Payment Channel

A payment channel is a layer two scaling system and a type of state channel designed to enable high volume, fast and low-cost payments outside of a layer one blockchain. A payment channel is established and funded through an on-chain transaction (on a layer one blockchain) between two or more parties that allows them to send off-chain transactions between one another and settle on the layer one blockchain when necessary. The on-chain transaction locks funds from all parties involved, and the product of the off-chain transactions collectively cannot exceed the locked funds. Due to the burden of establishing a channel, payment channels are more suited to parties that transact with each other frequently. Payment channels afford users some degree of privacy in their transactions: although the transactions that open and close the channel are visible on-chain, the individual payments within the channel are only visible to the two parties participating, thus, pinpointing the exact value or timing of economic activity is difficult, especially if that channel is open for an extended period.