What is payment channel?

A two-party arrangement in which a funding transaction is published on chain, then any number of balance updates are exchanged privately and only the final state is settled.

The Lightning Network is a network of such channels, specified in the open BOLT documents (source: the Lightning BOLT specifications). The idea generalizes: two parties who transact repeatedly do not need to pay a blockchain for every single payment, only for opening and closing the relationship.

The insight worth carrying is that a channel is not a payment method built on trust. Each update is a fully signed transaction either party could publish, which is what makes the arrangement enforceable without an intermediary.

How it works

1. Both parties fund a shared address with an on-chain transaction. That single transaction is the only cost until the channel closes.
2. To pay, they exchange newly signed versions of a settlement transaction reflecting the updated split. Nothing is broadcast.
3. Old states are invalidated by a revocation mechanism. If one party publishes a stale state that pays themselves more, the other can claim the entire channel balance during a dispute window.
4. Closing cooperatively publishes the final state as one on-chain transaction. Closing uncooperatively publishes the last state and waits out the dispute period.

Payments hop across channels using htlc locks, so you can pay someone you have no channel with. The route is found through the network, each hop is conditional on the next completing, and either the whole path settles or none of it does.

The trade-offs are real. Funds sit in an online wallet rather than in cold wallet storage. Capacity is limited by what is locked in the channel and by the liquidity available along the route, so a channel funded to send is not automatically able to receive. And an uncooperative close settles after a delay measured in blocks.

Several exchanges support Lightning withdrawals for small amounts, which is the most common way people encounter it.

Example

Illustrative arithmetic. Two parties open a channel with $500 each, one on-chain transaction. Over a month they exchange 400 payments back and forth.

On chain, that is 2 transactions: one to open and one to close. Directly on the base chain it would have been 400, each paying a network fee. At an illustrative $1.50 per transaction, the channel cost $3 against $600. The saving is why the design exists, and it only pays off for a relationship with many payments, since a single payment is cheaper sent directly.

Why it matters when you buy

Lightning withdrawals are often cheaper and faster than on-chain ones for small Bitcoin amounts, so it is worth checking whether your exchange offers the option. The limits are usually low and the destination must be a Lightning-capable wallet. Withdrawal routes and costs by venue are compared at the fee comparison, and the per-network measurements are on the chain rankings.

Related terms

• lightning network — the network these channels form
• htlc — the lock that makes routing work
• settlement — what closing a channel does
• on chain off chain — where channel updates sit
• cold wallet — the storage this is not
• network fee — the cost channels amortize

Questions

Is Lightning safe for large amounts?

It is designed for payments rather than storage. Channel funds are in an online wallet, capacity is limited, and defending a channel requires being online or delegating that to a watchtower service.

Why can I receive less than I can send?

Because capacity is directional. Your side of a channel holds what you can send, and the other side's balance is what you can receive. Receiving requires inbound liquidity, which is a separate thing to arrange.

Do all exchanges support Lightning withdrawals?

No. Support is growing but far from universal, and where it exists there are usually low per-transaction limits. The exchange's withdrawal screen lists the networks it offers.