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Blockchain Semantics Blog Payment Channel

Payment Channel

By Anurag Srivastava | April 16, 2018, 2:17 p.m. GMT

Payment channel is an important concept in the bitcoin world. The concept of payment channel allows users to transfer a cryptocurrency (say, bitcoin) instantly. Any bitcoin transfer usually takes at least one hour to realize. the blocktime of the bitcoin blockchain network is about 10 minutes and if you take 6 confirmations into account, the time taken for any transaction to be considered immutable is at least 60 (10*6) minutes. It is this lag time that payment channel intends to fix.

What is a payment channel?

Let's take an example. I have a friend named Carol and she buys milk from a specific mart daily. If she has to do this transaction today in bitcoin, it will be a nightmare, considering the time and expenses. What she does instead, is creates a payment channel between the mart and herself. This channel will then create a multisig address.

What is a multisig address?

A multisig address is slightly different from your regular bitcoin address. If you wish to send some BTCs, you need to sign the transaction with your private key. A multisig address needs to be authorized by multiple private keys. In a two-way multisig address, a transaction will be deemed valid by the miners only if that transaction is signed by the private keys, of both the parties involved.

...back to the payment channel

So, now that Carol has established a payment channel and created a multisig address, she is ready to transact with the mart. She sends 0.01 BTC to the multisig address and signs it with her private key. This transaction will also be signed by the mart with its own private key. The transaction is now considered valid. Mart and Carol realize that they transact daily. They, therefore, decide to keep the channel open for one month. In this one month period, Carol will keep on sending 0.01 Bitcoins to the mart in exchange of packets of milk.

A payment channel can be allotted a pre-decided validity period. The channel will close once the validity period is reached. In our example, the validity period is one month.

Both the parties are happy as the transaction is instantaneous. But, there is a catch. In a payment channel, the ledger is shared with the involved parties only. This transaction is happening outside of the blockchain network and is sent to the network only once the validity period is over or all the involved parties agree to send it there. The complete ledger is then submitted to the network and it goes through the regular process of mining and confirmations.

In a regular bitcoin system, Carol would have to make at least 30 distinct Blockchain transactions. That's quite a lot of transaction fees and wait time. With the help of a payment channel, this is reduced to just one blockchain transaction, which is both efficient and pocket-friendly.

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