The Lightning Proposal
The Lightning Network, as we now know it, is based on a paper published in early 2015 by Thaddeus Dryja and Joseph Poon: The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments.
The Basic Idea
The Lightning Network starts with nodes. A node is typically a computer, but for now, let's just think of it as a box.
This node can hold bitcoin.
Now, let's add another node.
It also holds Bitcoin.
Now, let's connect these two boxes in a network.
Let's send a payment from Node #1 to Node #2.
Did you see what just happened? The total amount of Bitcoin in the network did not change. We just moved some of the Bitcoin from one box to another.
What if we expanded this network to four nodes?
Let's see what happens when we move a payment from Node #1 to Node #4.
As you can see, the intermediary nodes, #2 and #3, didn't lose or gain any Bitcoin in the process. They just helped move the payment from one node to another.
Also, there are fees
The diagrams above show an oversimplified version of the Lightning Network. The most important thing missing are the fees. When you send a payment through the network, you have to pay a fee to the nodes that help you move the payment.
The intermediary nodes are compensated by these fees, so the flow looks more like this:
This can be a bit hard to grasp at first (It certainly was for me!), so let's go through this step by step.
- Node #1 wants to send 0.2 BTC to Node #4.
- Node #1 sends 0.20002 BTC to Node #2. It is sending an extra 0.00002 BTC to cover the fees.
- Node #2 keeps 0.00001 BTC as a fee.
- Node #2 sends 0.200001 BTC to Node #3. It is forwarding the extra 0.00001 BTC to cover the fees.
- Node #3 keeps 0.00001 as a fee.
- Node #3 sends 0.2 BTC to Node #4.
By the way, the fees are not fixed. We'll get to that later.