Payment Channel

A payment channel is the general concept of two parties locking up Bitcoin in a shared on-chain output and exchanging signed balance updates between themselves, off-chain, without broadcasting each one. The chain sees two transactions total - one to open, one to close - while potentially thousands of transfers happen in between.

The mechanism solves Bitcoin's scaling tradeoff. On-chain, every payment costs block space, takes ~10 minutes on average to confirm, and pays a fee. Off-chain inside a channel, every payment is instant and costs nothing on-chain. What keeps both sides honest is that either one can take the latest signed state to the proof-of-work chain at any time: the chain is the court of last resort, not the venue for every payment.

The minimum building blocks for a payment channel:

1. A 2-of-2 multisig output locking both parties' funds, created by one on-chain funding transaction.
2. Commitment transactions - signed but unbroadcast transactions that each represent the current balance allocation. Each new transfer creates a new commitment that supersedes the previous one.
3. A revocation mechanism so that broadcasting an old commitment that favors you is punished: in Lightning, the cheated party can claim the channel's entire balance with a penalty transaction. Without this, parties could cheat by reverting to a state they liked better.
4. A timeout mechanism so that no party can be permanently held hostage if the other goes offline.

The Lightning implementation uses HTLCs for conditional payments and a fresh revocation key for every commitment, handed over once the next state is signed, to make this trustless. See Lightning Channel for the Lightning-flavored details.

Other payment-channel designs exist or have been proposed. Eltoo (also called LN-Symmetry), proposed in 2018 by Christian Decker, Rusty Russell and Olaoluwa Osuntokun, lets any later channel state replace any earlier one, so the penalty machinery is no longer needed; it depends on the SIGHASH_ANYPREVOUT signature mode of BIP-118, which is still a draft soft fork. As of 2026, the BOLT-specified Lightning channel is what's actually deployed at scale.

Payment channels are how Bitcoin scales without enlarging the base chain. The Lightning Network is the practical realization of this idea.