Authors: Dr. Jonas Gross, Jonathan Knoll, Denis Scheller
As explained in the first part of our article series, the Bitcoin Lightning Network enables low-cost, real-time payments. To conduct a payment it typically only requires the user to scan a QR code with a Lightning-supporting application. The payment is then executed and processed within a few seconds - similar to digital payments today. In this article, we provide a step-by-step guide on how to pay via the Lightning Network.
Setup the wallet
The first step requires you to download and set up a Lightning wallet on your smartphone or computer. Setting up a Lightning wallet is relatively intuitive and similar to setting up a self-hosted Bitcoin wallet, where you are in possession of your private key. In contrast, with hosted wallets, third parties such as crypto exchanges have access to your private key.
After downloading the Phoenix wallet in the app store press the "Create new wallet" button in the Phoenix app.
Immediately afterwards, the app is ready to receive funds. For this, you need to click on “receive”.
Please note that the first payment you receive is at least 10,000 satoshi (0.0001 BTC).
As the app provides a self-hosted wallet, you are responsible for securing and storing your seed phrase. If you click on the “recovery phrase” button in the Phoenix app, the seed phrase is shown. Please write it down and store it in a safe place. This seed phrase is necessary to generate private and public keys.
It is important to note that the Phoenix wallet is a self-hosted wallet. This means you are solely in possession of the seed phrase and the private key. For Lightning specifically, you also need to backup the state of your open channels to be able to recover your funds. Never share the seed phrase, the private key or the backup of your channels with anyone and always keep them inaccessible to third parties. To safeguard yourself from hacker attacks, it is crucial to store this information in a place that is not connected to the internet.
Deposit funds into the wallet
The next step is to deposit funds into the Lightning wallet. Therefore, you need to transfer bitcoins from your self-hosted Bitcoin wallet or your account at custodial service providers, such as Coinbase and Binance, to the Lightning wallet you have set up. All you have to do is enter the Lightning receive address via the Bitcoin wallet (for example via a QR code scan) and authorize the payment by signing with the private key.
For security reasons, you should wait for several confirmations of the Bitcoin blockchain (typically 6 confirmations which take approximately 60 minutes) to be sure of the final settlement of the deposit. If you don't have any bitcoins yet, some wallets like Bluewallet or Bison offer you the possibility to buy bitcoin directly via the app, e.g. by credit card or bank transfer. Another possibility is to “earn” them, e.g. by getting donations or value-4-value approaches. This allows you to easily enter the world of Lightning.
Open a payment channel and make a deposit
Next, you need to open a payment channel with your transaction partner. For example, if you want to pay for a coffee with Lightning, you can open a payment channel with the cafe where you want to buy your coffee. Payment channels are essential for Lightning to make fast and inexpensive Bitcoin payments. Instead of conducting all payments on-chain through the Bitcoin blockchain, payments are conducted bilaterally and off-chain via the corresponding payment channels and are not written to the blockchain. This can save transaction costs and reduce waiting times.
Within the opening process, money is deposited into the payment channel. This step is also referred to as a ‘funding transaction’. The deposited money is subsequently available for payments within the payment channel. The deposit transaction constitutes an on-chain transaction, which is why the receiver should wait again for several confirmations from the Bitcoin blockchain to ensure your payment is indeed settled and funds are not double spent.
Pay via Lightning
After the money is deposited, transactions can be made between each other within the payment channel. For example, a coffee can then be paid for via Lightning. For this to happen, the cafe requests a payment and issues a so-called Lightning Invoice. This can be in the form of a QR code, which is scanned via a wallet such as the Phoenix wallet mentioned above. Afterwards, the payment only needs to be confirmed in the app. The app then reports that the payment has been made successfully.
Setting up a Lightning wallet takes only a few minutes; initial deposits to the Lightning wallet and payment channel take about an hour each on average. Once liquidity is available in the wallet and payment channel, payments can be made via Lightning to each other and in real time. The main advantages of Lightning then fully emerge: fast payments at low transaction fees. This is especially important when you want to pay smaller amounts (e.g. for a cup of coffee). We will go into more detail on Bitcoin Lightning Network use cases in a later article.
In practice you do not need to open a Lightning channel with each of your favorite coffee shops. Instead of opening a new channel, the respective Lightning wallets route the money through the network of available channels to the desired destination. The routing is dependent on the channel capacity as well as the distribution of the liquidity. In order to ensure a high number of successful payments and a high network reliability, participants should not maximize for lowest routing fees. So called “selfish routing strategies” drain channel capacity and could ultimately result in a reduced number of payments, which can be processed by the lightning network.
After this simple step-by-step guide, you might be wondering how exactly Lightning works technically? Find out more in the next article in the series.
About the authors
Dr. Jonas Gross is Head of Digital Assets and Currencies at etonec GmbH. Jonas holds a Ph.D. in economics from the University of Bayreuth (Germany), and his main fields of interest are central bank digital currencies, stablecoins, cryptocurrencies, and monetary policy. Further, Jonas is Chairman of the Digital Euro Association (DEA), co-host of the German podcast "Bitcoin, Fiat, & Rock'n' Roll," and member of the Expert Panel of the European Blockchain Observatory and Forum. You can reach Jonas via email@example.com.
Jonathan Knoll is Founder and Managing Director at etonec GmbH. He has more than 25 years of experience in the payment & banking and blockchain industry working for innovative companies such as Sun Microsystems, PayPal/eBay, and Libra/Diem, where he was Head of Strategic Partnerships. At etonec, he is excited about building solutions at the intersection of crypto, payments & banking, and regulation. You can reach Jonathan via firstname.lastname@example.org.
Denis Scheller is Senior Manager Bitcoin Suisse Pay at Bitcoin Suisse. Denis holds a degree in International Business Administration from Cooperative State University Mannheim (Germany) and has worked many years in payments and e-commerce. At Bitcoin Suisse Pay, Denis helps building crypto payment infrastructure. He is interested in macroeconomics and how bitcoin and lightning technology can enable a fairer society. You can reach Denis via email@example.com.
The authors appreciate the great support and feedback from René Pickhardt. His insights and comments were essential to making this article a reality.
This article does not represent any financial advice, advertisement or similar.