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How do layer-2 solutions like Lightning Network reduce congestion?  

Layer-2 solutions such as the Lightning Network reduce congestion on blockchains through several mechanisms.

  1. Off-Chain Transactions:
    • Payment channels: Through funding transactions, users establish channels on the main blockchain (Layer 1). The main blockchain is bypassed by subsequent transactions that occur off-chain. When the channel is closed only the final state of the channel is settled on the blockchain, reducing the amount of transactions on the chain.
  2. Network of Channels
    • Routing : Payments are routed via multiple interconnected channels. This allows transactions to be made between parties who do not have direct channels. This network effect allows for many off-chain transaction without adding additional load to the chain.
  3. Reduced Chain Load
    • Batch processing: By settling transactions off-chain (channel open/close), only the most critical transactions are used, freeing up space in blocks for other transactions.
  4. Instant settlements and Lower Fees
    • Micropayments Off-chain transactions allow for instant, low-fee micropayments. These are not possible on Layer 1 because of high fees. The small and frequent transactions are moved away from the main network.
  5. Smart Contracts for Security
    • Hashed Timelock contracts (HTLCs): These are used to ensure the integrity of transactions off-chain. On-chain dispute resolution is possible, using Layer 1 security. Most transactions do not need to be performed on-chain.
  6. Scalability:
    • Increased Throughput : By processing transactions outside the chain, the network can handle significantly more transactions per sec than Layer 1 alone. This reduces congestion.

Limitations:

  • Channel liquidity: The funds must be locked into channels which can limit the liquidity.
  • Online Requirements Participants are often required to be online in order to receive payment.
  • Routing complexity: Relying on well-connected Nodes for reliable routing.

The Lightning Network, as well as similar Layer-2 solutions, enhances scalability by offloading transaction from the main blockchain, using off-chain channels and smart contracts. They also maintain security via Layer 1 settlement.

Read : What are the ethical implications of anonymous blockchain transactions?