The Lightning Network enables users to conduct numerous transactions outside of the main blockchain but rather record them as a single entry.
The initial idea of channels between parties does sound like you will not be able to scale it. This is exactly what makes the future of the lightning network exciting. You will not always (or ever) need to create your own channel. The system will automatically find the shortest route for a payment from a pool of connected parties.
This is how the Lightning Network might eventually provide a solution to making micropayments online and offline. We can sum this up as:
“the ability to make instant secure micropayments online and offline, without any fees.”
It is important to note that the fundamental mechanics of the Lightning Network means that the system will work on top of a blockchain. This means it will not actually have the level of security of the blockchain on top of which it operates. As a result, it is more likely that it will be used for small or even microtransactions such as paywalls. Higher value transfers which require decentralized security will most likely still be done on the core layer.