Understanding the Lightning Network, Part 1: Building a Bidirectional Bitcoin Payment Channel
At least three companies – Poon and Dryja's Lightning, Blockstream and Blockchain – are currently working on implementations of the technology. But few outside this small technological frontline fully grasp how the “future of micropayments” is set to boost Bitcoin’s capabilities.
In this three-part series, Bitcoin Magazine lays out the basic building blocks of the Lightning Network, and shows how they fit together to realize this upcoming protocol layer.
This first part of the series establishes the necessary building blocks, and shows how these can be combined to create “smart contracts,” which can be applied to realize the first requirement of the Lightning Network: a bidirectional payment channel.
(Note: Anyone with a solid understanding of Bitcoin can skip the building blocks.)
Building Block #1: Unconfirmed Transactions
At its heart, the Bitcoin protocol consists of transactions, that are typically linked to previous transactions, and potentially to future transactions. Each transaction contains inputs, which refer to addresses bitcoins are sent from, and outputs, which refer to addresses bitcoins are sent to. Additionally, inputs must include the requirements to send the bitcoins, like signatures that prove “ownership” of the input-addresses. Outputs, meanwhile, establish the new requirements, that must be included in the input of a subsequent transaction.
As one of its key features, the Lightning Network is built up from more or less regular Bitcoin transactions. It's just that these transactions are typically not actually broadcast over the Bitcoin network. Instead, they are stored locally, on the nodes of users - but they can be broadcast over the network at any time.