What Is A Lightning Channel

A Lightning channel is a direct payment connection between two parties, funded with Bitcoin and settled on the blockchain only at open and close.

Here’s the payment pipe analogy.

Imagine a physical pipe connecting two tanks. Alice’s tank has 1 Bitcoin on her side. Bob’s tank has 1 Bitcoin on his side. The pipe between them represents the channel — a total of 2 Bitcoin that can flow back and forth instantly.

When Alice pays Bob 0.1 Bitcoin, the water level shifts: Alice now has 0.9, Bob has 1.1. Nobody drills a new pipe. Nobody calls the bank. The balance just shifts, recorded in a shared private ledger between them.

When Alice pays Bob another 0.1 Bitcoin, the balance shifts again: 0.8 and 1.2. Each payment is instantaneous. Each payment costs almost nothing.

The only Bitcoin transactions that touch the blockchain are the ones that open the channel (funding it with the initial 2 Bitcoin) and close it (settling the final balances). Everything in between happens off-chain, at the speed of the internet.

A few things follow from this design.

Capacity matters. The channel can only route payments up to the total amount committed to it. A channel with 0.01 Bitcoin can’t route a 0.5 Bitcoin payment.

Liquidity direction matters. If Alice has sent most of her Bitcoin to Bob, she has less capacity to send more — and more capacity to receive. Managing this inbound and outbound liquidity is one of Lightning’s more nuanced practical challenges.

Most users never think about this. Wallet software handles it automatically. But understanding it clarifies why Lightning behaves the way it does.

Tomorrow: what is routing — how payments find their way across the network.

— The Daily Bit