Why? “The Bitcoin Lightning Network” was first proposed in 2015, aiming to solve the obvious problem that Bitcoin’s network cannot handle meaningful scale
What? Lightning Network is an off-chain decentralized protocol using a network of micropayment channels to reduce the load on Bitcoin’s network
How does it work? There are 2 core components to understand: first, the protocol whereby 2 parties communicate over a channel, and second, routing transactions via multiple channels
A and B want to transact. The channel between A and B is essentially just a 2 of 2 multisig wallet (they both agree to all transactions). They can transact as many times as they want, which updates their respective balances. This is all done off-chain. When the channel is closed, only the final state of their balances is recorded on-chain.
Each transaction requires A and B to both sign commitment transactions that update the balance of the channel, the new balance invalidates the old state
There are a few mechanisms that prevent fraud and here I’ll explain a revocable transaction:
In addition to commitment transactions, there is a revocable transaction that has a balance (let’s say 5BTC) and a timeout (let’s say 1000 confirmations). Essentially if either party tries to send a fraudulent balance to the Bitcoin blockchain, there is a 1000 confirmation time period where the other party can use a revocation key to take the whole balance of the blockchain as punishment. This part is complicated but functionally, it acts as a proof that one party violated the terms of the contract and this is programmatically adjudicated by the blockchain
This is quite complicated but what you need to know is it’s not efficient if every party A and B had their own channel, because the number of channel would grow exponentially
So let’s say A wants to transact with E, and there are existing channels that A could use such that A could send to B, B to C, C to D, and finally D to E
A would use an HTLC (a contract with a hash and timelock component). A essentially says in the contract “I will pay B some amount if you can route me to E within the next 10 blocks”
B and the other middlemen each try to pass the transaction towards E and if successful, take a fee for the routing. If unsuccessful at any point in the routing, the funds stay frozen until the timelock expires at which point funds get returned
This is an oversimplification (a tldr version if you will), but hopefully gives you a sense of one of the most prominent attempts to make Bitcoin’s vision of digital transaction currency truly mainstream-adoptable
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