what is the Lightning Network and how
does it work for non-technical people let's see if I can answer this question
as well as I can alright so first of all the Lightning network is an overlay
network which means that it's not a blockchain it's not a side chain it's
not a state chain it's not a drive chain it's not any kind of chain
it's a peer-to-peer network that operates alongside or on top of Bitcoin
and uses Bitcoin in order to secure its transactions so it uses the consensus
rules and security from the Bitcoin blockchain in order to do something very
interesting which is provide very fast and very cheap transactions so we're
going to talk about how that works next well first of all important to
understand lightning is used to make Bitcoin payments it can also operate on
other blockchain such as the litecoin blockchain and perhaps in the future
others too for now it's bitcoin and litecoin and
it's important to understand that lightning does not have its own currency
or its own blockchain it is simply a network for exchanging Bitcoin
transactions let's keep that in mind first so let's say myself and my friend
Rene Pickhardt who's in the chat have a lightning connection we want to
establish a connection so we can send payments to each other with a lightning
Network so what we will do is we will set up what's known as a payment channel
now a payment channel isn't a physical thing it's not even a network thing it's
basically a set up of Bitcoin transactions in such a way that we can
exchange value between the two of us and the way it works is by using two key
features of the Bitcoin blockchain the first one is multi signature
transactions Multi signature transactions are transactions where it
takes two people to sign to move money or 3 or 4 or any number of people and
the second feature it uses is time locks which is where you can set
transaction to not be executable until some points in the future these two
features together are basically all you need in order to set up a lightning
payment channel and any blockchain that supports these features such as for
example litecoin can theoretically be incorporated into the Lightning Network
so let's get back to our example Rene and I want to open a payment channel so
the first thing we do is we create a two of two multi signature address a two of
two multi signature address is basically an address where if you put money into
it it can only be spent from that address if both of us sign so in the
background over a network connection Rene and I exchanged some keys so that
we can set up this multi signature address so we effectively exchange
public keys so that we can set up this multi signature address now at that
point one of us will fund this address by putting money into it let's say I put
one tenth of a Bitcoin into this transaction so zero point one Bitcoin
into this transaction into this address so I do a regular transaction on the
Bitcoin blockchain that sends zero point one Bitcoin to this multi signature
address that transaction is called the funding transaction because it funds the
channel between us so again let's take a step back what is a payment channel a
payment channel is basically an arrangement between me and Rene and it's
an arrangement in this case that allows us to spend money if we both sign and
allows us to keep track of a balance that we keep in that virtual payment
channel that allows us essentially to transfer money from one party to the
other for me to rename from Rene to me for example using transactions that are
potentially broadcast on the Bitcoin network so I've put zero point one
Bitcoin into this multi signature address
after six confirmations this will now be valid and fully confirmed on the Bitcoin
blockchain and now we have a funded Channel now what is the balance of this
channel an interesting thing in lightning is a
payment channel has two balances it has what is called a local and what is
called their remote balance and of course it depends on their perspective
my local balance is the money I have in the channel and my remote balance is the
the money that Rene has in the channel and for Rene of course it's the opposite
his local balance is what he has in the channel and his remote balance is my
balance so in every payment channel those two balances think of it as a pile
of money sitting on one side of the channel and a pile of money sitting on
the other side of the channel when we opened this channel between us because I
funded it into the multi signature address with a transaction the money is
all sitting on my end of the channel essentially there's zero on the other
side and there's zero point one Bitcoin on my side and that's our current
balance I own zero point one Bitcoin which is in the channel on my side now
if I wanted to send money over this payment channel to Rene
now the magic of lightning starts because I do not need to do an on chain
Bitcoin transaction in order to exchange value with Rene I can't spend out of
this channel without Rene's agreement Rene can't spend out of this channel
without my agreement and that means we don't have to trust each other
as part of the address there's also a script that allows me to get a refund
for the money I put in after a period of time in case Rene just disappears and
leaves me hanging so there is a mechanism to ensure that the money isn't
just locked in there and unable to be retrieved by anyone all right so now we
can start exchanging transactions what we do is let's say I want to send money
across this payment channel to Rene what I'm going to do is I'm going to
partially sign a commitment transaction that spends from this Multi signature
address and it creates two outputs one output which is let's say 0.01
Bitcoin that is spendable to Rene and one output which is 0.09 Bitcoin which
is spendable to me so I took the 0.1 Bitcoin and I took a tenth of that and
gave it to Rene and 9/10 back to me and if Rene agrees he can counter sign that
broadcast it on the network and as a result get that's Bitcoin but there's no
reason to broadcast that transaction because Rene knows that any point in
time since it's already signed by me Rene who's my counterpart in this
channel can spend it all they have to do is apply a signature broadcast it's on
the Bitcoin blockchain and the Bitcoin blockchain will split the money in the
proportion of the channel balances agreed so at this point the channel has
a balance of 1 100th of a Bitcoin on Rene's side 9 hundredths of a Bitcoin on
my side and so we've split that balance effectively what has happened is I've
moved 0.01 over to Rene's side but nobody knows this the only thing that
happened is we exchanged a signed transaction over this peer-to-peer
network effectively moving balance between us now this is the basic concept
of a payment channel if Rene wanted to move money back to me we could then
create a new transaction that spends the original funding transaction that was
sent to the multi signature address but which has a different distribution of
balances between Renee and me and effectively that transfers balance back
and forth and back and forth and we can do this as many times as we want we can
send these transactions as fast as we want to each other hundreds of times per
second and each one that we send uses a clever trick to invalidate the previous
transaction so that now only the latest one can be spent if we decide to close
this channel and allocate the balance as is that's the basic concept of a payment
channel now imagine that Rene has a payment
channel to Carol and I have a payment channel to Rene and I
to pay Carol well instead of opening a new payment channel directly from me to
Carol what we can do is we can make an agreement whereby Carol shares a hash
with me and I pay to that hash that's done in the form of the Lightning
invoice and the way we do that is that Carol has a secret that is hashed and
Carol will only reveal that secret when Carol is paid so I make a payment over
my channel to Rene for the amounts that Carol is to receive and that payment is
contingent upon the secret from Carol Rene then makes a payment on his
channel to Carol which is also contingent on the same secret Rene can do that
because he knows that if he gets the secret from Carol because she cashed his
payment he can use that same secret to get the payment from me which means that
there's no risk he doesn't have to trust Carol he doesn't have to trust me if
neither of us come through nothing happens and the channels are back where
they used to be that transaction that is routed between us is called a hash time
lock contract or HT LC and you can string as many payment channels as you
want in this way where I make a promise to Rene Rene makes a promise that Carol
Carol makes a promise to Dave Dave makes a promise to Elizabeth Elizabeth makes a
promise to Franck etc etc and once we set up all of the promises then the
secret flows backwards and each of these promises gets fulfilled no one can be
cheated along the way no one ever has custody because every channel requires
two signatures and agreements between both parties no one can ever be cheated
because if anybody drops out halfway through then none of the payment chain
happens and everything revert back people can get refunds after a time out
if the other party disappears etc so this is a trustless system nobody has to
trust anyone it's a noncustodial system because no one has custody of the money
it's in a multi-sig between the two parties for every payment channel and
because we don't have to wait for confirmation
because we only do that when we close channels all of the payments in between
give us the ability to make very very fast payments now if in each one of
these hops the parties who are participating ensure that the payment
they receive is a few satoshis more than the payment they send out to the next
person that difference of a few Satoshi's is effectively a routing fee
that they can collect and they can tell the rest of the network routing fees
they want in order to forward a payment and that way there is a mechanism of
fees as well in the Lightning Network so that's the overview of how the Lightning
Network works and the most important things to remember is that the Lightning
Network transmits partially signed or fully signed Bitcoin transactions that's
a simplification not exactly it's it's easier to just transmit the signatures
but effectively we're operating in the realm of Bitcoin transactions perfectly
valid Bitcoin transactions that can be constructed by each of the pairs these
transactions are based on spending from a two of two Multi signature which means
that neither party can run away with the money which means that there's no trust
involved when you when you string along several payment channels in order to
make a payment no one has to extend any trust people can receive refunds if the
other parties disappear and the payments that we are transmitting are Bitcoin
transactions that are transmitting Satoshi so this is just Bitcoin just on
a faster basis with private peer-to-peer transactions that can operate very
cheaply if you enjoyed this video please
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