21 September 2022

What Happens When You Pay With Lightning?

Find out what happens when you pay with the Lightning Network — a new, faster payment processing system.

What Happens When You Pay With Lightning?


    The Journey from Your Credit Card to the Coffee Shop
    Lightning Network

It's a Monday morning. You stumble out of bed at 6:30 in the morning before hitting the gym. They say that getting up early in the morning is supposed to make you feel like a superhero, but you feel like whoever said that is lying. You race to a nearby coffee shop to get enough liquid caffeine to make even the most diehard coffee addicts nervous. You get to the front, pull out your credit card, and pay.

This process takes a few seconds, but what goes on behind the scenes might have you questioning why credit card companies are still in business. Credit card companies have entrenched themselves in the very fabric of our society, making themselves indispensable while charging fees every step of the way. The Lightning Network disrupts the whole lot—fee structures, technology stack, risk management—and provides an instant, decentralized alternative to credit card payments.

Before we get into what happens when you pay with Lightning, we have to take a look at what happens when you pay with a credit card.

The Journey from Your Credit Card to the Coffee Shop

Some might think that the journey is complete when your payment says "confirmed" at the payment terminal. But, in actuality, quite a bit happens behind the scenes to ensure that your payment is completed successfully. Let's look at the three main steps when you make a credit card payment. We say "main" because, within each stage, there are various other processes that occur to make the whole thing work.

Step 1 - Authorization

The journey's first stage is an authorization check, which occurs when you hand your credit card to the cashier at the coffee shop. Throughout the authorization process, the following occurs:

  1. You swipe or insert it into the payment terminal.
  2. Next, the payment information is sent via an encrypted connection to the credit card network.
  3. The credit card network forwards the payment information to the issuing bank (in this case, your bank).
  4. Your bank checks to see if you have enough available credit to cover the purchase. Assuming you have enough credit, your bank sends an authorization code back to the credit card network.
  5. The credit card network forwards the authorization code to the merchant's bank (in this case, the coffee shop's bank).
  6. The merchant's bank approves or denies the transaction. The credit card network requests payment from your bank if the transaction is approved.

It's like a giant game of ping-pong, isn't it? Six steps, just in the first step. Let's move on.

Step 2 - Authentication

The second stage is authentication: when your bank makes sure you are who you say you are. You guessed it—more steps. Here's what happens:

  1. Your bank checks to see if everything is kosher. What's the credit card number? The CVV number? Expiration date? Enough credit? All of these must match what's on file and must be checked out. Your bank sends an authentication code back to the credit card network if everything looks good. Your bank says, "Hey, this is John. He's a good guy. He can pay for this."
  2. The credit card network forwards the authentication code to the merchant's bank. The merchant's bank says, "Alright, we accept John's payment."
  3. Once the merchant receives that authorization, your bank has the go-ahead to place a hold on the funds. All payments in a day are usually grouped and processed at night (called a "batch), which is why your bank will place a hold on the funds until they finish processing.

Phew! Only one more step. We're almost there.

Step 3 - Settlement

The last stage is settlement, which is when the money actually changes hands. Here's how it works:

  1. At the end of the day, the merchant's bank sends all of the day's transactions to the credit card network. The credit card network charges all respective banks for all of the transactions in the batch. In our case, the credit card network would charge your bank for the amount of the coffee. But they also do it for Tommy, Georgia, Angel, and everyone else who used their credit card that day. All told, there are thousands of transactions in a batch.
  2. Once your bank pays the credit card network, they finally send the money to the merchant's bank. The merchant's bank then sends the money to the coffee shop. Sometimes, it can take a few days for the merchant's bank to receive the funds.

And what goes on throughout this process? Fees. Lots of fees. The merchant pays a fee to their bank. The credit card network collects a fee from the merchant's and your bank. It's fees everywhere.

Make sense? To us, it barely does. At every step, the credit card network is the middleman who facilitates the transfer of information (and money) between you, the merchant, and the banks. It's complicated and wildly inefficient.

Lightning Network is different. With Lightning Network, you can transact directly with the merchant—no middlemen required. No ping-pong.

How? We'll explain.

Lightning Network

The Lightning Network is a "second layer" solution that allows for near-instant, low-cost payments on top of the Bitcoin blockchain. It's essentially a network of nodes that can interact without broadcasting their transactions to the entire Bitcoin network.

Here's what happens when you make a payment with Lightning:

Step 1 - Connecting to a Lightning Network Node

The first thing you need to do is connect to a Lightning Network node. A node is just a computer that is running the Lightning Network software. You can connect to a node in one of two ways:

  1. You can run your own Lightning Network node. This requires you to have a certain amount of technical expertise and to put up some collateral in the form of Bitcoin.
  2. You can connect to a Lightning Network node that is being run by someone else. This is called a Lightning Network "hub." Lightning Network hubs are usually run by businesses or organizations looking to make it easy for people to use Lightning Network.

The Lightning Network hub that you connect to will likely have a user interface (and maybe one with a really great user interface, like NOAH), which will make it easy for you to interact with the Lightning Network and send/receive payments.

Most people that connect through a hub don't have to do anything (i.e., all you do is open the NOAH app, and you're connected).

Step 2 - Opening a Lightning Network "Channel"

The next thing you need to do is open a Lightning Network "channel." A channel is a two-way connection between you and another Lightning Network node. Again, unless you're running your node, most people won't have to lift a finger. The Lightning Network hubs they connect to will automatically open channels with other nodes on their behalf (e.g., NOAH would already have a channel open with ZEBEDEE, Wallet of Satoshi, or another providers.

When a channel is open, you and the other node in the channel can start sending Lightning Network payments back and forth. The great thing about Lightning Network channels is that they're very flexible—you can send as many or as few payments as you want and send them for any amount.

Step 3 - Making a Lightning Network Payment

Once you have a channel open, making a Lightning Network payment is easy.

Let's say you want to buy a coffee from your favorite café that accepts Lightning Network payments (all the cool cafés do). When you pay, the café will have you scan a QR code. Or, if they're extra cool, they'll give you their Lightning Address—say, baristabeans@noah.me.

When you scan the QR code or enter the Lightning Address, your Lightning Network node (e.g., NOAH) will find the best path to the café's Lightning Network node. Naturally, the best path is the one that has the fewest number of "hops" (i.e., the fewest number of nodes between you and the café) and the lowest total fees.

Your Lightning Network node will send a payment to the café's Lightning Network node. The process happens in a matter of seconds and for a fraction of a penny.

That's it. Literally. No ping-pong back and forth between payment providers, credit card networks, and banks. No end-of-day batch files, credit card holds, or other headaches that come with traditional payments. And best of all, none of those crazy fees.

Traditional payments are slow, expensive, and opaque, layered with intermediaries that take a cut out of every transaction. Lightning Network payments are fast, cheap, and transparent, with no intermediaries required.

Lightning Network is the future of payments, and it's here today. So next time you're at one of the cool cafés that accepts Lightning, get a taste of the future and give it a shot. You might be surprised at how easy and seamless it is.

Please be aware that: Cryptocurrencies are unregulated in the UK; Cryptocurrencies are not protected under Financial Ombudsman Service or Financial Services Compensation Scheme (FSCS); Profits may be subject to capital gains tax; The value of investments can go down as well as up.

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