Payment channel

A payment channel is the basic building block of the Lightning NetworkGlossaryLightning NetworkA second layer on top of Bitcoin for fast, low-cost payments. Amounts move off the blockchain via payment channels; only opening and closing a channel ends up in a block as a normal transaction.On the learning path: Stage 1 · Step 3 – How does Bitcoin work? →In the glossary →×: a shared pot between two parties, whose split both of them sign again with every payment.

Open, pay, close

1. Open: Anna pays 500,000 sats ($400 at an example price of $80,000 per BTC) to an address that can only be spent with both her signature and Ben’s (2-of-2 multisigGlossaryMultisig (multi-signature)A wallet in which several keys jointly control the bitcoin – for example 2 of 3. If one key is lost or stolen, the bitcoin stays safe. In return, setting it up and backing it up is considerably more demanding.On the learning path: Stage 6 · Step 4 – Inheritance & emergency plan →In the glossary →×). This transaction goes on the blockchain.
2. Pay: for each payment, both simply sign a new channel state – in seconds and without a blockchain entry. After 20 coffees at 5,000 sats ($4) each, it stands at ‘Anna 400,000, Ben 100,000 sats’.
3. Close: the last state is written to the blockchain as a normal transaction. That way, 20 payments become two transactions.^[1]

Protection against cheating

With each new state, both hand over a secret that revokes the old one. If Anna still publishes an old state in which she had more, Ben can claim the entire channel balance.^[1] To give him time to do so, a relative timelockGlossaryTimelockA condition under which bitcoin may only be spent from a certain block height or point in time, or after a waiting period. Timelocks are a building block for Lightning and for inheritance and emergency setups.On the learning path: Stage 6 · Step 4 – Inheritance & emergency plan →In the glossary →× locks Anna’s share for a while.^[2] During that time, Ben’s wallet or a service he appoints (a ‘watchtower’) has to watch the blockchain.

Limitations

You can only send what is on your side of the channel, and only receive what is on the other side. Opening and closing cost normal network fees. How payments travel across several channels is explained in The Lightning Network.