My current understanding of the need for, and functioning of, LN

Limitations of the blockchain:

The Bitcoin (BTC) blockchain, also called "layer 1," is secure but relatively slow.  It can handle about 3 - 7 transactions per second.  By comparison, Visa and MC can handle thousands of transactions per second.  When BTCs layer 1 has many transactions pending, the costs to entice a miner to record your transaction can become expensive.  As I write this, I see that some transactions are costing $12, $17, or even more.  Others, though they might have lower fees, can take hours to process.

"You can't buy a cup of coffee with Bitcoin":

So, the two problems that keep people from buying a cup of coffee with BTC are:  (1) the fee could cost several times more than the purchase and (2) if the fee is lower, your transaction might not clear for tens of minutes or even an hour or more.  To save money, people aren't going to sit in the coffee shop for half an hour waiting on the cheaper transaction to record before the barista gives them their coffee.

So, the common complaint about BTC is that it is a store of value more than a currency to use day-to-day.  "Nobody is going to buy a coffee with Bitcoin" is a common saying.

A potential solution in layer 2, or the Lightning Network:

Lightning Network (LN) offers a solution to both of the numbered problems above.  (1), regarding fees, LN transactions are often fractions of a penny.  (2), regarding speed, LN transactions usually take only a few seconds.  I myself bought a Panda Express gift card using LN.  It was free (because I bought it through my own node) and took about one second between the time I authorized the payment from my phone and the time that the website registered that I had successfully paid for the gift card.

LN also seems to solve the problem with BTC's limited number of transactions per second by allowing this to scale up with the number of nodes and channels on the network.

How Lightning Network works:

At the most basic description, LN is a network or web of nodes and the channels between them.  If I have 1,000,000 sats (0.01 BTC) unused on my node, for example, I can make a channel of that size or two of half that size, and so on.  The creation of that channel is a transaction that must be recorded on the blockchain.  So, the fee and speed limitations are potential problems with only the opening of the channel.

Once the channel is in place, it can remain open indefinitely, processing transactions "off-chain" in its own layer, layer 2, the network of nodes and channels that make up LN.

A good way to a channel is as one row on an abacus.

In the image above, imagine that the abacus represents five channels (red, orange, yellow, green, and blue).  When your node opens a channel, all the beads are on your side of the channel; all the sats are yours.  The on-chain transaction basically tells the blockchain that such a row of beads exists between your node and the other node, the remote or inbound side.

A node ideally has many channels that have the potential to route inbound and outbound traffic.  If each bead above was 100,000 sats, the red and blue channels can route 700,000 sats of payments from your node to the other side.  After such a thing happened, all the beads would be on the remote side, ready to come back to you of a payment were routed from that remote node back to yours.

Similarly, the green channel could route 200,000 sats to your node or 800,000 sats from your node.

In such a manner, any one channel might route millions, tens of millions, or more sats over its lifetime.  Your node earns sats only on forwarding transactions (that is, sending them to the other node from yours).

If both nodes are happy with the channel, each may choose to never close it.

Once a channel is closed, the opener pays the on-chain fee for the blockchain to see the current state of the abacus/channel, record it on the chain, and distribute it to the two nodes.

If the yellow channel were closed, for example, your node would get 500,000 sats, and so would the remote node.  Whoever opened the channel would pay the on-chain fee from those 500,000 sats.

May write more later, but wanted to publish this for now.

Node Operational for One Week

Downloading the BTC blockchain to the node took about three days.  Last weekend, I was able to install and open the app Thunderhub to run my node.  The first step was to send BTC to the node's BTC wallet.  That is the source of BTC that is used to open channels.  The node also has a Lightning wallet address.

I used LightningNetwork.Plus to open most of my 22 current channels.  They have several services, but one is that two others and I form a "liquidity triangle."  A opens a channel to B.  B opens and channel to C, and C opens one back to A.  They are useful to quickly give my node two channels for the price of opening just one.  Also, one of the channels, the one opened to me, is fully funded on the inbound side to give me inbound liquidity.

As I was doing this, I also opened two channels to merchants that sell gift cards for BTC and other crypto.  The hope is that these channels will be "fee farms" as people use them to buy gift cards by routing Lightning payments through my node.

I've had two people open channels to me, unsolicited.  That may be a good sign that my node is showing up on searches as "good," that it is well-connected, or that its name and description are attractive to people.

Regarding channels, I'm finding that evenings in my time zone and weekends tend to have lower on-chain fees.  Because the only way to earn BTC is by a channel forwarding Satoshis, or Sats (*1), the lower the opening cost, the sooner the channel will be in the positive.

Another tactic here seems to focus on larger channels.  If it costs me 1,000 Sats to open a channel and that channel is only 50,000 Sats, it will have to do a lot of work back and forth before it pays for its opening cost.  If it costs the same to open a 5,000,000 channel, it can more quickly pay for itself via its fees.

Going forward, I'm going to set a target of 4 to 5 million Sats for channels I open.

For channels that are opened to me, since they are "free" from my point-of-view, I'll let them be any size.  Also, I might as well keep them open as long as the other person wants them to be open, for they'll only feed me liquidity and increase my routing capacity.

*1 = A Satoshi is 1/100,000,000th of a BTC or 0.00000001 BTC.

Hash Time-Lock Contracts (HTLCs)

Hash Time-Lock Contracts (HTLCs) seem to be the method by which the correct amount gets sent to the final recipient, the correct fees are taken at each hop/node, and that it is done within a certain time.  My understanding now is the following.  Assume node A wants to send to node D 10,000 Sats.  They don't have a direct connection, so it will go through nodes B and C.  If B's node will charge 5 Sats and C's node will charge 4 Sats, then A sends 10,009 Sats in an HTLC so that exactly 10,000 Sats will arrive to D after all the steps are completed.

Learning More about Lightning Network

One of the first podcasts I found was very helpful:  this episode of "We Study Billionaires."  The host speaks with Ryan Gentry, who is in business development at Lightning Labs.  So long as you know some of the qualities and rules of Bitcoin, you should be able to get good information from the episode.  It's over an hour long.

A quicker one that was still helpful was this episode of "Upgrade the World."  It is only 10 minutes long and also assumes that you know some basics about Bitcoin.

The third helpful podcast was this 1/2-hour episode of "Who Is Satoshi."

Some of what I learned...  VISA and Mastercard can process thousands of payments per second.  If Bitcoin is ever to be widely used to buy day-to-day things, like lunch, it ought to have that kind of capacity.  But, the Bitcoin network can only process about seven transactions per second.  A reason for this is the limited number of transactions that can be included in each 10-minute block.  In addition to that limited capacity, the cost of each transaction can be relatively high.  To pay for a $8 lunch with Bitcoin, you might incur a $3 fee.  Lastly, I learned that Bitcoin transactions can take many minutes to even hours to be confirmed.  You might pay for your lunch but have to wait at the restaurant for 1/2-hour for the transaction to clear before they'll let you leave the building!

The Bitcoin blockchain is "layer 1," and Lightning Network is "layer 2."  They are interconnected and communicate with each other, but Lightning Network allows for faster and cheaper transactions that can scale up far above seven transactions per second.

My understanding now is that many Lightning Network nodes connect to each other to form that network.  A channel is opened between two nodes and funded with some amount of Bitcoin.  This is a transaction that requires the blockchain, layer 1, and will incur an on-chain fee.  Once the channel is funded, though, it can take part in Lightning transactions that are faster and cheaper.  With only two nodes connected to each other and funded in both directions, they are the only two that can send Bitcoin.  However, the network is now thousands of nodes large.  Many sites have graphic representations of the network,  Here is one.  A screenshot of its state on 9/29/2023 is below.

The podcasts above have nice examples of how the network functions.  Briefly, if my wife and I each have a Lightning Network node, we can open a channel between the two nodes.  It is a payment channel that has an ongoing balance and an incoming balance, from the point-of-view of your node; my outgoing balance is my wife's incoming balance on that channel.

Generally, if I were the one to open the channel, it would only be funded on "my" outgoing side.  Bitcoin could only be sent from my node to hers.  However, once such a transaction occurred, she would have some funds on her side of the channel, her outgoing side and my incoming side.  At that point, transactions can go in either direction, provided there is enough Bitcoin to fulfill the transfer.

To be more specific, if I open the channel between our two nodes and choose to fund it with 1 million Satoshis (0.01 Bitcoins), that transaction will be recorded on the blockchain.  Then, I have 1,000,000 Sats that I can send to her node or through her node.

For that second part, if my wife has a channel to Jane, but I don't, I can send money to Jane through my wife's node.  The only requirements seem to be that some path can be made through the network and that each step has enough outgoing Bitcoin in the channel to complete the transaction.  If my channel to my wife has the 1 million Sats available outgoing, but her channel to Jane has only 50,000, I can only send 50,000 Sats to Jane.

At the start of that example, assume Jane's outgoing to my wife is 0 and my wife's outgoing to me is also 0.  No funds can come to me from Jane or my wife.  However, once I send the 50,000 Sats to Jane through my wife, they each have 50,000 Sats on their side of the channel.

(My 50k went to my wife but stayed in our channel.  They are on "her side" of the channel and now owned by her.  My wife's node then sent 50k to Jane through their channel.  Jane now can see and use the 50k Sats, for they are hers; they are on her side of their channel.)

With many nodes interconnected, the network can find paths for Sats to be sent from one person to another through as many channels as are needed.

Next, I think I'll post about funding and channel strategy.