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Liquidity Channels

The the total amount of money(Bitcoins) kept in the shared wallets upon creating a channel by the connecting Peers is called the Channel Capacity.

Lightning Network works by allowing the connecting Participants to create an instant Transactional/Payments channels on Bitcoin blockchain. This channel will continue to exist as long as the connected participants wants it. Because the lightning Transactions involves only two participants, the transaction fees applicable is neither very little or negligible.

In Lightning Network channels, all transactions takes place or goes outside of the blockchain.

In Lightning Network two Participant can peer-up and setup a channel on Lightning Network with a Multi-signature Wallets where they can fund their money(Bitcoin) and transactions can be performed by the Peers with the Bitcoin deposited in their share wallets.

The main transaction is done once the channel is closed, each of the participants gets his bitcoin balance as their bitcoin balance gets propagated to their respective bitcoin blockchain accounts.

Analyzing Scenario

Okay Lets assume that Romeo and Juliet wants to perform transactions using Lightning Network. They both setup a transaction Channels on the lightning Network. Both creates a Multi-signature(Multi-Sig) Wallets so that they can send funds(Bitcoin) to each other using their various/respective Wallets Privates Key.

The wallets in which the money is deposited thus becomes their Shared Wallets and the money its said to be locked up, an analysis suggesting that since the money is in channel, it cannot be used outside the channel. The Total Money deposited in the wallets thus becomes Channel Capacity and its owned by the both parties/Peers. From the fund deposited in the shared Wallets both Parties can now send fund to each other.

Remember that Lightning Network works by allowing the connected Peers to perform an unlimited amount of transaction outside the main blockchain and then record and propagates all these transactions as just one transactions.

So lets assume that both Parties (Romeo and Juliet) deposits 5 Bitcoin each. In the event that Romeo wants to send fund(Eg. 7 BTC) to Juliet, an authorization is required using their both respective privates keys to sign and update the balanced account.

The main Funds only gets allocated to each participant once the channel is closed by broadcasting only the Funding and closing Transactions to the blockchain. At the end of the transactions, Juliet will now have 7BTC and Romeo will have 3BTC in his blockchain account.

Finally, remember that the total amount of money(Bitcoins) kept in the shared wallets upon creating a channel by the connecting Peers is called the Channel Capacity and is said to be locked up and thus might create a scenario where some connected participant may choose liquidity either within(Inbound Liquidity) or outside(Outbound Liquidity) on the lightning Network.

Inbound Liquidity: the amount of funds(Eg, Bitcoin, Litecoin etc.) that Participant can recieve. Outbound Liquidity: the amount of funds(Bitcoin, Litecoin etc.) that Participant can to send.