How Do Payment Channels, like the Lightning Network, Circumvent the Need for Zero-Confirmation Security?
Payment channels, such as the Lightning Network (LN), circumvent the need for zero-confirmation security by using pre-signed, unbroadcasted Bitcoin transactions and a penalty mechanism. Funds are locked into a two-party channel, and all subsequent transactions within the channel are instant and trustless because they are secured by the ability to broadcast the most recent valid state to the main chain.
The penalty mechanism (Revocable Sequence Maturity Contract) ensures that any attempt to broadcast an old, invalid state results in the cheater losing their funds.
Glossar
Penalty Mechanism
Consequence ⎊ A penalty mechanism within cryptocurrency derivatives functions as a pre-defined deterrent against counterparty risk, particularly relevant in perpetual swaps and options contracts where mark-to-market processes are continuous.
Zero-Confirmation
Risk ⎊ Accepting a transaction before it is included in a confirmed block exposes the recipient to the immediate risk of transaction reversal via a chain reorganization.
Payment
Settlement ⎊ Payment within cryptocurrency, options trading, and financial derivatives represents the actual transfer of value, typically digital assets or fiat currency, to fulfill contractual obligations arising from a trade or contract execution.
Lightning Network
Scalability ⎊ The Lightning Network represents a layer-two scaling solution for Bitcoin and other blockchains, designed to facilitate micropayments and high-frequency transactions that are impractical on the base layer due to block size limitations and associated fees.
The Lightning Network
Architecture ⎊ The Lightning Network is a Layer 2 protocol built atop Bitcoin, employing bi-directional payment channels to facilitate high-speed, low-cost off-chain transactions.