Excerpt
I explain what the Lightning Network is, how payment channels work, and what you need to know about managing them. I share why Lightning makes Bitcoin faster, cheaper, and more private, plus some of the risks and trade-offs compared to on-chain. Watch now!
Transcript
What is the Lightning Network? Talking about the lightning network, I also want to clarify that I always speak of payments in the context of Lightning and of transaction when value is sent on the Bitcoin blockchain. The Lightning Network is off-chain. It is a layer 2 technology that means its payments are being routed through a network of payment channels that are connected to the Bitcoin blockchain, which we call layer 1 or base layer, by opening and closing transactions that establish a channel between two Lightning nodes. So you can imagine having here layer 1, the base layer, the Bitcoin blockchain with its blocks, one block after the other, in which you have transactions. So, and on top of that, when you open a channel and you close it with another node, then you have a payment channel. And there are thousands of these payment channels that then create a network within itself that is secured by the Bitcoin blockchain. At the moment, in June 2025, there are about 12,000 public nodes and 42,000 public channels. There might be many more as channels and nodes can run privately too. The capacity of the lightning network at the moment is 4,100 Bitcoin. That means the value of 4,100 Bitcoin is now off-chain, held on the Lightning channels and nodes in the network and flowing through all these channels. So what is the main advantage of the Lightning network compared to Bitcoin? It allows micro-payments. It is fast, payments are instantly settled. It has much lower fees than on-chain transactions, especially when those are in high demand. It scales the Bitcoin network as it can, in theory, handle millions of transactions per second across the entire network and the entire world. Compared to only around 7 transactions per second on-chain. It also minimizes the electricity needs of Bitcoin as it shifts payments on to the second layer. It improves the privacy as Lightning payments are not being recorded on the public transparent blockchain. Only the channel opening and closing events are visible on the chain. While the actual payments, the routing of those, happens privately between nodes. It also allows the use of private channels, as I said before, which are hidden. But by now, the privacy of recipients is sadly not as good as it should and can be. But an upgrade to lightning called Bolt12 brings so-called blinded paths, which will reveal the recipient’s node to the sender. That means the privacy of the recipient will be highly increased. And as soon as this solution, as Bolt12, is being implemented by all nodes and all the wallets, the privacy on Lightning will be very, very, very high, compared to on-chain transactions and, of course, even more to the traditional banking system. Lightning also makes Bitcoin programmable money, as it enables sophisticated payment flows, like conditional payments, saying, if this happens, do that and pay this. You can create subscription services on lightning and automated recurring payments, which you can’t on Bitcoin on the blockchain. And also think of AI agents that can be paid for their work in real time in satoshis in very, very small amounts. It is also the foundation for eCash, a custodial solution facilitating the Lightning Network to create private payments that can even be done without being online. How do Lightning channels and nodes work? If you’re using a self-custodial lightning wallet like Phoenix, ZEUS, or an AlbyHub, for instance, you need to manage the channels with varying degrees of maintenance work. A channel can only be established if you open it by putting a certain amount of bitcoin into it. It’s crucial to understand that a channel and sats in there, or bitcoin inside of the channel, work similar to an hour class and sand. So, when you open a channel between two nodes and send 200,000 satoshis into it, you create a channel with 200,000 sats total capacity. And it will be fully filled on both sides, on the sending and the receiving end. Just like if you imagine the hourglass that is fully filled, both glasses are full. Nothing can get in, only out. That means you have to spend bitcoin from the newly created channel first to be able to receive Bitcoin. What you then have is usually indicated as spending and receiving or inbound liquidity in a channel that has a total capacity, in our case of 200,000 satoshis. This total capacity is important. So, what you sent in the first transaction to open the channel, that’s important because it limits the amount you can receive or send. So, let’s say you open the channel with 200,000 satoshis, then you spend 50,000 satoshis. That means your receiving capacity is only 50,000 satoshis because you spent them first and now you can fill the channel again. It’s not possible to send a higher amount than 50,000 through that channel. Phoenix Wallet has solved that issue already. It will automatically increase the channel capacity in this case for you. But not all wallets have implemented this feature yet. That means, if you’re using Alby for instance, you need to open a second channel, a bigger channel. And the automatic channel increase in the liquidity of Phoenix will of course cost some fees, as a new on-chain transaction is being done. And that can incur relatively high fees in times of high demand for Bitcoin transactions. Because as we said before, to open a channel, you open it with Bitcoin transaction. And if the fees are high on the layer 1, then that will reflect in layer 2 while opening a channel or closing it. So that’s why it’s important to open a channel at times when the on-chain fees are low and to put an amount into it that reflects the size of payments you want to be able to receive and send in the future. The advantage of a self-custodial channel and wallet with Phoenix, ZEUS, Alby or Voltage is that you can’t get rock pulled. Even if you subscribe to a hosted node with Alby or Voltage, for instance, you have the private keys. You have a seed phrase. And if the channel gets closed for any reason, the sats will be swapped out automatically onto a Bitcoin address. Lightning maintains important security properties because the Lightning network uses Bitcoin’s underlying security model as it is strictly connected to the blockchain. Also payments are cryptographically secured. Sats in a channel cannot be stole and you can always fall back and pay out your Bitcoin to the base chain to layer one by closing the channels. And also disputes are resolved on-chain. That also sounds very complicated, but it’s just important for you to know. When you run a hosted node on Alby, for instance, or if you use the Phoenix wallet, you don’t need to think about these kinds of things. Channel management is done by the software. You don’t have to do that. The only thing that happens here and there is that a channel gets closed and you need to open a new one. So the Lightning network also, with all technologies, has some vulnerabilities. For instance, routing failures. These happened very often in the early days of the Lightning network. I remember I had my first channel opening in January 2019 and back then many, many payments failed, but today as the network has matured, payments are highly reliable. Then you might have liquidity constraints. Payments can fail if there isn’t sufficient liquidity along the route between the different nodes to the destination node, which makes the Lightning network a little bit less reliable for larger transactions. It depends, of course, on what larger means for you. At Bitcoin for fairness, we have sent and received payments up to two million satoshis on the Lightning network without any issues. Then you have channel management risks. So in general, you need to monitor your channels actively because the Lightning network only works when everything is online. If your counterpart tries to cheat by broadcasting an old channel state, you have a limited time window to catch and penalize them. If you or your node basically is offline during this period, you could lose some funds. But as I said before, the software does all of that for you. It has happened that a channel of us on Albi was being closed. And then automatically, the sats are being sent out to our Bitcoin address where we hold the keys. The channel closings are also happening much less than in the early days. Lightning nodes have to be online to send and receive payments. That’s different to on-chain Bitcoin where you can receive if you’re offline. This makes a node a hot wallet, which is much less secure than cold storage options for on-chain Bitcoin or the liquid side chain. That means don’t store your lifetime savings on a Lightning node. It’s much more secure on-chain. Best using a hardware wallet for this. And of course, if you’re using a custodial wallet like Wallet of Satoshi, then you have full third-party risks. Wallet of Satoshi has announced to offer self-custody in the future, but no one knows yet how this feature is being implemented and how secure it is and how much self-custody it really is. So comparing on-chain Bitcoin and Lightning in terms of security. On-chain Bitcoin focuses on security and decentralization above all else. While Lightning sacrifices some of that certainty for instant and cheap payments. For small, frequent payments, many consider this trade-off worthwhile. But for large value transfers or long-term storage, on-chain remains superior. So the trade-off between Bitcoin on-chain and Lightning on layer two is essentially coming down to security and reliability versus speed and cost. So for me, I, as I said before with Bitcoin for fairness, we opened a two million sats channel for instance, but I would not send two million sats over Lightning to pay someone with it. Then I would use Bitcoin or the liquid side chain for that. But we have been using a lot of smaller payments with Lightning with up to about 500,000 satoshis.
