Payment Channels, also called Micropayment Channels, are designed to allow users to make multiple Bitcoin transactions without committing all of transactions to the Bitcoin main chain. Therefore, it is made possible to do Bitcoin transactions at very high speed and very low cost.
Payment Channels are transactions on the Bitcoin network that lock funds into a 2-of-2 multi-signature address.
Payment channels are a trust-less mechanism for exchanging bitcoin transactions between two parties outside of the bitcoin blockchain. However, the Bitcoin blockchain can be seen as a court, transaction can be submit to the Bitcoin blockchain to prove which participant is doing evil.
Only two transactions are settle on the Bitcoin blockchain. the first transaction and the last. The first transaction is used to open the channel by locking the funds, and the last one to close channel and get each participant his final balance back. So in a typical payment channel, only two transactions are added to the block chain but an unlimited number of payments can be made between the participants.
In short, Payment Channels are mechanisms for under-burdening the blockchain, by moving a lot of transactions out of the Bitcoin blockchain and into private routed channels between users.
Let walk through how Payment Channels work.
If I have a channel with Alice and that channel has funds locked. That is I commit an amount of coin in the balance of the channel, say 1BTC, and Alice too 1BTC. We both commit those into a 2-of-2 multi-signature address. We both have to sign to release those funds.
Once we have this, what we can do is that we can sign transactions to changes the balance. So that we can sign a transaction whereby I reduce my balance to 0.9 and increase Alice’s balance to 1.1. We do that by simply updating the multi-signature address with new transactions that update the balance of the channel.
That’s a payment channel because we don’t transmit the transaction to anyone else, we just hold on to it. We can write a transaction to each other. This is a real bitcoin transaction, I say OK, I use to own 1 BTC in this channel, I am gonna to sign a transaction that Alice can cash in the future that actually gives her 1.1 BTC and return 0.9 to me from this multi-signature address. I am going to sign it and give it to Alice. Then Alice can sign it and cash it, and she gets the 1.1, or she can just hold on to it, and then wait. If I want to do another transaction, I can sign another transaction that reduces my balance to 0.8 and increase Alice’s to 1.2. Now Alice has a transaction has new balance, If she take the transaction and actually cash it. She will get 1.2 BTC, and I will get 0.8BTC.
But what if Alice want to pay me back, so Alice write a transaction that change the balance and send it to me. So the transactions go on and on between us, and we can make any many transactions as we want.
Lightning Network is based on the idea of Payment Channels.
Lighting Network is one of the scaling approaches to the Bitcoin blockchain. It’s a routed network of payment channels connected end-to-end, meaning any sender can route a payment from channel to channel until he reaches the receiver, therefore they don’t need to set up a channel themselves in the first place.
Lightning Network is not a side chain. It’s a overlay network, a layer 2 solution. It’s good to have a basic understanding of payment channels before you dig deeper into the Lightning Network.
Lightning Network and Payment Channels can also be used for alt-coins
So that is all about Payment Channels. They are transactions that two participants lock their funds in. Then the two participants and do any number of transactions between them without touching the Bitcoin blockchain, and thus the speed and low fee. Lighting Network is a network of nodes connected by Payment Channels.