What is the Difference Between On-Chain and Off-Chain Transactions?
If you have been in the crypto trading space for a while now, you might have heard of ‘on-chain’ and ‘off-chain’ transactions. However, what’s the difference between these two terms?
If you would, think of a blockchain as a kind of cloud storage platform. This cloud storage system is divided into two parts: private and public. On the one hand, material stored in a public cloud is accessible to everyone.
The data in the private cloud, however, is only accessible to a select few people. They both belong to the same primary cloud storage facility, though.
So now, we can compare on-chain transactions to the public cloud services, in the sense that anyone can see and use them. Meanwhile off-chain transactions are more comparable to private clouds, because anyone unauthorized can not access the data stored there.
Now, what are the various points of difference between on-chain and off-chain transactions? Let’s find out in this post!
On-Chain Transactions
As the name suggests, these are transactions that take place on top of a blockchain. They are stored within decentralized ledgers, so every participant on the blockchain can see them. So suppose for a chain like the Bitcoin blockchain, miners validate on-chain transactions and record them on the blockchain. The blockchain network is updated and distributed after the transactions are added to the ledger.
When the transaction volume on a particular blockchain is low, on-chain transactions can be pretty quick. However, these are still a few issues with on-chain transactions, based on the development of blockchain technology at the moment. Namely, transactions that take place on top of a blockchain need to be verified by a majority of the participants upon the network. Only then can miners begin to add these transactions to the blocks, which means the overall transaction period increases significantly for on-chain transactions.
For a blockchain network as big as Bitcoin, the chain can be quite congested with the amount of transactions waiting to be processed. This further means the transaction charges are quite a lot as well, making on-chain transactions inefficient as well as cost-ineffective.
Off-Chain Transactions
Off-chain transactions, as the name suggests, take place outside of a blockchain. The technique for off-chain transactions is similar to those used by online payment services like PayPal.
With an off-chain transaction, there is an intermediary acting as a guarantee. All participants get into an agreement outside of the blockchain, and once all the conditions are met, the trade occurs in the presence of the aforementioned third-party and is later recorded on top of the main blockchain.
Usually crypto layer-2 solutions are used for these off-chain transactions. Some well-known off-chain transaction providers would be the Lightning Network (for Bitcoin) and Polygon (for Ethereum).
Differences Between On-Chain and Off-Chain Transactions for Crypto
There are quite a few points of differences between the two. Let’s see what they are.
On-chain transactions are obviously processed on top of the blockchain network, and they are irreversible. Meanwhile, off-chain transactions are done without disrupting the goings-on of the main chain.
On-chain transactions take a lot longer than off-chain transactions. However, with off-chain transactions there is no need for validation from a majority of the network participants, therefore transactions are sped up by a lot. Plus, off-chain transactions charge a lot less in terms of transaction fees.
With on-chain transactions, the blockchain network they take place on ensures their security. However, with off-chain transactions, as they don’t get recorded on the blockchain in real-time, the security aspect is slightly lower than on-chain transactions.
This does also mean that when a participant wants to no longer participate in a transaction, if it’s an off-chain one, they can do so with a lot more ease than with an on-chain transaction.
Conclusion
Off-chain transactions merely move the value of assets off-chain to undertake crypto-related operations that are not directly recorded on the ledger, whereas on-chain transactions always refer to transactions that are explicitly recorded on the blockchain. Even while the presence of off-chain transactions in the crypto world may appear paradoxical, they have some cost advantages over on-chain transactions on congested networks, as we saw. This is why layer-2 solutions are growing in popularity with every passing day.
The debate on on-chain transactions vs. off-chain ones is long standing and it’s going to carry on without a very clear winner, as both have their own sets of pros and cons. Ultimately it falls upon you as a user to decide which one is preferable to you.
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Disclaimer: Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions.
