If you’ve been keeping up with all things blockchain and cryptocurrency, you might have heard about new tokens that process off-chain transaction. What are off-chain transactions about and how is this new development important? As with most cryptocurrency developments, discussions on forums and news are often full of jargon and can be quite hard to grasp at first. Here, we’ll discuss the difference between on-chain and off-chain transactions, and why that matters in the world of cryptocurrency.
First, let’s start off with on-chain transactions
On-chain transactions are transactions on the public ledger. Bitcoin, the very first cryptocurrency, processes transactions in an on-chain public ledger so everyone on the network can see every transaction that has taken place.
Want to know more about public ledger and Bitcoin? Read this article.
Generally, we simply call on-chain transactions, “transactions” since that’s how transactions worked with the earlier cryptocurrencies. These transactions are validated by a number of individuals who use their computers to solve a complicated math problem every time a block transaction is added to the blockchain.
What are off-chain transactions?
Off-chain transactions occur on a cryptocurrency network outside of the blockchain. Unlike on-chain transactions, off-chain transactions can be carried out in a few ways.
Firstly, parties can agree to transfer and transact among themselves. Alternatively, transacting parties can bring in a third-party, who acts as a guarantor, to see that the transaction happens in an agreeable manner. Another method off-chain transactions can adopt is through a coupon-based payment system. An individual first purchases coupons with their own tokens. Next, they would give the code of these coupons to another individual who will then redeem the tokens. The tokens redeemed could be in the same cryptocurrency or in different cryptocurrencies, depending on the coupon service provider.
With rising interest in off-chain transactions, newer technology has been developed recently. For instance, Bitcoin’s Lightning Network has developed a Muti-signature technology to facilitate peer-to-peer transactions outside of its blockchain.
What’s the big deal with off-chain transactions?
One of the biggest problems with on-chain transactions is that it takes up lots of computer power. Additionally, on-chain transactions are not quick enough to be adopted by the masses. BTC, for instance, can only process 7 transactions each second — definitely not quick enough if it intends to become the mainstream means of transaction.
With off-chain transactions, there are multiple benefits which can be enjoyed. For one, off-chain transactions can be carried out more instantaneously as on-chain transactions are loaded with different transactions waiting to be validated.
Secondly, off-chain transactions are less costly. Taking transactions off-chain will not incur any fees for parties involved as no miners are required to authenticate transactions. What’s more, taking transactions off-chain can offer more anonymity since these transactions are not broadcast in the public ledger. While the blockchain’s public ledger can mask participants’ identity to some extent, transactions can still be traced (read more about privacy and anonymity here).
Some concerns regarding off-chain transactions
While off-chain transactions solves some of the biggest problems we have with on-chain transactions, there are also some shortcomings with taking transactions off the blockchain. Since all transactions are recorded on the blockchain, these transactions are irreversible. However, by taking these transactions off-chain, the same cannot be guaranteed.
Additionally, since off-chain solutions require a third party to help see through transactions, this goes against cryptocurrency’s original raison d’être which is to facilitate direct transactions and cutting away the middle man. Off-chain transaction, in some ways, opposes the purpose of adopting cryptocurrency as a mode of transaction and many would not understand why there’s a need to use cryptocurrency as a mode of payment if it functions just like PayPal or Google Wallet.
At the moment, there has been lots of hype on off-chain transactions in the crypto community. However, opinions on whether off-chain solutions really solve current problems in cryptocurrency are still highly debated and discussed.
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