Payment channels

A Micropayment Channel or Payment Channel is class of techniques designed to allow users to make multiple Bitcoin transactions without commiting all of the transactions to the Bitcoin block chain. In a typical payment channel, only two transactions are added to the block chain but an unlimited or nearly unlimted number of payments can be made between the participants.

Several channel designs have been proposed or implemented over the years. This article describes some of them. Many designs are vulnerable to transaction malleability.

Nakamoto high-frequency transactions

Implemented in Bitcoin 0.1 were features such as transaction replacement, input sequence numbers (nSequence), and nLockTime that would allow two or more parties to repeatedly update the state of an unconfirmed transaction prior to it becoming confirmed.

Satoshi Nakamoto described the technique to a Bitcoin developer in a personal email:

An unrecorded open transaction can keep being replaced until nLockTime. It may contain payments by multiple parties. Each input owner signs their input. For a new version to be written, each must sign a higher sequence number (see IsNewerThan). By signing, an input owner says "I agree to put my money in, if everyone puts their money in and the outputs are this." There are other options in SignatureHash such as SIGHASH_SINGLE which means "I agree, as long as this one output (i.e. mine) is what I want, I don't care what you do with the other outputs.". If that's written with a high nSequenceNumber, the party can bow out of the negotiation except for that one stipulation, or sign SIGHASH_NONE and bow out completely.

The parties could create a pre-agreed default option by creating a higher nSequenceNumber tx using OP_CHECKMULTISIG that requires a subset of parties to sign to complete the signature. The parties hold this tx in reserve and if need be, pass it around until it has enough signatures.

One use of nLockTime is high frequency trades between a set of parties. They can keep updating a tx by unanimous agreement. The party giving money would be the first to sign the next version. If one party stops agreeing to changes, then the last state will be recorded at nLockTime. If desired, a default transaction can be prepared after each version so n-1 parties can push an unresponsive party out. Intermediate transactions do not need to be broadcast. Only the final outcome gets recorded by the network. Just before nLockTime, the parties and a few witness nodes broadcast the highest sequence tx they saw.

This design was not secure:^{[citation needed]} one party could collude with a miner to commit a non-final version of the transaction, possibly stealing funds from the other party or parties.

Spillman-style payment channels

Discussed on the bitcoin-development mailing list and implemented in BitcoinJ, this one transaction to create a secured deposit and a second transaction to release the deposit funds in the manner agreed to by both parties, preventing miners from being able to commit a non-final version of the transaction. However, opening a channel in the Spillman model exposed the depositor to malleability risk where the counter party would be able to hold the depositor's funds hostage.

Spillman payment channels expire after a specific time, and both parties need to finalize the channel before the expiration.

CLTV-style payment channels

Were made possible in Decemember 2015 by the activation of the CLTV soft fork^{[citation needed]} after discussion that began in the #bitcoin-wizards IRC channel^{[citation needed]}, moved to the bitcoin-development and bitcoin-dev mailing lists, and included a design specification in BIP65. Channels constructed using the new OP_CLTV opcode were resistant to the malleability problem inherent in the Spillman-style construction.

CLTV-style payment channels expire after a specific time.

Poon-Dryja payment channels

Poon-Dryja payment channels were presented in the paper that also introduced the Lightning Network. Channel backing funds are locked into a 2-of-2 multisig, but before the funding transaction is even signed, commitment transactions for each party are first written and signed. As it requires referring to transactions that have not been signed yet, it requires using a transaction format that separates signatures from the part of the transaction that is hashed to generate the txid, such as Segregated Witness.

Poon-Dryja channels may be closed unilaterally (requires the participation of only one party) or bilaterally (requires the participation of both parties). When closed bilaterally Poon-Dryja channels are indistinguishable on-chain from 2-of-2 multisig address spends. When closed unilaterally, the funds of the party that closed the channel is temporarily timelocked; this allows the other party to dispute the state transmitted by the closing party (who might have given old state on closing).

Poon-Dryja payment channels have indefinite lifetime. The Lightning BOLT specifications include recommended implementation of Poon-Dryja payment channels.

Hashed Time-Locked Contracts (HTLCs)

Full article: Hashed Timelock Contracts

A technique that can allow payments to be securely routed across multiple payment channels.^{[citation needed]} For example, if Alice has a channel open to Bob and Bob has a channel open to Charlie, Alice can use a HTLC to pay Charlie through Bob without any risk of Bob stealing the payment in transit. HTLCs are integral to the design of more advanced payment channels such as those used by the Lightning Network.