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The Lightning Network (LN) is a protocol layered on top of Bitcoin that facilitates fast and low-cost transactions. Deep dive in our short guide.
The Lightning Network (LN) is a protocol that can be seen as a layer on top of Bitcoin.
In comparing the Lightning Network to a bar tab system, think of it like this: Initially, when you order your first drink, you establish a payment channel, much like providing your credit card to start a tab. As the night progresses and you order multiple drinks, these orders are logged as transactions within the channel.
Importantly, despite enjoying numerous beverages, no actual funds are exchanged until the tab is settled at the end of the night. On the Lightning Network, this settling process involves two transactions: opening the payment channel (initiating the tab) and closing it (settling the tab).
Let's take an example: Alice posts a transaction to open a channel of 1 million satoshis (1 sat = 0.00 000 001 BTC) with Bob. Alice can thus send up to 1 million sats to Bob without fees and almost instantly.
But why would Alice do this instead of just sending 0.01 BTC on-chain to Bob?
This allows two things:
Regarding fees, if you own your own Lightning node, you will mainly pay the fees required to open and close channels.
If your channels are public, you can charge fees on other users' transactions passing through your channels.
Higher fees allow businesses to manage their liquidity and routing nodes to cover their costs related to electricity, computer hardware, as well as on-chain fees.
These fees are defined by a fixed amount or a variable amount. For example, let's say Bob sets a minimum fee of 50 sats + 0.1% of the variable amount, and he serves as a relay for a transaction of 1 million sats. To calculate the total fee Bob collects, you first calculate the variable fee by taking 0.1% of the transaction amount (1 million sats), which is 0.1/100 * 1,000,000 = 1,000 sats. Then, you add the fixed fee of 50 sats to this variable fee, resulting in a total fee of 1,000 + 50 = 1,050 sats. Thus, for a transaction of 1 million sats, Bob will then collect 1,050 satoshis.
In the previous diagram, if Alice intends to transfer 1 million sats to Candice, her transaction will pass through Bob's node, incurring a fee of 50 sats plus 0.1%, totaling 1050 sats.
However, Candice cannot send satoshis to Alice because she lacks a channel with her, and Bob has no satoshis on his side of the channel with Alice.
According to this second drawing, if Alice wants to send 1 million sats from her Blink wallet to Daniel's Blink wallet, no fee is incurred since it constitutes an "intraledger" transaction between two Blink wallets.
It is important to note that the Lightning Network is vast, with about 15,000 nodes and 59,000 public channels. Although most transactions favor the shortest paths with the lowest fees, some transactions can be more expensive or even fail due to a lack of an adequate path.
As wallets utilize different infrastructures and fee strategies, it's crucial to always verify the fees estimated by your chosen wallet. Blink, Muun Wallet, Phoenix, and Wallet of Satoshi and others apply different fees to their transactions. Therefore, before confirming any transaction, ensure that you won't pay excessive fees.
In case you want to transfer Bitcoin from the main chain to the Lightning Network or vice versa, an on-chain transaction is necessary to close or modify the size of a channel. The cost of this transaction depends on on-chain fees, which can vary significantly depending on blockchain congestion.
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