The Lightning Network (LN) is a protocol designed to allow instant and cheap Bitcoin transactions. The Lightning Network is still experimental, but it shows promise for Bitcoin’s ability to scale. This protocol is built around bidirectional payment channels, which allow two parties to send money back and forth to one another. In addition, multiple channels can be strung together to route payments between parties who do not have a direct connection.
In order to open one of these bidirectional payment channels, two users send bitcoin to a joint-custody address by submitting an on-chain Bitcoin transaction. The bitcoin in this joint-custody address can be instantaneously rebalanced between the two parties for free without a Bitcoin transaction. For example, if Alice and Bob both contribute 0.5 BTC to a joint-custody address, the Lightning Network will show their balances as 0.5 BTC each. If Alice then wishes to send Bob 0.1 BTC, she updates the state of the joint-custody address. Bob now has 0.6 BTC while Alice has 0.4 BTC. This transaction is not sent to the Bitcoin blockchain yet, and the pair can continue to transact many more times, updating their respective balances as they go. Only when they wish to close the channel is one final transaction sent to the Bitcoin blockchain. This transaction represents the net change in the two users' balances.