Key Points

  • The Lightning Network is a payment layer built on top of Bitcoin. It moves bitcoin between people without recording every payment on the main chain.
  • It works through payment channels: two parties lock bitcoin on-chain once, then pay each other off-chain as often as they like until they close the channel.
  • Payments can hop across several channels to reach someone you have no direct channel with, which is what turns individual channels into a network.
  • Lightning suits small, frequent payments. It is a poor fit for storing large amounts, because channels need liquidity, care and, for some wallets, a device that comes online regularly.
  • Many Lightning wallets are custodial, meaning a company holds the bitcoin for you. Self-custodial options exist, but they ask more of the user.

Quick Answer

The Lightning Network is a second layer for Bitcoin that makes payments fast and cheap by keeping most of them off the main chain. Two people lock bitcoin in a shared channel with one on-chain transaction, then update the balance between them privately for each payment. Only the opening and the final balance are recorded on Bitcoin. Read it as a tool for spending and sending, not for saving. The common misread is that Lightning is a separate coin. It is not: every payment is in bitcoin, settled against the Bitcoin blockchain.

What is the Lightning Network?

The Lightning Network is a network of payment channels that sits on top of Bitcoin. It lets people send bitcoin in seconds for fees that are usually a tiny fraction of an on-chain fee.

Bitcoin's base layer produces a block roughly every ten minutes, and each block has limited space. When demand is high, on-chain fees rise and buying a coffee with bitcoin stops making sense. Lightning, which went live on Bitcoin's main network in 2018, takes the everyday payments off the base layer and uses Bitcoin only to open and close channels and to settle disputes. It is the best-known example of a Bitcoin Layer 2, which our guide to Layer 1 and Layer 2 blockchains explains in more depth.

How does a Lightning payment channel work?

A channel is a shared pot of bitcoin between two parties. It opens with one on-chain transaction and closes with another, and everything in between happens off-chain.

  1. Opening. One or both parties send bitcoin into a 2-of-2 multisignature address on the Bitcoin blockchain. Neither can move those funds without the other's signature.
  2. Paying. Each payment is a new, signed agreement about how the pot is split. If Alice pays Bob 10,000 satoshis, they both sign an updated balance that gives Bob 10,000 more. Nothing is broadcast to Bitcoin.
  3. Closing. When they are done, they broadcast the latest balance to Bitcoin and each receives their share.

A satoshi is the smallest unit of bitcoin: one bitcoin is 100,000,000 satoshis. Lightning amounts are usually shown in satoshis, often shortened to sats.

What stops someone cheating in a channel?

Each time the balance changes, the old balance is effectively cancelled with a penalty attached. If one party tries to close the channel using an older, more favourable balance, the other party has a window of time to prove it and claim the entire channel as a penalty.

That protection relies on someone watching. A self-custodial wallet either needs to come online within that window, or it can hand the job to a watchtower, a service that monitors the blockchain for cheating attempts on your behalf.

How do payments reach people you have no channel with?

Payments route through other people's channels. If you have a channel with Carol and Carol has one with Dave, you can pay Dave through Carol without trusting her with the money.

This works through a lock called a hashed timelock contract. Dave creates a secret and gives you its fingerprint in an invoice. Every hop along the route agrees to pass the payment on only if the next hop reveals the secret, and only within a time limit. Either the whole payment completes or none of it does, so an intermediary cannot take the money halfway. Routing nodes charge a small fee for passing payments along, made up of a fixed part and a percentage of the amount.

What is inbound liquidity, and why does it matter?

You can only receive as much as the other side of your channels is holding for you. That is your inbound liquidity.

If you open a channel by putting in 100,000 sats, all of the balance starts on your side, so you can send but not receive. To receive, you need channels where the bitcoin sits on the other side. Many self-custodial wallets solve this by working with a Lightning service provider that opens channels to you on demand, usually for a fee. Custodial wallets hide the problem entirely, because the company manages the channels for you.

Custodial or self-custodial: which kind of Lightning wallet?

A custodial Lightning wallet is an account with a company that holds the bitcoin. It is simple to use, but you are trusting that company, and it can freeze or lose your funds. A self-custodial wallet gives you the keys and the channels, which means more control and more responsibility.

For small spending amounts, many people accept a custodial wallet for convenience. For anything you would be upset to lose, the usual approach is to keep it on the base layer in self-custody and move only what you plan to spend onto Lightning. Our guide to self-custody covers the trade-offs, and the crypto wallets hub has setup guides.

What are the limits of the Lightning Network?

  • Size of payments. Large payments can fail if no route has enough liquidity. Lightning works best for small and medium amounts.
  • On-chain costs to open and close. Opening and closing channels are normal Bitcoin transactions, so they cost an on-chain fee and take on-chain time.
  • Staying online. Self-custodial users, or a watchtower acting for them, need to stay alert to old balances being broadcast.
  • Privacy is better, not perfect. Individual payments are not on the public blockchain, but channel openings and closings are, and routing nodes see some information.
  • Invoices expire. A standard Lightning invoice is single-use and time-limited. Reusable formats such as Lightning addresses and BOLT 12 offers are making repeat payments easier, but support varies between wallets.

How do you send or receive a Lightning payment?

To receive, your wallet creates an invoice, shown as a code or a QR image, for a set amount. The sender scans or pastes it and approves the payment, and it usually settles within seconds. Some wallets also give you a Lightning address that looks like an email address, which people can pay without asking for a fresh invoice each time.

Several large exchanges now let you withdraw or deposit bitcoin over Lightning as well as on-chain. If yours does, it can be a cheaper way to move small amounts, but check the network you have selected before you confirm a withdrawal.

Frequently Asked Questions

Is Lightning a different cryptocurrency?

No. Lightning moves bitcoin. There is no separate Lightning coin, and every channel is backed by bitcoin locked on the Bitcoin blockchain.

Are Lightning payments really instant?

Most settle within a few seconds once a route is found. A payment can fail if no route has enough liquidity, in which case the wallet usually tries another route or the funds stay with you.

How much does a Lightning payment cost?

Routing fees on small payments are usually a few satoshis, set by the nodes along the route. Opening or closing a channel costs a normal on-chain fee, which depends on how busy Bitcoin is at the time.

Can I lose money on Lightning?

Yes. A custodial provider can fail, a self-custodial wallet can lose its backup, and a channel closed incorrectly can be costly. Keep only what you plan to spend on Lightning and keep your backups safe.

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Further Reading

Sources

  • Lightning Network specifications (BOLTs), including BOLT 11 invoices and BOLT 12 offers: github.com/lightning/bolts
  • Public Lightning network statistics, including channel and capacity data: mempool.space/lightning

This article is for education only and is not financial, investment or legal advice. Crypto assets are volatile and you can lose some or all of the money you put in. Lightning wallets, channels and service providers carry technical and counterparty risks, including software faults, lost backups and provider failure. Do your own research and consider independent advice before making any financial decision.