Blockchain networks have been a revolutionary technology since their introduction in 2008. Blockchains offer transparency and efficiency in completing transactions and are some of the reasons behind their meteoric rise. Nowadays, companies store their blockchain data on an on-chain or off-chain storage system.
Let’s look at an analogy to understand the differences between on-chain vs. off-chain transactions. Let’s imagine a blockchain as a cloud storage facility. There are two sections to the storage facility: public and private. Data in the public cloud space is publicly accessible. These represent on-chain transactions. Data in the private cloud space is only accessible to a few. These represent off-chain transactions. But both are part of the same main cloud storage space.
This article will evaluate how these two mechanisms work. We will also look at the differences between on-chain and off-chain transactions. Finally, analyze if one transaction mechanism is better than the other.
What is On-chain transaction?
On-chain transactions occur on the blockchain. These transactions are stored on the decentralized ledger. They can be viewed by anyone with a copy of the ledger. The blockchain is updated every time an on-chain transaction is registered.
On-chain transactions are quick when transaction volume is low. New crypto assets and network protocols have been designed to improve the network’s transaction speed. These new protocols are becoming common.
Shortcomings of On-chain Transactions
In an ideal world, on-chain transactions should happen in real-time. But on-chain transactions need to be validated and verified by the participants of various networks. Next, miners must perform additional actions like adding the transaction to the blockchain, depending on the consensus mechanism. These actions add to the transaction times.
Blockchain networks like Bitcoin have become very popular. This popularity brings more requests for transactions on the blockchain network. This increase in transactions leads to further congestion in the network. A congested blockchain network is a costly and slow network. These areas are where off-chain transactions excel.
What is Off-chain transaction?
Transactions that take place outside the blockchain are called off-chain transactions. Off-chain transactions have a third party acting as a guarantee. The parties of the transaction work with each other outside the blockchain network. However, both parties of the transaction rely on a third party to complete the transaction. Off-chain transactions are completed and recorded on the blockchain once all criteria are satisfied.
Layer 2 solutions play a crucial role in these transactions. The Liquid network and the Lightning network are some of the most widely adopted off-chain solutions.
The lightning network is a cheap and fast layer two solutions. This network is built on the Bitcoin blockchain. This solution enables users to open a channel between two participants. Once this channel opens, a transaction can be conducted cheaply between these participants. At this stage, this transaction is not recorded or uploaded to the blockchain. The transaction is recorded on the Bitcoin blockchain once the channel is closed.
The difference between on-chain and off-chain transactions
On-chain transactions are processed on the blockchain network and are irreversible. On-chain transactions take more time to complete compared to off-chain transactions. On-chain transactions are highly secure since transactions are confirmed by participants of the network and published on the blockchain network.
The blockchain network is not affected by off-chain transactions. Hence, off-chain transactions do not need to be validated by anyone on the blockchain network. As a result, this speeds up the transaction process and lowers the transaction fees. Off-chain transactions can be completed instantly. These transactions have no lag time, unlike on-chain transactions. Off-chain transactions do not take place on the blockchain, and the costs associated with these transactions are minimal.
Off-chain transactions are not recorded on the blockchain network like on-chain transactions. If a participant in an off-chain transaction decides to no longer participate in the transaction, they can do so without leaving a record of the same. This feature helps in providing anonymity to users involved in off-chain transactions.
The winner of the on-chain vs. off-chain transactions debate depends entirely on your needs. On-chain transactions offer security and immutability in transactions. Off-chain transactions are suited for those looking for anonymous, cheap, and quick transaction mechanisms. So, remembering the cloud storage analogy from earlier, do you want your data to be stored on a public but secure cloud or a private but faster cloud? The choice is yours.