I'm reading the lightning network whitepaper, and at some point it states this:
Therefore, it is possible in bitcoin to devise a bitcoin script whereby all old transactions are invalidated, and only the new transaction is valid.
I would like to know the specifics of how this can be done. Seems to me that what they are describing here is some kind of transaction overriding? It is somewhat different from the mechanism I understood a micro payment channel works.
Lightning payment channels are established by two parties Alice and Bob paying into a 2-of-2 multisignature address. Concurrently, they create two "exit-transactions", one for each participant which pay out the current allotment of the payment channel, txAliceExit_1 and txBobExit_1. These exit transactions lock the fund of the executing party for some blocks.
When a payment is performed between Alice and Bob, they update the balance, create two new "exit-transactions", txAliceExit_2 and txBobExit_2.
To invalidate the previous "exit-transactions" each party gives the counterparty another transaction that builds on the previous exit transaction by spending the party's output to the counterparty if the old "exit-transaction" were broadcast to the network, txAliceExit_1-TakeAll and txBobExit_1-TakeAll. I.e. if Bob executes txBobExit_1 the funds are time-locked for a little bit, meanwhile txAliceExit_1-TakeAll would become valid and Alice could take them before he can spend them.
OP_CHECKLOCKTIMEVERIFY. AFAIK it also requires the transaction malleability fix that will be introduced with SegWit. Currently, an attacker could use malleability to change a previous exit transaction, invalidating the follow-up TakeAll transaction.
A commitment transaction is a transaction that sends person A's bitcoins to person A, and person B's bitcoins to an intermediate address (let's call it B*). B* can be spent by person B, but only after the input to that transaction is 1000 blocks deep (ie after about a week). But person A can also spend from B* if person A obtains B's commitment secret.
So once new commitment transactions are created (which use fresh secrets and hashes), both parties exchange their old secrets allowing, for example, A to spend from B*. Since B* will only receive money if B posts an outdated commitment transaction, B* wouldn't have any money for A to spend. But if B does post an outdated commitment transaction, A has 1 week to notice and spend B*'s money for himself.
So the exchange of old secrets is what invalidates the old transaction. But some machine still has to watch the blockchain to ensure that action is taken if an outdated transaction is posted.
You can read more details here: https://governology.wordpress.com/2017/07/21/so-you-wanna-understand-bitcoin-part-2/
