The first sentence is correct. Lightning is a noun, in spite of its "ing" ending. So you wouldn't say "I saw the sky was lightning yesterday". You might even simplify the first sentence to "I saw lightning in the distance yesterday".

Well, there are many ways for a person to say it, like: ''I could see/saw flashes of lightning (across the sky) in the distance yesterday.'' ''The sky was shiny with lightning flashes yesterday.'' ''I saw the sky full of lightning flashes yesterday.'' ''I saw flashes of lightning striking across the sky yesterday.'' (or ''I saw flashes of lightning in the sky yesterday'') ''I saw the sky shining with lightning flashes yesterday.'' Hope that helps!!!

I saw lightning flashing in the distance yesterday

I should add to my answer that your second sentence is not correct as the word ''lightning'' is not an adjective - rather, it is a noun. So, you can not say that the sky was ''lightning''; you can say that it was shiny with (something), however.