The Lightning Network (LN) is a possible solution to the (bitcoin) scaling problem. It works by limiting on-chain transactions and settling most transactions off-chain through payment channels. To dive deeper into Lightning, visit the official website.
- The Blockhain will continue to function unaltered (same blocksize, PoW mining, etc.)
- But instead of every transaction being stored, payment channels are used, which can be regarded as direct p2p connections between nodes (users) on the network.
Inside a payment channel, the nodes that established the channel can freely exchange bitcoin as their starting balance permits. These transactions are referred to as off-chain transactions because, unlike regular transactions, they are not immediately recorded onto the blockchain. Only when such a channel is closed, will it lead to an actual final transaction, aggregating all transactions made. Off-chain transactions are secured by the nodes’ shared knowledge of a random number.
All nodes can freely create channels between them. So in the example, A can transact directly with B and D, but also with C through B, and E through D. There is no time-limit for channels, so these can stay open indefinitely – or until funds are to be released, upon which (one of) the nodes close(s) the channel.