Off Chain vs On Chain

 

The difference between off-chain and on-chain transactions

Let us consider blockchain as a cloud storage having two different types of storage viz., private and public. In this analogy, public cloud can be compared to ‘on-chain’ – visible to all, whereas private cloud to ‘off-chain’ – data is not publicly accessible. Yet, both are part of one main cloud storage facility.

What are on-chain transactions?

These are the transactions that occur on the blockchain and are stored on the distributed ledger and are visible to anyone who has a copy of the ledger. Therefore, every time an on-chain transaction occurs, it leads to an update of the overall blockchain network. These transactions should happen in real-time which is time consuming. First, the transaction needs to be validated by the network participants. Then the miners must solve complicated algorithmic problems to bundle the validated transactions into blocks and add them to the blockchain ledger – which is very time consuming.

And as the popularity of Bitcoin/blockchain increases, the transaction volume increases, leading to the congestion of the network – simultaneously increasing the transaction fees. Thus, off-chain transaction was introduced to solve the issues.

What are off-chain transactions?

Off-chain transactions are processed outside the blockchain. They involve a third party that plays the role of a guarantor. The transacting parties enter an agreement outside the blockchain. However, a third party is involved to facilitate the execution of the agreement, by setting the terms and conditions of the agreement. The transaction is only then executed and recorded on the blockchain when all the terms are met.

The third party here is usually a layer-2 solution such as the ‘lightning network’ designed to carry out the transactions independently and therefore reduce the congestion of the mainchain.

In lightning network, the channel between two transacting parties is being created. Once the channel is established, the two parties can instantly send BTC to one another at a minimal cost. The transactions are not transmitted to the Bitcoin blockchain.

Once the parties conclude their transactions, the channel is closed. The final amounts are sent to the participating parties as per the transfer history recorded on the channel – which is only stored on the mainchain.

In the nutshell, off-chain transactions can be executed almost instantly, have lower fees, and offer privacy as its off the mainchain. On the other hand, on-chain transactions are not scalable, because layer-one solutions can only process “seven transactions per second.” Therefore, people prefer off-chain transactions for lower fees. Off-chain are also immediate.