A transaction that is processed outside the blockchain network with an increased speed and reduced cost.
There are two different transactions that occur on the blockchain:
On-chain transactions are those reflected on the distributed ledger and are visible to all the network users. On the other hand, off-chain transactions occur outside the blockchain network. Such a transaction doesn’t need the services of miners because no ledger verification is conducted.
Unlike on-chain transactions, off-chain transactions can be made instantly. This method entails lower fees, happens instantly, and offers more anonymity.
On-chain transactions are reflected on the distributed ledger by the blockchain network. It includes the verification of the ledger by miners to validate the transaction. Since it’s all happening on-chain, transaction details are recorded. The transaction is added to the distributed ledger and made visible on the entire blockchain. This makes it irreversible.
Considering various other transactions waiting for validation in the queue and a number of steps to be fulfilled, it is easy to understand why on-chain transactions take longer to occur successfully. On top of that, there are potentially high fees associated with on-chain transactions. These are the reasons many users would prefer off-chain transactions. However, many projects are working on increasing the speed and reducing the network fees on blockchain transactions to make them more efficient.
Off-chain transactions, on the other hand, occur almost instantly via a few different methods. Without having to wait for confirmations from the blockchain network, transactions are conducted faster. On-chain transactions require validators to validate the transactions and end up costing high fees. While off-chain transactions are usually free or low cost. These transactions aren’t visible on the blockchain, offering more privacy.
Off-chain transactions can occur between two parties by having a transfer agreement. A third party might work as a guarantor to ensure a successful transaction. Today, some payment processors also work along these lines.
Off-chain transactions happening outside a blockchain network can be carried out in different ways. One of the methods is to use payment chains like Bitcoin’s Lightning Network that conduct peer-to-peer transactions.
Another common off-chain transaction method is to swap private keys to an existing wallet. With this method, a new owner is assigned to a specific wallet. This doesn’t alter the blockchain network and is an instant way to perform the transaction.
Some decentralized exchanges (DEX) have adopted the role of an escrow to work as a guarantor between two individuals willing to do an off-chain transaction. P2P trading on Binance is a classic example where a platform is offered to users to exchange a wide range of crypto tokens and pay through a number of off-chain payment methods, including bank transfers, Payoneer, and PayPal.
Typically, off-chain transactions occur among trusted parties or individuals. Because of the time, cost, and privacy advantages, off-chain transactions are becoming popular. However, many crypto projects, like Solana, are working towards low-cost on-chain transactions with a high TPS.
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