WHAT IS STATE CHANNEL & BITCOIN LIGHTENING NETWORK:
A state channel is a general term and technique used in blockchain technology to enable off-chain transactions, which can reduce transaction costs and increase transaction speed. State channels are similar to payment channels used in the Lightning Network, but can also be used to enable more complex smart contracts that can be settled off-chain. In other words, state channels are a more general concept that can be used for a variety of off-chain transactions beyond just payments.
State channels are an alternative way to process transactions that allows participants to conduct off-chain transactions without the need for every transaction to be recorded on the blockchain. In a state channel, two or more parties can create a private channel where they can conduct multiple transactions without having to wait for each transaction to be recorded on the blockchain. The state of the channel is updated as transactions are made, and the final state of the channel is recorded on the blockchain when the channel is closed.
State channels can be used for other applications besides micropayments, such as voting, messaging, and other forms of off-chain communication that require repeated interactions between parties.
Scalability issues with Bitcoin Network:
As we understand that cryptocurrency is the future money but there are some limitations that requires solutions.
For instance, if we take example of Visa, visa has the capability to process 4000 transactions per second while bitcoin network can only process 5 to 7 transactions per second. In addition, To confirm single transaction on Bitcoin network depends on multiple factors, including the current network traffic, the transaction fee paid, and the size of the transaction in bytes. Generally, the higher the transaction fee paid, the faster the transaction will be confirmed. On average, a Bitcoin transaction can take around 10 minutes to be confirmed but it can take longer during periods of high network activity. In some cases, it can take several hours or longer for a transaction to be confirmed and settled.
Scalability issues include;
Blockchain size: The block size on the Bitcoin network is currently 1 megabyte (MB). However, it’s important to note that the actual size of a block can vary depending on the amount of data contained within it. The size of the Bitcoin blockchain continues to grow as more transactions are added to the network. This can make it more difficult and resource-intensive to run a full node, which can make it harder for individuals to participate .
Centralization of mining power: As the difficulty of mining Bitcoin increases, it becomes more difficult for individual miners to compete. This can lead to the centralization of mining power in the hands of a few large mining pools, which can be a threat to the security and decentralization of the network.
Energy consumption: As more miners join the network, the amount of energy required to secure the Bitcoin network also grows. This can lead to concerns about the environmental impact of the network, as well as concerns about the long-term sustainability.
Bitcoin Lightning Network:
The Lightning Network is a layer 2 solution and a type of state channel that uses payment channel and scripting or programming language to enable off-chain transactions between participants. Off chain means the transaction are not recorded on main blockchain It allows users to make near-instant and low-cost transactions without having to wait for confirmations on the Bitcoin network. Low cost transactions include the initial transaction that opens the payment channel and the final transaction that closes the channel need to be recorded on the blockchain, and these transactions will incur normal Bitcoin transaction fees.
Let’s take an example of Bitcoin Lightening Network;
Mike has to buy tea every morning from a tea shop. If he conduct this transaction on main blockchain , he might end up paying more transaction fee than price of tea. With the help of lightening network, mike can create separate payment channel with tea shop. Opening payment channel occur on main blockchain for complete transparency. Both participants will deposit certain amount in multi signature address or digital safe. Suppose, mike deposit 0.1BTC while tea shop deposit 0btc as he is goods and services provider. Suppose, one tea cost 0.001 btc so mike order the tea and reduce his balance from 0.1btc to 0.099 btc and add 0.001btc to teashop balance. Both participants will sign the latest balances with their digital signatures. Now mike can buy tea every morning. and every time balance sheet will be updated with the latest balances , without actually broadcasting those transactions to the Bitcoin network. The latest balance sheet will state that how the funds should be distributed upon closure of payment channel. When a state channel is closed, the final state of the channel is broadcast to the blockchain network to update the balances of the parties involved. This final state is a transaction that must be validated and confirmed by the network’s miners to be added to the blockchain ledger.
The miners validate the transaction by verifying its digital signature, checking that the funds being transferred are available, and confirming that the transaction meets the network’s consensus rules. Once the transaction is validated, it is added to a block and broadcast to the rest of the network for confirmation.
After the transaction is included in a block and confirmed by several subsequent blocks, the channel is considered officially closed, and the funds can be unlocked and used by the parties involved.
The advantage of using state channels is that they enable faster, cheaper, and more private transactions than conducting them directly on the Bitcoin network. However, they require a high degree of trust between the parties involved, as the funds held in the channel are controlled jointly by both parties.
Currently, the Lightning Network is the only state channel implementation that is widely used on the Bitcoin network. Whereas, there are other layer 2 solutions including sidechain, rootstock , drivechain and statechain.
How to setup payment channel:
Define the channel: Define the parameters of the payment channel, such as the parties involved, the amount of funds to be locked into the channel, and the type of transactions that can be conducted off-chain.
Fund the channel: Both parties may contribute an initial amount of cryptocurrency to the payment channel, which will be used to conduct off-chain transactions. These funds are locked into the channel and can only be unlocked when the channel is closed.
Conduct off-chain transactions: The parties can now conduct transactions off-chain, updating the state of the payment channel with each transaction. These transactions are not broadcast to the blockchain network until the channel is closed.
Close the channel: Once the parties are finished conducting off-chain transactions, they can close the payment channel by broadcasting the final state of the channel to the blockchain network. The final state will include the updated balance of each party, which will be settled on the blockchain.
Hello, this is Zohaib.
I'm a certified cryptocurrency expert and professional banker with over 17 years of experience in trade finance and corporate banking. With a passion for technology evangelism and a drive to help people understand complex digital products, I have dedicated myself to providing clear and concise explanations of emerging financial technologies such as cryptocurrencies, blockchain, and other innovative financial products. Through this platform, I seek to share my knowledge and insights with others, helping them to navigate the rapidly evolving landscape of digital finance.