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How the Lightning Network Works

Payment channels

  • trustless between peers

  • operation takes place off chain

  • throughput bound by TCP/IP traffic

  • have capacity which is split into a balance sheet

  • instant payments between peers

Multisig address

  • short review of bitcoin transactions

  • review of segwit multisig addresses

Funding Transaction

  • opens the payment channel

  • encodes the capacity of the channel

  • not clear who owns what fraction of the capacity

  • visible onchain transaction (even for private channels)

Commitment Transaction

  • encodes the balance of the payment channel

  • kept secretly between channel partners

  • everyone has their own set of transactions

  • encumbered with a time lock to give time to penalize protocol breach

  • smart contract inside which gives possability to penalize protocol breach

Announcing the channel

  • gossip protocol

  • option to have private channels

Closing the channel

  • the good way - mutal close

  • the bad way - force close

  • the ugly way - protocol breach

Invoices

An alternative structure for the subsections of the invoice section (while covering the same topics) could be: (creating, decoding, paying as 3 sub chapters)

  • creating invoices

  • decoding invoices

  • bech32 encoding and human readable part of invoices

Payment Hash

  • pre_image as proof of payment

  • random numbers and selecting the pre_image

Meta Data

  • Description

  • routing hints

  • fallback address

  • expire time

  • signature

Delivering the payment

  • gossip protocol

  • network of payment channels

  • different scope of the network

    • global path finding (entire knowledge of the network necessary)

    • multihop routing (onion necessary only a subset of nodes involved)

    • locally setting up and setteling htlcs (only peers involved)

Finding a path

  • trivial case / channel partner as destination with enough funds in the channel

  • topology information from the gossip protocol

  • fees and pathfinding from destination to source

Onion routing

  • construct an onion using

    • SPHINX

    • payment hash

    • path

Payment Forwarding Algorithm

  • receive an incoming HTLC

  • forward an HTLC

  • BOLT 02 channel update protocol

  • sending back errors

Comparison with Bitcoin

  • select outputs vs select payment channels / finding a path

  • change outputs vs no change on lightning

  • mining fees vs routing fees

  • public transactions on the blockchain vs. secret payments

  • waiting for confirmations vs instant settlement (if everything works smoothly)

  • arbitrary amounts vs capacity restrictions

  • variying fees depending on the traffic vs announced fees (might become dynamic too?)

  • blockchain to save all transactions vs blockchain as a court system