Lightning Network

An ordinary Bitcoin payment waits for inclusion in a block and competes with others for limited space. Lightning takes another approach: participants first set up a payment channel and can then change the allocation of funds by exchanging signed information. Each completed payment therefore needs no separate block entry during normal cooperation. Bitcoin transactions remain the foundation for settlement. This additional layer neither removes Bitcoin’s rules nor issues a token of its own. [2] [1]

A channel is an arrangement between two participants backed by real bitcoin. Opening it creates a funding transaction on Bitcoin’s base network. Its output, a specific amount with spending conditions, underpins the channel. Participants hold prepared, signed commitment transactions that allow the funds to be divided when the channel closes. Balances change by reallocating claims to bitcoin already locked up, not by creating more bitcoin. [2]

With a self-custodial wallet, you need control of both the keys and the information required to manage channels. Some apps handle this directly; others use supporting services. With a custodial service, however, the operator controls the funds and channels, and your balance is its record of how much it will let you withdraw. The Lightning label and an amount on a screen do not distinguish these arrangements. What matters is who can sign, what you back up, and whose availability you depend on. [2]

When you pay your channel partner, you jointly sign a new allocation of the funds. In the usual channel design, older versions are revoked: trying to enforce a revoked state can cost the cheating party its funds. This is more than an informal change to a number in an app. If the partner stops cooperating, a prepared commitment transaction provides a route to closing unilaterally through Bitcoin. Protection still requires the right state information and a timely response. [3]

A simplified channel has 1 000 000 sat on your side and 0 sat on your partner’s. A satoshi, or sat, is the smallest BTC unit. After a direct payment of 200 000 sat, the allocation is 800 000 sat for you and 200 000 sat for your partner. The total stays the same, and this update itself needs no new block. The example leaves out fees and required reserves. It does not mean a real channel can send its entire displayed balance. [3]

You need not have a direct channel with the recipient. A payment can cross several connected channels, but every step needs funds available in the payment’s direction. This is directional liquidity: how much can actually be transferred that way. A large total channel capacity is no help if the money is on the wrong side. Reserves, limits on pending payments, forwarding fees and node availability also affect the outcome. [3]

Routed payments are linked by HTLCs, short for Hashed Timelock Contract. These are conditional claims: payment depends on revealing the same secret matching an agreed cryptographic fingerprint, and on time limits. That secret is called the preimage. Revealing it lets the recipient claim the final payment and intermediaries claim their incoming payments. Time limits get shorter towards the recipient, giving intermediaries time to respond. If the payment does not complete, the funds can be reclaimed under the relevant timeout conditions, though not necessarily immediately. [3]

A route may lack funds in the right direction, a node may be unavailable, or fees may exceed the selected limit. Channel information can also become outdated. The wallet may try another route or split the payment if it supports that. A failed attempt therefore does not automatically mean theft or disappearing bitcoin. Equally, normally fast payments are not a guarantee that every invoice succeeds immediately on the first attempt. [3]

You must protect the channel’s current state and monitor for a partner publishing a revoked version. A watchtower can help: it is a service that watches for such attempts and can respond in time. Its help does not replace every backup or the recovery procedure for your particular wallet. A Seed Phrase, the backup sequence of words used to recover keys, may not restore the necessary channel information by itself. Before using a setup, you therefore need to understand its backups, recovery and reliance on supporting services. [4] [5] [6]

Opening and closing a channel use Bitcoin transactions. A unilateral close can add waiting periods, fees and further transactions to resolve pending HTLCs. Funds in a pending payment can remain locked until the relevant conditions resolve it. Failure therefore promises neither an immediate nor a cost-free return, and a fast ordinary payment does not promise an equally fast on-chain withdrawal. Yet this ability to settle on Bitcoin is what backs channels under your own control. [4]