On-Chain vs. Off-chain Transactions – The Main Differences

Beginner’s Guide / 05.05.2020

Blockchain technology is the underlying tech that introduced cryptocurrencies. The technology, yet so young, has immensely transformed the fintech industry, making it possible for persons to transfer value across the globe without any geographical or third-party limitations.

The technology enhances the transparency of transactions not only for the grantee but also for the beneficiary. While most people are familiar with the concept of Blockchain technology, few actually understand the two types of transactions necessitated on the blockchain, On-chain, and Off-chain transactions.

These two types of transactions have their own unique benefits as well as downsides and are mostly leveraged based on the appropriateness of the situations involved.

Here is an in-depth look at the two types of transactions on the blockchain network where you will get to know their differences, examples, and implications.

On-Chain Transactions

On-chain transactions, commonly referred to as blockchain transactions since the transactions reflected on the public ledger, visible to all participants on the blockchain network. It is the most common of the two transactions and usually requires an overall update of the blockchain network.

How Does On-Chain Transaction Work?

For an online transaction to be complete and considered valid, it has to reach a consensus by a defined number of participants (miners). The participants verify transactions, and the validations signatures from all participants need to be similar for that transaction to be considered valid. The different details regarding a transaction are recorded on the block and distributed to the entire blockchain making the transaction both unalterable and irreversible – it can only be reversed if the majority of the blockchain’s hashing power comes to a consensus to reverse the transaction.

On-Chain transactions take quite long compared to Off-chain transactions since they have to be validated by participants who use their computers to solve a complicated math problem every time a block transaction is added to the blockchain. On-chain transactions become completed and validated only when more than 51% of the network’s participants reach a consensus, and the ledger is fully updated.

The time taken for a transaction to be completed and validated is usually dependent on network congestion. Sometimes, there is a delay in transaction confirmation, especially when a large volume of transactions needs to be confirmed at a go. Nonetheless, you can still pay a higher transaction fee for your transaction to be completed faster.

For blockchain transactions to remain secure, verifiable, transparent, and instantaneous, on-chain transactions are supposed to occur in real-time. This is, however, never accomplished in reality as it takes some time for the transactions to gather the sufficient number of verifications and authentication from the miners to become complete and valid.

Advantages of On-Chain Transaction

  • On-chain transactions grant users immutability, security, and transparency in their transactions. All transactions are recorded on the blockchain and timestamped, sealed with hashes. The transactions are also synchronized in each node in the network. This makes it extremely difficult for the network to be hacked, and transaction details changed. Additionally, all transactions are verified and can be seen by all participants in the network.

Disadvantages of On-Chain Transaction

  • Speed-On-chain transactions may sometimes be slow, especially when the network is congested. Also, it takes time to accumulate enough confirmations to ensure that they cannot be reversed
  • Privacy/Anonymity-On-chain transactions can be traced directly to the source since all transactions are recorded publicly on the blockchain thus are not inherently anonymous. Addresses can easily be linked to identities by a third party; hence isn’t fully private. To remain anonymous, users may want to use Bitcoin mixers.
  • Cost/Scalability- The transaction charges on on-chain transactions are quite high. On-chain transactions also suffer from scalability issues; thus cannot handle higher transaction volumes.

Off-chain Transactions

As the name implies, off-chain transactions are conducted outside the blockchain using different methods/agreements. These agreements could include: two parties having a transfer agreement or existence of a third-party who guarantees that the transaction is complete and valid. Several modern payment processors such as PayPal employ such protocol.

Off-chain transactions can also involve the exchange of private keys by the parties involved. In this system, the crypto assets to be exchanged remains in the wallet/address but still is channeled to a new owner via change of ownership.

Unlike on-chain transactions, off-chain transactions occur instantly since ownership of digital assets is changed without altering the blockchain.

How does Off-chain Transaction Work?

As mentioned earlier, off-chain transactions can be executed using multiple methods which include:

  • Sidechains – Uses two-way pegging systems to move coins between the main chain and the sidechain
  • Payment chains – peer-to-peer transactions using multi-signature technology such as Bitcoin’s Lightning Network
  • Credit-based solutions – Record debits and credits between two trusted parties such as Ripple
  • Trusted Third Parties – Acts as a guarantor to record and guarantee the transaction. An example is Blockbasis

Advantages of off-chain transaction

  • Executed Instantly – Off-chain transactions are immediately executed as network participants do not take part in validating the transactions.
  • No Transaction Fees – Off-chain transactions usually don’t have a transaction fee since no miner or participant is required to validate the transaction to be rewarded. With no fees involved, they are perfect when transferring large sums of money.
  • More Secure and Anonymous – Off-chain transactions are not publicly recorded on the network, thus offers users a high level of security and anonymity. Users’ identities, therefore, cannot be linked to their addresses.

Off-chain Vs. On-chain Transactions

Off-chain and on-chain transactions are both suitable depending on the use case. In many ways, on-chain transactions are ideal for cryptocurrency transfers, while off-chain transactions are perfect for non-crypto related transactions. Off-chain transactions are a “private” form of blockchain, thus good for projects requiring a high level of privacy such as decentralized identifiers (DIDs) and personally identifiable information(PII).

Several crypto projects have combined some aspects of both on-chain and off-chain transactions to develop hybrid transactions—projects employing hybrid transactions such as Vertex. Market  (a P2P platform) requires instant transactions which are not costly and also needs to be decentralized for transparency.

Author’s Thoughts

Transactions on blockchain networks can either be on-chain or off-chain. On-chain transactions are executed on the blockchain and verified by a predetermined number of network participants, also called miners. Off-chain transactions are carried out between trusted two or more parties and usually occur outside the public blockchain but still on the blockchain. Off-chain transactions may seem to offer better perks compared to on-chain transactions, thus are preferred by most crypto projects. Nonetheless, depending on the projects’ use cases, both deliver their roles perfectly with both having cons and pros.

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Born in Bucharest, Marius is the founder of Crypto Adventure. Since his first contact with Bitcoin and cryptocurrencies, he never stopped believing that they are one of the most important innovations of our time, which will forever change the way business is done.